Grant_Clinic

Grant Clinic, Inc: Equipment Purchase and Capital Budget James Pavetto, Jenn Roberts, Seapa Stovall FIN/HC571 January 28, 2012 Douglas McFadden Summary Dr. David Dunn is the head of the radiology department. Dr. Dunn has asked Team C to review his budgeting decision on the organizations capital purchases. Dr. Dunn has chosen two equipment pieces offered by two vendors, vendor A, and vendor B. Team C has decided to recommend vendor A. The selections were reviewed given the net purchase value method of calculation, 40% tax charge on the current value each year, initial cost, and expected savings to the organization. Team C calculated both pieces of equipment. The pieces included the net present value, internal rate of return (cost of capital), and payback method (University of Phoenix, 2011). Team C must decide which method to choose from. The net present value is the difference between what something is worth and what it costs (Emery, Finnerty, & Stowe, 2007). The internal rate of return is the project’s expected return, if the cost of capital equals the IRR, the NPV equals zero (Emery, Finnerty, & Stowe, 2007). Last, the payback method finds the length of time it takes to recover the initial investment, without regard to the time value of money (Emery, Finnerty, & Stowe, 2007). In reviewing the three methods, Team C will choose the net present value because the method measures the value the project will create, and assumes that the reinvestment rate will equal the cost of capital (Emery, Finnerty, & Stowe, 2007). The budget method with vendor A, has the purchase price of $120,000 with an estimated annual labor savings over the life of the equipment of five years is $40,000 with a net present value of $14,088. The purchase price for vendor B has a price of $110, 000 with an estimated annual labor savings over the life of equipment of $32,000, and the net present value of -$2729.6. Team C recommends that if the net present value is positive, the organization should use this as the organizations capital budget to begin the equipment project. Payback Method and Net Present Value The Grant Clinic equipment purchase and capital budget show interesting demographics from model A and Model B. As the clinic proceeded to choose between the two models the savings started to be the relative circumstances of what model to select. The preceding was Model “A” cost installation was $120.000 with a $40,000 estimated annual labor savings. Model “B” cost installation was $110,000 with an estimated annual labor saving of $32,000. The following illustration presented will use a chart format of the Payback Method: |Payback Method | | | | | | | | | | | | |Payback Period = |Initial Investment Cost | | |(in years) |Annual Operating Savings | | | | | | | | | |Model A | | | | | | | | | | | | | | |$120,000 |Initial Investment Cost | | | |$40,000 |Annual Operating Savings | | | |3 yrs. |Payback |Period | | | | |. | | | | | | | | | | | |Model B | | | | | | | | | | | | | | |$110,000 |Initial Investment Cost | | | |$32,000 |Annual Operating Savings | | | |3.44 yrs. |Payback |Period | | | | | | | | | The Payback method is a financial metrics that takes an investment view of action. It is a simple method that does not take any circumstances, but tells the individual what investment to pay for it self. The above table reveals that Model A is the model of installation Team C looked for with the prospect of purchase. Moving forward the clinic must exemplify the Net Present Value (NPV). The NPV is a diagram that produces the accounts for time value of money. The following illustrates demonstrates the reaction of the models preferred. | | | | | |Net present Value (NPV) | | | | | | |Model A | |Model B | | |PV at 15% of inflow |3.3522*40000 |3.3522*32000 | | | |134088 | |107270 | | |Less initial investment |-120000 | |-110000 | | |NPV | |14088 | |-2729.6 | | The NPV associated with model “A” is the validation of the diagnostic equipment for the Grant Clinic because Model “A” is a positive number and Model ”B” is a negative number. The purchasing advantage is the clinic needs to understand that using the Payback method, Net Present value will incorporate the correct decision. Internal Rate of Return Every organization has a different way that they format their budget. Each organization may use a different format when looking at revenue and expenses. The internal rate or return, IRR, or capital cost, “is the incoming and outgoing cash into account over the life of the equipment,” (Baker 137). Baker indicates that the IRR is, “the rate of interest that discounts future net inflows down to the amount invested,” (102). This method is similar to the breakeven point. The method shows the organization on how the organization has paid for the capital investment over a three-year period, and the profit made for the last two years at Grant Clinic, INC. |CAPITAL PROJECT BUDGET SUMMARY | | | | |GRANT CLINIC, INC. | | | | | | |Pro Forma | | | | | | | |Model A |Year 1 |Year 2 |Year 3 |Year 4 |Year 5 |  | |Equipment Purchase |120,000 | | | | | | |Labor Savings/year |40,000 |40,000.00 |40,000.00 |40,000.00 |40,000.00 | | |Cumulative | | | | | | | |Payback: |-120,000 |-80000 |-40,000 |40,000 |80,000 | | |Rate of return |6,000 |6,000 |6,000 |46,000 |46,000 | | |NPV |5,217.60 |4,536.60 |3,945 |26,302.80 |22,871.20 | | |IRR |0.8696 |0.7561 |0.6575 |0.5718 |0.4972 | | |Depreciation/year |40,000 |40,000 |40,000 |0 |0 | | | | | | | | | | |Model B |  |  |  |  |  |  | |Cost |110,000 | | | | | | |Labor savings/year |32,000.00 |32,000.00 |32,000.00 |32,000.00 |32,000.00 | | |Cumulative | | | | | | | |Payback: |-110,000 |-73,334 |-36,666 |36,666 |73,334 | | |Rate of return |5,500.00 |5,500.00 |5,500 |42,166.00 |42,168.00 | | |NPV |4,782.80 |4,158.55 |3,616.25 |24,110.50 |20,965.93 | | |IRR |0.8696 |0.7561 |0.6575 |0.5718 |0.4972 | | |Depreciation/year |36,666 |36,666 |36,668 |0 |0 | | Conclusion The organization wants to make an equipment purchase that does not incur a loss in the end. After reviewing the calculations to yield the best equipment purchase for Grant Clinic, Inc with an income tax rate of 40% over a five-year period on the cash flow of operations, Team C has decided that vendor A would provide Dr. Dunn with a capital budget with a higher net value at the end of five years. References Baker, J. J., & Baker, R. W. (2006). Health care finance: Basic tools for nonfinancial managers (2nd ed.). Sudbury, MA: Jones and Bartlett. Emery, D., Finnerty, J., & Stowe, J. (2007). Corporate Financial Management, Third Edition. Chapter 9: Business Investment Rules. Prentice Hall, Inc. A Pearson Education Company Grant Clinic, Inc (2011). Retrieved from University of Phoenix, Week Four, FIN/HC571-Health Care Finance course website. ----------------------- Running head: Grant Clinic, Inc: Equipment Purchase and Capital Budget 5