FMW4A

1. Summarize the advantages and disadvantages of leasing. Provide an example in your response.

2. Wimpy, a character in Popeye cartoons, offers to “gladly pay you Tuesday for a hamburger today.” Why might Burger King find this to be an unattractive offer? Please be sure to relate your answer to investment analysis.

3. Do capital budgets have an impact on operating budgets? Explain your answer thoroughly.

4. What are the limitations of the internal rate of return method and the problems with the payback method?

The response to each question should be must be at least 200 words in length in APA format.

References:

Financial Management for Public Health and Not-for-Profit Organizations (4th edition)

Assignment reading attached!

1

1. Describe key methodologies for the practical application of financial management in healthcare
organizations.
1.1 Describe capital budgeting and discuss why a separate capital budget is needed.
1.2 Explain how mortgages and bonds work.
1.3 Discuss the advantages and disadvantages of leasing as a source of long-term financing
1.4 Explain how debt payments and values can be computed.

6. Discuss the future of healthcare financial management in the United States.
6.1 Discuss the tools of investment analysis, including net present cost, annualized cost, net

present value, and internal rate of return.

Reading Assignment

Chapter 5:
Capital Budgeting

Chapter 6:
Long-Term Financing

Unit Lesson

In Unit IV, you will learn that assets with lifetimes of more than one year are often referred to as capital
assets. The process of planning for the purchase of capital assets is often referred to by many as capital
budgeting. A capital budget is prepared as a separate document which becomes part of the organization’s
master budget. Keeping capital funds separate from operating funds is crucial, as you will learn. This certainly
comes into play in healthcare organizations, considering all the technology and equipment we need for a
modern healthcare facility today.

Capital assets are considered separately from the operating budget because it is not appropriate to charge
the entire cost of a resource, which will last more than one year, to the operating budget of the year it is
acquired. Who could ever justify buying a new hospital or clinic building if the entire cost of the construction
were included as an operating expense in the year it was acquired? It would not make sense. However, when
the cost of a new building is considered over a period of years, the approximate useful life of the building,
then things begin to make sense. Later in the course, you will learn about depreciation schedules and ways to
reflect equipment and facilities in the hospital financial statements.

Capital items also require special attention because (1) the initial cost is large, making a poor choice costly;
(2) the items are generally kept a long time, so the organization often lives with any poor choices for a long
time; (3) we can only understand the financial impact if we evaluate the entire lifetime of the assets; and
(4) since we often pay for the asset early and receive payments as we use it later, the time value of money
must be considered. You will see that the hospital or clinic board of directors pays special attention to capital
decisions for these reasons. They do not scrutinize every payrate for nurses, therapists, or other staff, and
they do not pay close attention to the prices of bandages or IV solutions, but they perk up considerably when
the chief executive officer (CEO) talks about spending hundreds of thousands or even millions of dollars on a
capital purchase!

There is a lot to think about when making capital decisions for a healthcare organization. Let’s take the
example of a new computerized tomography (CT) scanner for the hospital. If we want the latest and greatest

UIT IV STUDY GUIDE

Planning – Part III

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UNIT x STUDY GUIDE

Title

technology in this field—all the bells and whistles—the total purchase price could easily exceed
$1,000,000.00. Count the zeros—that is one million dollars. Now, that is a major investment for any
healthcare organization. Meanwhile, if our CT technology is outmoded, we could lose millions of dollars in
business when doctors and patients decide to take their CT business to another facility which has state-of-
the-art technology. The reality in medicine today is that technology is almost always outmoded before it is
actually worn out. Our old CT scanner may be working perfectly well for the functions and at the level for
which is was designed to operate, but that is not good enough now. New CT technology which creates better
images for physicians to interpret and entire new procedures may be available today that did not even exist a
few years ago when our old CT scanner was manufactured. In order to be competitive and keep our staff
members busy taking care of patients, we need to invest in a new scanner. The most common experience is
that technology in departments like radiology, laboratory, respiratory therapy, and critical care will outmode
approximately every three to five years. The process is ongoing; constant planning for replacement of
technology that is not broken but is simply out of date.

Consideration of the time value of money requires careful attention to the principles of compound and
discount interest. Present values and future values must be determined where appropriate to allow managers
to make informed decisions. As of this writing, hospitals are seeing capital lease rates which are the lowest in
many years. That is actually driving advancements in hospital technology which might now have been
expected at this time.

Some hospitals are choosing three year capital leases with an option to buy out the technology at the end.
That gives the hospital flexibility to watch technology change over three years and then decide what moves to
make. For illustration, let’s go back to our CT scanner example. The monthly lease payments on a state-of-
the-art scanner might be in the $10,000 to $15,000 per month range, but we should be able to generate
considerably more than that amount each month in revenues from the service. As the end of the lease
approaches, we can look at changes in technology, service volumes, reimbursement, and other factors, and
ask ourselves this question: “Are we still glad that we bought this CT scanner, and do we want to keep it?” If
the answer is yes, then we pay a predetermined amount to the vendor and keep the scanner for a few more
years. More importantly, if technology has changed so much over the three years that our scanner is
outmoded and we do not want to own it, then we simply turn it back over to the vendor and negotiate a deal
for a new system. Capital leasing is working out well for a lot of hospitals today. The worst scenario for those
who purchase technology outright is if we buy the equipment today and within a few months an advancement
comes along that makes our equipment obsolete. Along with attractive lease rates, that is one reason why
capital leasing is so popular today.

Often, it is necessary to employ time value of money (TVM) techniques such as net present cost, annualized
cost, net present value, and internal rate of return when assessing potential capital investments. That is
simply good business, and you will learn a lot about TVM as you read in your textbook this unit.

Unit IV goes on to consider that capital assets are often so costly that they cannot be paid for using just
money generated from current operating activities. Instead, many organizations pay for the purchase of a
building or major pieces of equipment by using long-term financing. Long-term financing refers to the various
alternatives available to the organization to get the money needed to acquire capital assets. Long-term
financing comes from either equity financing or debt financing. The common types of equity financing are
retained earnings, stock issuance, taxes, and contributions. The common types of debt financing are notes,
mortgages, and bonds. The options for long-term financing are different depending upon the type of
healthcare facility you are managing. For example, some options are available only to not-for-profit healthcare
organizations, other options are available only to government-owned facilities, and some are available to for-
profits and all types of facilities. You will come to understand the options better as you study this unit.

Conclusion

Capital decisions are significant for healthcare organizations. They draw strong attention from the
organization’s board of directors, and they should. One misstep in this area could cost the organization
millions of dollars, and nobody wants that, so chief executive officers (CEO), chief financial officers (CFO),
and department directors need to be very well versed in capital. You will have a much better understanding of
that as you complete Unit IV!