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An in-sourcing decision in the health care industry: should an orthopedic practice buy an MRI?: a case study.(Instructor's Note)

CASE DESCRIPTION

The primary subject matter of this case is a capital budgeting decision. Capital budgeting issues are appropriately discussed in accounting and/or finance disciplines, as well as healthcare management courses. The case and teaching note support the discussion and analysis of several secondary issues, in addition to the quantitative and qualitative factors incorporated in capital budgeting decisions. These issues include, but are not limited to, ethical issues, government policy practices, and sensitivity analysis. The quantitative analysis requires the student to demonstrate an understanding of the complexity that may be involved in determining relevant factors included in a capital budgeting decision, as contrasted with the simplicity of most textbook capital budgeting problems. The case is appropriate for use in junior level classes (level three) and above. There is a great deal of flexibility incorporated in the case, dependent on the instructor's desire to pursue, or not pursue, discussion of the secondary issues. This flexibility makes the case suitable for advanced analysis and discussions at higher course levels, up to and including first year graduate levels (level five). The number of class hours required to teach the case is dependent on the depth explored by the individual professor. However, class hours would be expected to range from one to two hours; preferably over two class meetings. Preparation hours required of the student are expected to average two to four hours.

CASE SYNOPSIS

This case considers the dilemma being confronted by an orthopedic physicians group. The practice is facing shrinking revenues driven by government plans to reduce Medicare reimbursements. In an effort to avoid salary cuts to physicians that appear imminent, members of the practice suggest raising rates to private payers. When this alternative is ruled out, it is decided that an expansion of ancillary services may provide a solution to the dilemma. The primary decision is whether to expand services by in-sourcing the Magnetic Resonance Imaging (MRI) diagnostic tool. Quantitative analysis of this decision requires the student to identify and determine the projected cash flows, associated with acquiring the MRI, over a twelve year period using net present value analysis. The realism of this decision problem is enhanced due to the fact that the physician's group serves several different classes of customers as well as using the MRI as a diagnostic tool for a variety of ailments/injuries. Each patient group and procedure results in a different reimbursement amount. This analysis is then expanded with two potential alternatives; a ten percent increase in prescribed MRIs or elimination of service to Medicare/Medicaid patients. Students should identify the quantitative impact of acquiring the MRI versus the status quo, as well as the ethical considerations associated with eliminating services to Medicare/Medicaid patients. This addition invites the discussion of business ethics from a stakeholder perspective.

INSTRUCTORS' NOTES

Recommendations for Teaching Approaches

In the following sections we propose questions to be used in conjunction with the case and offer solutions and suggestions for stimulating classroom discussion.

DISCUSSION QUESTIONS

1. Calculate the NPV of the project given the current patient mix of POGI and the proposed 800 MRI procedures per year.

2. Which of the following would have a more significant impact on the NPV of the project?

a) a ten percent increase in the number of MRI s performed?

The only variable cost associated with the increased number of procedures is the cost of film. The NPV increases by $330,610.

b) the elimination of Medicare and Medicaid patients while maintaining the 800 projected MRI procedures per year?

(Assume the 280 MRIs ordered for Medicare and Medicaid patients are replaced by Private Pay patients--75%, Worker's Comp patients--20%, and Uninsured patients--5%.) The NPV increases by $392,352; the 280 Medicare and Medicaid patients are distributed as follows: 210 to private pay, 56 to workers' comp, and 14 to uninsured.

3. Would the profitability of the investment be significantly impacted if there were a change in cost of capital for the physicians' group?

NPV of the project has been calculated under each scenario using a discount rate of 8%. The Internal Rate of Return (IRR) under each scenario is between 28% and 32%. It would appear that any reasonable discount rate would result in a positive NPV making the analysis insensitive to minor fluctuations in cost of capital. (See Tables 7, 7-A, and 7-B)

4. Will the opportunity to provide "one stop" services improve the quality of care for the patients?

If patients are relieved of the "hassle" of scheduling an MRI appointment at the hospital and having to travel to another facility to receive the diagnostic treatment, patient (customer) satisfaction should increase. Offering the imaging service "in house" could reduce the time usually required to schedule at another facility as well as relieve the patient from providing another medical history at the MRI facility. In addition, the "turn around time" in obtaining readings could be reduced. Each of these factors should enhance the quality of diagnostic treatment as well as the overall patient experience.

5. What do you think that the impact will be on hospitals that provide MRIs at significantly higher prices than that charged by POGI if they acquire a magnet? Is there any potential impact on the long-term quality of care for patients of these hospitals?

Magnetic Resonance Imaging is generally considered to be a profitable service. Hospitals that are burdened with significant overhead costs in addition to the responsibility to provide quality care to indigent patients will resent physicians' groups "pirating" this profitable service. Although hospitals may be unhappy with this situation they are not likely to be in a position to retaliate specifically against this physicians group or patients, thereof. However, if profitable offerings are diminished at the local hospital, the local hospital may have to rethink indigent care, staffing levels, and consider other "cuts" in services in order to remain financially viable. Decisions such as these could, in fact, have a long term impact on the quality of care provided by the affected hospitals.

6. What, if any, ethical issues do you see surrounding the potential acquisition of MRI capabilities by POGI?

One significant ethical issue looming is the potential to "over-prescribe". This may be kept "in check" from at least two different directions. One, private pay insurance company regulation may deter unnecessary MRI orders. Two, most doctors are, in fact, ethical and would not choose to intentionally prescribe unwarranted testing or procedures. A further ethical issue is the long term impact on quality of care provided by the local hospital, as referenced above.

Another ethical issue to consider is with respect to "dropping" Medicare/Medicaid patients from the patient mix. How difficult will it be for these patients to secure alternative care? Recent surveys regarding physicians providing care to the poor report mixed results. Modern Healthcare (Jan. 9, 2006) reports that, in spite of deep cuts in Medicare reimbursement that occurred four years ago and stagnant increases since, the physician in America are not closing doors to Medicare patients. About 73% in 2004-2205 accepted new Medicare patients, a two percentage point increase since the steep cut. The Associated Press reported on March 23, 2006, that the percentage of physicians who serve the poor has dropped to about 67%. As physicians leave solo practices to join large groups they lose control over patient mix and the larger the group the less likely that the poor (Medicaid patients) will be served. The report released by the Center for Studying Health System Change disclosed that only 62% of physician groups with more than 50 physicians accept Medicare patients.

A proposed cut in Medicare reimbursements of 10.1% was scheduled to be implemented in 2008. In light of proposed cuts, a more recent survey was conducted by the American Medical Association (AMA). They received responses from 2,216 members and nearly 56% of the respondents indicated they would stop accepting any new Medicare patients while 32.8% reported that they were unsure as to whether they could continue seeing their current Medicare patients (Champlin, 2006). A similar survey in Minnesota conducted by the Minnesota Medical Association reported that 53% of the physicians would reduce the number of Medicare patients they treat if a smaller (4.4%) Medicare reimbursement cut went through (Minnesota Medicine, 2007). In addition, the American Academy of Family Physicians reported that 30.5% of internists took no new Medicaid patients in 2005 (Finkelstein, 2006).

Congress passed a "stop gap" measure in December 2007, allowing payments to increase 0.5% and agreed to revisit the issue in June. This is the sixth year in a row that congress has acted to not implement cuts that are required by the sustained growth rate formula (Family Practice Management, 2008). On July 15, 2008, Congress voted to override President Bush's veto of another "stop gap" bill. The 10.1% cut in Medicare reimbursements has been delayed for 18 months with a 0.1% increase allowed for 2008 and 1.1% for 2009 (Cardiology Today). Physicians are subject to the formula-derived cuts but hospitals, insurance companies, and other entities are not, leading practitioners to believe they are being treated unfairly.

Nelson (2005) provides guidance to healthcare professionals when faced with difficult ethical decisions. His decision model is rooted in the concept of procedural justice and suggests the organization's mission and value statements may assist the organization when prioritizing and ranking the cost/benefit to stakeholders. The stakeholder theory advanced in business ethics would suggest that the rights, values, and interests of the individuals and groups affected by the decision must be considered (Mintz and Morris, 2008). In this case the predominant stakeholders are the physicians, the Medicare/Medicaid patients that may be "dropped", the local hospital, and the insurers. Asking students to address the potential issues from the perspectives of these stakeholders will likely result in a lively discussion about the complexity of decisions related to healthcare.

Capital budgeting decisions in the healthcare industry have more recently focused on investment in information systems, particularly in integrated networks (Morrissey, 1997). Morrissey contends that a healthcare facility manager's decision to invest in facilities or services previously focused on the issue of "impact on bottom line". Although profitability is still an important factor, a non economic question is typically included in the decision process; "How will this investment provide a continuum of quality care?" (Addressed in Question 3, above.)

Weiss (2005) offers a number of additional factors to be considered when making a decision to expand services. She suggests that, first, a real need should be identified. Second, a sound cost analysis is required. Hire a consultant to assist not only in identifying the expenses but also to provide input to a lease versus buy decision. (Note that in the quantitative analysis of cash flows, an interest expense is not calculated in determining before tax cash flows associated with the investment. The interest expense is related to the financing decision not the capital budgeting decision. Likewise, evaluating lease versus buy would be the financing decision, not acquisition decision.) Investigate any restrictions from private payer insurance groups; are their patients required to go elsewhere. Assess the additional risk that you are adding by offering the service. The manner in which the new service will be marketed must be considered. And, finally, consult a healthcare attorney prior to adding the service. The Stark II ban prohibits self-referral. (O'Sullivan, 2004.) Noncompliance with the law, particularly with respect to referrals of Medicare/Medicaid patients, whether intentional or not, can result in fines, denial of reimbursements, or both. There are exceptions to the "self-referral" ban and those exceptions are met in this case. The only factor not specifically addressed in the case is that, to meet the provisions of the "exception" requirements, physician compensation cannot be tied to the service, i.e., the number of referrals.

With increasing revenue compression, physicians' groups are seeking alternative means to combat shrinking revenues and increasing costs. This case explores the alternative of expanding ancillary services to include offering MRI diagnostic procedures "in house". The financial issues to be evaluated in this decision, as well as qualitative factors including ethical issues, are considered in this case analysis.

REFERENCES

Champlin, L. (2006, March). Academy Survey Results: FPs would trim new Medicare patients in response to pay cuts, AAFP News Now, 29.

Family Practice Management (2008, January). Congress delays potential cuts in Medicare pay for six months, News & Trends, Vol. 15, No. 1.

Finkelstein, J. B. (2006, August). Number of physicians taking new Medicaid patients continues to shrink, AAFP News Now, 24.

Freaking, Kevin (2006, March). Smaller percentages of doctors provide free care for poor, Associated Press, 23.

Internal Revenue Service (2008), "How to depreciate property," Publication 946.

Minnesota Medicine (2007, August). Physicians, seniors urge Congress to stop Medicare cut, MMA News.

Mintz, S. M. & R.E. Morris (2008). Ethical Obligations and Decision Making in Accounting, Boston, et al: McGraw-Hill Irwin, 56-57.

Morrissey, J. (1997). Getting beyond the bottom line: Integrated networks instead are focusing on info systems' contributions to the continuum of care. Modern Healthcare, 27(26), 112-115.

Nelson, W. A. (2005, Jul/Aug). An organizational ethics decision-making process, Healthcare Executive, 20(4), 8-15.

O'Sullivan, Jennifer (2004). Medicare: Physician self-referral ('Stark I and II')", CRS Report for Congress, July 27, CRS-13-14.

Raible, E. (2008). Practitioners influence Congressional fight about Medicare pay cuts, Cardiology Today, Retrieved from ttp://www.cardiologytoday.com/print.aspx?rid=31962

Romano, M. (2006). Docs don't shy from Medicare, Modern Healthcare, 36(2), 6.

Weiss, G. G. (2005). Adding ancillaries: Boosting the bottom line, Medical Economics, 82(21), 98-104.

Kevin Devine, Xavier University

Thomas Ealey, Alma College

Priscilla O'Clock, Xavier University
Table 3: Projected MRI Revenue by Procedure Type and Patient
Group (Percentages reflect the proportion of the 800 expected
MRIs per year for each procedure and patient type)

                      Spines   Knees   Hips   Shoulders   Wrist/arm

Procedure Mix          20%      30%    25%       5%          5%
Patient Mix
Medicare        25%    $850    $400    $750     $440        $325
Private Pay     40%   $1,084   $538    $918     $640        $452
Workers' Comp   20%   $1,020   $480    $900     $528        $390
Medicaid        10%    $550    $285    $475     $350        $225
Uninsured       5%     $434    $215    $367     $256        $181

                C-spine/head   Bi-lateral Knee

Procedure Mix       10%              5%
Patient Mix
Medicare            $700            $770
Private Pay        $1,116           $985
Workers' Comp       $840            $924
Medicaid            $225            $550
Uninsured           $446            $394

This table projects the revenue from the 800 expected MRIs by
type of MRI and by type of patient. For example, 20% of the
MRIs (160) will be of the spine. Of those 160 spine MRIs, 25%
(40) will be provided to Medicare patients. The projected
reimbursement for a spine MRI for a Medicare patient is $850.

Table 3A: Projected MRI Revenue by Procedure Type and Patient Group
(Percentages reflect the proportion of the 880 expected MRIs per
year for each procedure and patient type)

                      Spines   Knees   Hips   Shoulders   Wrist/arm

Procedure Mix          20%      30%    25%       5%          5%
Patient Mix
Medicare        25%    $850    $400    $750     $440        $325
Private Pay     40%   $1,084   $538    $918     $640        $452
Workers' Comp   20%   $1,020   $480    $900     $528        $390
Medicaid        10%    $550    $285    $475     $350        $225
Uninsured       5%     $434    $215    $367     $256        $181

                C-spine/head   Bi-lateral Knee

Procedure Mix       10%              5%
Patient Mix
Medicare            $700            $770
Private Pay        $1,116           $985
Workers' Comp       $840            $924
Medicaid            $225            $550
Uninsured           $446            $394

This table projects the revenue from the 880 expected MRIs by type
of MRI and by type of patient. For example, 20% of the MRIs (176)
will be of the spine. Of those 176 spine MRIs, 25% (44) will be
provided to Medicare patients. The projected reimbursement for a
spine MRI for a Medicare patient is $850.

TABLE 3-B
PROJECTED MRI REVENUE BY PROCEDURE TYPE AND PATIENT GROUP

(Percentages reflect the proportion of the 800 expected MRIs per
year for each procedure and patient type)

                800   SPINES   KNEES   HIPS   SHOULDERS   WRIST/ARM

PROCEDURE MIX          20%      30%    25%       5%          5%
PATIENT MIX
PRIVATE PAY     66%   $1,084   $538    $918     $640        $452
WORKERS' COMP   27%   $1,020   $480    $900     $528        $390
UNINSURED       7%     $434    $215    $367     $256        $181

                C-SPINE/HEAD   BI-LATERAL KNEE

PROCEDURE MIX       10%              5%
PATIENT MIX
PRIVATE PAY        $1,116           $985
WORKERS' COMP       $840            $924
UNINSURED           $446            $394

This table projects the revenue from the 800 expected MRIs by type
of MRI and by type of patient when Medicare and Medicaid patients
are eliminated from the mix. For example, 20% of the MRIs (160)
will be of the spine. Of those 160 spine MRIs , 66% (106) will be
provided to Private Pay patients. The projected reimbursement
for a spine MRI for a Private Pay patient is $1,084.

Table 4: Annual Revenue Generated by Procedure and by Patient Group

     Procedure         Number of Mris   Medicare   Private Pay

Spines                      160            40          64
Revenue                                 $34,000      $69,376
Knees                       240            60          96
Revenue                                 $24,000      $51,648
Hips                        200            50          80
Revenue                                 $37,500      $73,440
Shoulders                    40            10          16
Revenue                                  $4,400      $10,240
Wrist/arm                    40            10          16
Revenue                                  $3,250      $7,232
C-spine/head                 80            20          32
Revenue                                 $14,000      $35,712
Bi-lateral Knee              40            10          16
Revenue                                  $7,700      $15,760
Total Number of Mris        800           200          320
Total Revenue                           $124,850    $263,408

     Procedure         Workers' Comp   Medicaid   Unisured   Revenue

Spines                      32            16         8
Revenue                   $32,640       $8,800     $3,469    $148,285
Knees                       48            24         12
Revenue                   $23,040       $6,840     $2,582    $108,110
Hips                        40            20         10
Revenue                   $36,000       $9,500     $3,672    $160,112
Shoulders                    8            4          2
Revenue                   $4,224        $1,400      $512     $20,776
Wrist/arm                    8            4          2
Revenue                   $3,120         $900       $362     $14,864
C-spine/head                16            8          4
Revenue                   $13,440       $1,800     $1,786    $66,738
Bi-lateral Knee              8            4          2
Revenue                   $7,392        $2,200      $788     $33,840
Total Number of Mris        160           80         40
Total Revenue            $119,856      $31,440    $13,170    $552,724

This table develops the total annual revenue from each procedure
by patient type. The table is developed by multiplying the
reimbursement by patient type and procedure in Table 3 for the
number of MRIs for each procedure and patient type. For example,
the reimbursement rate for a Medicare patient that receives a spine
MRI is $850. Forty Medicare patients are projected to receive spine
MRIs. Therefore, projected revenue for this procedure and patient
type is $850*40 = $34,000

Table 4A: Revenue Generated by Procedure and by Patient Group (a)

     Procedure         Number of MRIs   Medicare   Private Pay

Spines                      176            44          70
Revenue                                 $37,400      $76,314
Knees                       264            66          106
Revenue                                 $26,400      $56,813
Hips                        220            55          88
Revenue                                 $41,250      $80,784
Shoulders                    44            11          18
Revenue                                  $4,840      $11,264
Wrist/arm                    44            11          18
Revenue                                  $3,575      $7,955
C-spine/head                 88            22          35
Revenue                                 $15,400      $39,283
Bi-lateral Knee              44            11          18
Revenue                                  $8,470      $17,336
Total Number of Mris        880           220          352
Total Revenue                           $137,335    $289,749

     Procedure         Workers' Comp   Medicaid   Uninsured   Revenue

Spines                      35            18          9
Revenue                   $35,904       $9,680     $3,816     $163,113
Knees                       53            26         13
Revenue                   $25,344       $7,524     $2,841     $118,921
Hips                        44            22         11
Revenue                   $39,600      $10,450     $4,039     $176,123
Shoulders                    9            4           2
Revenue                   $4,646        $1,540      $563      $22,854
Wrist/arm                    9            4           2
Revenue                   $3,432         $990       $398      $16,350
C-spine/head                18            9           4
Revenue                   $14,784       $1,980     $1,964     $73,411
Bi-lateral Knee              9            4           2
Revenue                   $8,131        $2,420      $867      $37,224
Total Number of Mris        176           88         44
Total Revenue            $131,842      $34,584     $14,487    $607,997

(a) Some revenue amounts are rounded due to truncating.

This table develops the total annual revenue from each procedure by
patient type. The table is developed by multiplying the reimbursement
by patient type and procedure in Table 3-A for the number of MRIs
for each procedure and patient type. For example, the reimbursement
rate for a Medicare patient that receives a spine MRI is $850.
Forty four Medicare patients are projected to receive spine MRIs.
Therefore projected revenue for this procedure and patient type
is $850*44 = $37,400

TABLE 4-B
REVENUE GENERATED BY PROCEDURE AND BY PATIENT GROUP (a)

PROCEDURE              NUMBER OF MRIs   PRIVATE PAY   WORKERS' COMP

SPINES                      160             106            43
REVENUE                                  $114,904        $44,064
KNEES                       240             159            65
REVENUE                                   $85,542        $31,104
HIPS                        200             133            54
REVENUE                                  $121,635        $48,600
SHOULDERS                    40             27             11
REVENUE                                   $16,960        $5,702
WRIST/ARM                    40             27             11
REVENUE                                   $11,978        $4,212
C-SPINE/HEAD                 80             53             22
REVENUE                                   $59,148        $18,144
BI-LATERAL KNEE              40             27             11
REVENUE                                   $26,103        $9,979
TOTAL NUMBER OF MRIs        800             530            216
TOTAL REVENUE                            $436,270       $161,806

PROCEDURE              UNINSURED   REVENUE

SPINES                    11
REVENUE                 $4,683     $163,651
KNEES                     16
REVENUE                 $3,486     $120,132
HIPS                      14
REVENUE                 $4,957     $175,192
SHOULDERS                  3
REVENUE                  $691      $23,354
WRIST/ARM                  3
REVENUE                  $488      $16,678
C-SPINE/HEAD               5
REVENUE                 $2,411     $79,703
BI-LATERAL KNEE            3
REVENUE                 $1,064     $37,146
TOTAL NUMBER OF MRIs      54
TOTAL REVENUE           $17,780    $615,855

(a) Some revenue amounts are rounded due to truncating.

This table develops the total annual revenue from each procedure
by patient type. The table is developed by multiplying the
reimbursement by patient type and procedure in Table 3 for the
number of MRIs for each procedure and patient type. For example,
the reimbursement rate for a Private Pay patient that receives
a spine MRI is $1,084. One hundred and six Private Pay patients
are projected to receive spine MRIs. Therefore projected revenue
for this procedure and patient type is $1,084*106 = $114,904

Table 5: Projected Cash Expenses

Incremental      Year 1     Year 2     Year 3     Year 4     Year 5
Expenses

Tech (full       $37,440    $38,938    $40,495    $42,115    $43,800
time) wages

Tech (full        10,109     10,513     10,934     11,371     11,826
time) tax and
fringe

Malpractice       25,000     26,250     27,563     28,941     30,388

Film              24,000     24,480     24,970     25,469     25,978

Maintenance                  16,000     16,000     16,000     16,000
contract /
warranty

Property           8,000      8,160      8,323      8,490      8,659
Insurance

Training and       2,500      2,600      2,704      2,812      2,925
Cert
(average)

Total Incre-    $107,049   $126,941   $130,988   $135,197   $139,576
mental Cash
Expenses

Incremental      Year 6     Year 7     Year 8     Year 9     Year 10
Expenses

Tech (full       $45,551    $47,374    $49,268    $51,239    $53,289
time) wages

Tech (full        12,299     12,791     13,302     13,835     14,388
time) tax and
fringe

Malpractice       31,907     33,502     35,178     36,936     38,783

Film              26,498     27,028     27,568     28,120     28,682

Maintenance       20,000     20,000     20,000     20,000     20,000
contract /
warranty

Property           8,833      9,009      9,189      9,373      9,561
Insurance

Training and       3,042      3,163      3,290      3,421      3,558
Cert
(average)

Total Incre-    $148,130   $152,867   $157,796   $162,925   $168,261
mental Cash
Expenses

Incremental      Year 11    Year 12
Expenses

Tech (full       $55,420    $57,637
time) wages

Tech (full        14,963     15,562
time) tax and
fringe

Malpractice       40,722     42,758

Film              29,256     29,841

Maintenance       25,000     25,000
contract /
warranty

Property           9,752      9,947
Insurance

Training and       3,701      3,849
Cert
(average)

Total Incre-    $178,815   $184,594
mental Cash
Expenses

This table presents the annual operating expenses associated
with the acquisition of an MRI. The expenses are determined
from the information provided in Table 2 of the case.

Table 5A: Projected Cash Expenses

Incremental Expenses    Year 1    Year 2    Year 3    Year 4

Tech (full time)         37440     38938     40495     42115
wages

Tech (full time) tax     10109     10513     10934     11371
and fringe

Mal-practice             25000     26250     27563     28941

Film                     26400     26928     27467     28016

Maintenance                        16000     16000     16000
contract / warranty

Property Insurance        8000      8160      8323      8490

Training and Cert         2500      2600      2704      2812
(average)

Total Incremental      109,449   129,389   133,485   137,744
Cash Expenses

Incremental Expenses    Year 5    Year 6    Year 7    Year 8

Tech (full time)         43800     45551     47374     49268
wages

Tech (full time) tax     11826     12299     12791     13302
and fringe

Mal-practice             30388     31907     33502     35178

Film                     28576     29148     29731     30325

Maintenance              16000     20000     20000     20000
contract / warranty

Property Insurance        8659      8833      9009      9189

Training and Cert         2925      3042      3163      3290
(average)

Total Incremental      142,173   150,779   155,570   160,553
Cash Expenses

Incremental Expenses    Year 9   Year 10   Year 11   Year 12

Tech (full time)         51239     53289     55420     57637
wages

Tech (full time) tax     13835     14388     14963     15562
and fringe

Mal-practice             36936     38783     40722     42758

Film                     30932     31550     32181     32825

Maintenance              20000     20000     25000     25000
contract / warranty

Property Insurance        9373      9561      9752      9947

Training and Cert         3421      3558      3701      3849
(average)

Total Incremental      165,737   171,129   181,740   187,578
Cash Expenses

This table provides the annual operating expenses associated
with the acquisition of an MRI. The expenses are determined
from the information provided in Table 2 of the case and
applied to the patient/procedure mix in Table 4-A.

TABLE 5-B
PROJECTED CASH EXPENSES

Incremental             Year 1     Year 2     Year 3     Year 4
Expenses

Tech (full time)       $37,440    $38,938    $40,495    $42,115
wages

Tech (full time) tax    10,109     10,513     10,934     11,371
and Fringe benefits

Malpractice             25,000     26,250     27,563     28,941

Film                    24,000     24,480     24,970     25,469
Maintenance                        16,000     16,000     16,000
contract/Warranty

Property Insurance      8,000      8,160      8,323      8,490

Training and Cert       2,500      2,600      2,704      2,812
(average)

Total Incremental      $107,049   $126,941   $130,988   $135,197
Cash Expenses

Incremental             Year 5     Year 6     Year 7     Year 8
Expenses

Tech (full time)       $43,800    $45,551    $47,374    $49,268
wages

Tech (full time) tax    11,826     12,299     12,791     13,302
and Fringe benefits

Malpractice             30,388     31,907     33,502     35,178

Film                    25,978     26,498     27,028     27,568
Maintenance             16,000     20,000     20,000     20,000
contract/Warranty

Property Insurance      8,659      8,833      9,009      9,189

Training and Cert       2,925      3,042      3,163      3,290
(average)

Total Incremental      $139,576   $148,130   $152,867   $157,796
Cash Expenses

Incremental             Year 9    Year 10    Year 11    Year 12
Expenses

Tech (full time)       $51,239    $53,289    $55,420    $57,637
wages

Tech (full time) tax    13,835     14,388     14,963     15,562
and Fringe benefits

Malpractice             36,936     38,783     40,722     42,758

Film                    28,120     28,682     29,256     29,841
Maintenance             20,000     20,000     25,000     25,000
contract/Warranty

Property Insurance      9,373      9,561      9,752      9,947

Training and Cert       3,421      3,558      3,701      3,849
(average)

Total Incremental      $162,925   $168,261   $178,815   $184,594
Cash Expenses

This table presents the annual operating expenses associated with
the acquisition of an MRI to serve 800 patients. The expenses are
determined from the information provided in Table 2 of the case
and applied to the patient/procedure mix in Table 4-B.

Table 6: Projected Before Tax Cash Flows

               Year 1       Year 2     Year 3     Year 4     Year 5

Projected   $552,724 (a)   $580,360   $609,378   $639,847   $671,839
Revenue

Projected   $107,049 (b)   $126,941   $130,988   $135,197   $139,576
Expenses

Projected   $445,675       $453,419   $478,390   $504,650   $532,264
Cash Flow

             Year 6     Year 7     Year 8     Year 9    Year 10

Projected   $705,431   $740,703   $777,738   $816,625   $857,456
Revenue

Projected   $148,130   $152,867   $157,796   $162,925   $168,261
Expenses

Projected   $557,302   $587,836   $619,942   $653,700   $689,195
Cash Flow

            Year 11    Year 12

Projected   $900,329   $945,346
Revenue

Projected   $178,815   $184,594
Expenses

Projected   $721,515   $760,751
Cash Flow

This table provides the projected cash flows associated with acquiring
the MRI machine and serving 800 patients annually.

(a) Year 1 projected revenue is determined in Table 4. Revenue
(reimbursement) is expected to increase 1.5% per year.

(b) Projected expenses were determined in Table 5.

Table 6A: Projected Before Tax Cash Flows

                        Year 1      Year 2    Year 3    Year 4

Projected Revenue     607,997 (a)   638,397   670,317   703,833
Projected Expenses    109,449 (b)   129,389   133,485   137,744
Projected Cash Flow   498,548       509,008   536,832   566,088

                      Year 5    Year 6    Year 7    Year 8    Year 9

Projected Revenue     739,024   775,975   814,774   855,513   898,288
Projected Expenses    142,173   150,779   155,570   160,553   165,737
Projected Cash Flow   596,851   625,196   659,204   694,960   732,552

                      Year 10   Year 11    Year 12

Projected Revenue     943,203   990,363  1,039,881
Projected Expenses    171,129   181,740    187,578
Projected Cash Flow   772,073   808,623    852,303

This table presents the projected cash flows associated with
acquiring the MRI machine and serving 880 patients annually.
a Year 1 projected revenue is determined in Table 4-A. Revenue
(reimbursement) is expected to increase 1.5% per year.

TABLE 6-B
PROJECTED BEFORE TAX CASH FLOWS

              Year 1      Year 2    Year 3    Year 4    Year 5

PROJECTED   615,855 (a)   646,648   678,980   712,929   748,576
REVENUE

PROJECTED   107,049 (b)   126,941   130,988   135,197   139,576
EXPENSES

PROJECTED   508,806       519,707   547,992   577,732   609,000
CASH FLOW

            Year 6    Year 7    Year 8    Year 9    Year 10

PROJECTED   786,004   825,305   866,570   909,898   955,393
REVENUE

PROJECTED   148,130   152,867   157,796   162,925   168,261
EXPENSES

PROJECTED   637,875   672,437   708,774   746,974   787,132
CASH FLOW

             Year 11     Year 12

PROJECTED   1,003,163   1,053,321
REVENUE

PROJECTED    178,815     184,594
EXPENSES

PROJECTED    824,348     868,727
CASH FLOW

This table provides the projected cash flows associated with acquiring
the MRI machine and serving 800 patients annually. In this scenario
the patient mix consists of private pay, workers' comp and uninsured
patients only.

(a) Year 1 projected revenue is determined in Table 4-B. Revenue
(reimbursement) is expected to increase 1.5% per year.

(b) Projected expenses were determined in Table 5-B.

Table 7: Net Present Value Analysis

Year   Before Tax Cash   Depreciation   Taxable Income   Tax Expense
            Flow

 0      ($1,375,000)
 1         445,675         $275,000        $170,675        $59,736
 2         453,419         $440,000         13,419         $4,697
 3         478,390         $264,000        214,390         $75,037
 4         504,650         $158,400        346,250        $121,188
 5         532,264         $158,400        373,864        $130,852
 6         557,302         $79,200         478,102        $167,336
 7         587,836            $0           587,836        $205,743
 8         619,942            $0           619,942        $216,980
 9         653,700            $0           653,700        $228,795
 10        689,195            $0           689,195        $241,218
 11        721,515            $0           721,515        $252,530
 12        760,751            $0           760,751        $266,263

Year   After Tax   Pv Factor   Discounted after Tax Cash
       Cash Flow                         Flow

 0                     1             ($1,375,000)
 1     $385,939
 2      448,722
 3      403,354
 4      383,463
 5      401,412
 6      389,966
 7      382,093
 8      402,962
 9      424,905
 10     447,977
 11     468,985
 12     494,488
                                     $3,121,269.68
                     NPV =           $1,746,269.68

This table provides the net present value analysis associated
with the acquisition of the MRI machine, using a discount rate
of 8%.

TABLE 7-A
NET PRESENT VALUE ANALYSIS

YEAR    BEFORE TAX    DEPRECIATION   TAXABLE    TAX EXPENSE
        CASH FLOW                     INCOME

 0     ($1,375,000)
 1       498,548        $275,000     $223,548     $78,242
 2       509,008        $440,000      69,008      $24,153
 3       536,832        $264,000     272,832      $95,491
 4       566,088        $158,400     407,688     $142,691
 5       596,851        $158,400     438,451     $153,458
 6       625,196         $79,200     545,996     $191,099
 7       659,204              $0     659,204     $230,721
 8       694,960              $0     694,960     $243,236
 9       732,552              $0     732,552     $256,393
 10      772,073              $0     772,073     $270,226
 11      808,623              $0     808,623     $283,018
 12      852,303              $0     852,303     $298,306

YEAR   AFTER TAX   PV FACTOR     DISCOUNTED
       CASH FLOW               AFTER TAX CASH
                                    FLOW

 0                     1        ($1,375,000)
 1     $420,306
 2      484,855
 3      441,341
 4      423,397
 5      443,393
 6      434,097
 7      428,483
 8      451,724
 9      476,159
 10     501,847
 11     525,605
 12     553,997

                               $3,451,879.74
          NPV =                $2,076,879.74

This table provides the net present value associated with the
acquisition of the MRI machine when 880 patients are served,
using a discount rate of 8%.

TABLE 7-B
NET PRESENT VALUE ANALYSIS

YEAR    BEFORE TAX    DEPRECIATION   TAXABLE INCOME   TAX EXPENSE
        CASH FLOW
 0     ($1,375,000)

 1       508,806        $275,000        $233,806        $81,832
 2       519,707        $440,000         79,707         $27,897
 3       547,992        $264,000        283,992         $99,397
 4       577,732        $158,400        419,332        $146,766
 5       609,000        $158,400        450,600        $157,710
 6       637,875        $79,200         558,675        $195,536
 7       672,437           $0           672,437        $235,353
 8       708,774           $0           708,774        $248,071
 9       746,974           $0           746,974        $261,441
 10      787,132           $0           787,132        $275,496
 11      824,348           $0           824,348        $288,522
 12      868,727           $0           868,727        $304,054

YEAR    AFTER TAX      PV FACTOR     DISCOUNTED AFTER
        CASH FLOW                     TAX CASH FLOW
 0                         1           ($1,375,000)

 1      $426,974
 2       491,810
 3       448,595
 4       430,966
 5       451,290
 6       442,339
 7       437,084
 8       460,703
 9       485,533
 10      511,636
 11      535,826
 12      564,673
                                      $3,513,621.81
                         NPV =          $2,138,622
       IRR = 31.8%
                     NPV TABLE 7-A      $2,076,880
                      DIFFERENCE         $61,742

This table provides the net present value associated with the
acquisition of the MRI machine when services are provided to
private pay, workers' comp and uninsured patients only. The
difference between this second alternative and the first
alternative (a 10% increase in MRIs) is also noted.
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Article Details
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Title Annotation:Instructor's Note
Author:Devine, Kevin; Ealey, Thomas; O'Clock, Priscilla
Publication:Journal of the International Academy for Case Studies
Article Type:Case study
Geographic Code:1USA
Date:May 1, 2010
Words:5723
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