Portland Cancer Center

sheath 18 Leasing Decisions Background The Portland Cancer decoct is a not-for-profit inpatient and outpatient initiation dedicated to the prevention and give-and-take of backcer. Working to perfect noninvasive brain surgery techniques for the past ten eld, the Center is considering options to replace its original model of the Gamma dig. Radiosurgery is often referred to as the Gamma Knife. The Gamma Knife delivers 201 separate radiation sources to speak certain brain cancers without invasive surgery. For patients with deep lesions the Gamma Knife significantly reduces the pretend associate with handed-down surgical procedures.Other clinical benefits to the Gamma Knife include treating Parkinsons, trigeminal neuralgia, arteriovenous malformations, certain types of benign tumors and atomic malignant lesions. The Center allow for open a natural radiation therapy facility for several new radiosurgery procedures. Replacing the Gamma Knife at this point is viewed as a bridg e. This is because the Centers managers think that whether the equipment is purchased or charterd it will be used for no more than four eld before moving to the new facility.A fiscal decision on whether to buy the Gamma knife or remove it is most significant to this case. Facts * Expected physical life of the equipment is ten years * Possibility to write a cancellation article and per-procedure clause if operated * Possibility the Center will move to new facility sooner than expected * If equipment is to be purchased, revenue enhancement-exempt financing could be obtained * GB Financing lease signal * yearbook payments of $675,000 * Includes service contract so equipment will be maintained in good operative order (GBF will have to enter maintenece contract with manufacturer) GBF forecasts $1. 5 million residual value * If lease is not written, GBF could invest the funds in a four year term loan of standardized take a chance that yields 8% before taxes * The Centers risk is transferred back to lessor * Portland purchasing the Gamma Knife * Invoice price is $3 million, including delivery and installation * Maintenance contract for $100,000/year * Financed by a four-year simple interest conventional bank note at 8% * May claim tax deduction for portion of loan payment * Bears all the risk of equipment * Residual value is risky. 5% chance after four years will be $500,000 50% probability that it will be $1 million and 25% probability that it will be $2 million. * This risk adds a 5% risk adjustment to the base discount rate used on the other lease-analysis flows Analysis This decision is a complex one. Will it be better to use debt financing and purchase or make an enthronement decision to lease the piece of equipment? It is important to decipher is the lease can save money, eliminate the risk of technological obsolesce, and to share the mutual risk with the lessor.The dollar court analysis of the lessees address of owning and leasing can be seen in process 1. A 10% discount rate ( base on corporate cost of capital) was used to convert the cash flows to present values. The Lessees percentage cost analysis show the inherent cost rate (IRR) at 6%. This shows leasing is lower than the corporate cost of capital at 10%. Looking at the lease in terms of per procedure (Exhibit 2), the annual expected 100 procedures would cost the Center $25,000 more. Furthermore, if fewer procedures were performed the per-procedure lease would be favored.It could be useful to assess the clinics previous mickle patterns to determine the risk of this decision. Exhibit 3 shows the Lessors point of view to own the Gamma Knife. use an opportunity cost rate of 8% before taxes will yield 4. 8% after taxes. The 6. 2% after tax return exceeds the 4. 8% after tax return available on secondary investments of similar risk. This also confirms the NPV of the lease investment is expected to be better off by $99,368 if it writes the lease. Recommendations The f inancial advantage is for Portland Cancer Center to lease the Gamma Knife rather than purchase the equipment.The per procedure lease has a benefit to both parties, however reduces risk for the Center. It would only be advantageous is the volume of procedures was low, specifically below 100 procedures. Maintaining a state of the art healthcare facility is important and the lease will allow the Center to do so. The lessor is compensated for taking risk with tax deductions, however they will produce the risk with the technology. The NAL of $130,554 affirms that leasing creates more value than buying in this situation. The lessees IRR of 6% is well below the 10%, which also indicates a positive aspect to leasing versus buying.The terms of the lease should be carefully considered, especially the cancellation clause in the contract. This is important to address because of concerns with the new facility being ready before four years time. Significant costs could be associated with unutili zed equipment so GBF could consider adding a penalty to the cancellation clause. The decision is also weighed based upon the move to the new facility. If the Center moves early keeping the equipment and moving it to the new facility is always an option. The Center should also negotiate a lower yearly lease payment.The lease answers the clinics requirement of a short-term commitment with the least risk associated due to a new facility that is on the way. in that respect are also perks to a short- term lease agreement because this is not recorded on the lessees balance sheet. Exhibit 1 Lessees Analysis Cost of Owning twelvemonth 0 grade 1 Year 2 Year 3 Year 4 gain purchase price $3,000,000 Maintenance cost 100,000 $100,000 $100,000 $100,000 Maintenence tax savings 0 0 0 0 Depreciation tax savings 0 0 0 $0 Residual value 1,125,000 Residual value tax 0 displace cash flow $3,100,000 $100,000 $100,000 $100,000 $1,125, 000 PV cost of owning $2,223,685 Cost of Leasing learn payment $675,000 $675,000 $675,000 $675,000 Tax savings 0 0 0 0 give notice cash flow $675,000 $675,000 $675,000 $675,000 $0 PV cost leasing $2,354,239 Cost Comparison Net advantage to leasing (NAL)= $130,554 Lessees Percentage Cost Analysis Leasing-versus-owning CF $2,425,000 $575,000 $575,000 $575,000 $1,125,000 Lessees IRR= 6% Exhibit 2 Per-procedure Lease Per summons Lease Annual Lease Procedures Annual Annual Annual Annual Lease Net Annual Lease Net Annual moolah Payment Revenue Profit Payment Revenue Profit Difference 70 $490,000 $700,000 $210,000 $675,000 $700,000 $25,000 185,000 80 $560,000 $800,000 $240,000 $675,000 $800,000 $125,000 $115,000 90 $630,000 $900,000 $270,000 $675,000 $900,000 $225,000 $45,000 100 $700,000 $1,000,000 $300,000 $675,0 00 $1,000,000 $325,000 ($25,000) 110 $770,000 $1,100,000 $330,000 $675,000 $1,100,000 $425,000 ($95,000) 120 $840,000 $1,200,000 $360,000 $675,000 $1,200,000 $525,000 ($165,000) 130 $910,000 $1,300,000 $390,000 $675,000 $1,300,000 $625,000 ($235,000) GBF quoted per procedure lease rate of $7,000 *expected annual volume of 100 procedures *expected net revenue per procedure of $10,000 Exhibit 3 Lessors Analysis Cost of Owning Year 0 Year 1 Year 2 Year 3 Year 4 Equipment cost $3,000,000 Maintenance (100,000) ($100,000) ($100,000) ($100,000) Maint tax savings 40,000 40,000 40,000 40,000 Depreciation shield 240,000 384,000 228,000 $144,000 Lease payment 675,000 675,000 675,000 675,000 Tax on payment (270,000) (270,000) (270,000) (270,000) Residual value 1,500,000 Residual value tax (396,000) Net cash flow $2,655,000 $585,000 $729,000 $573,000 $1,248,000 NPV $99,368 IRR 6. 20%