645 Wk8 Case Study

Read Case 16 (pages 97-101) from Gapenski’s Cases in Healthcare Finance – “Seattle Cancer Center.”

Create a presentation in Microsoft PowerPoint (PPT), suitable for presentation to a senior level executive. The final product should include a title slide with your name and the name of the case. Two or three slides per question (see below) should be sufficient to respond appropriately to the case prompts. Slide numbers should be included. Use of non-case related graphics is not required. All Excel work should be imported into the presentation in table format (in the body of the document). Use of external resources and articles is encouraged.

References

should be cited in APA format, as a footnote on the slide where the information.

In your presentation, provide a response to the following questions from the case study:

1. Should the Center lease the equipment?
2. What is the maximum lease payment that the Center would be willing to pay?
3. What would be the NAL to the Center if tax-exempt (municipal) debt financing was available to the Center?
4. Would the availability of tax-exempt debt financing make leasing more or less attractive to the Center than before? Why?

As a baseline, assume all cash flows have the same risk; that is, ignore residual value risk and use the same discount rate for all lessee cash flows.

For additional guidance on how to construct a professional presentation, please see the link below. https://www.wiley.com/network/researchers/promoting-your-article/6-tips-for-giving-a-fabulous-academic-presentation

References

Pink, G. (2018). Gapenski’s cases in healthcare finance. (6th ed.). Health Administration Press.

Copyright 2018. Health Administration Press.
All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted under U.S. or applicable copyright law.
C AS E
S E AT T L E C A N C E R
CENTER
16
LEASING DECISIONS
Seattle Cancer Center is a nationally known not-for-profit inpatient
and outpatient facility dedicated to the prevention and treatment of cancer.
Specific treatment services include surgery, chemotherapy, bone marrow
transplantation, radiation therapy, and photodynamic therapy.
For the past ten years, Seattle has been working diligently to perfect
noninvasive brain surgery techniques. One technique, Gamma Knife radiosurgery, was developed in the 1950s and 1960s by Dr. Lars Leksell, a prominent Swedish neurosurgeon. The first patient treatment site was opened in
1968 in Stockholm, Sweden, while the first site in the United States was
established in Pittsburgh, Pennsylvania, in 1977.
The Gamma Knife uses 201 separate radiation sources to treat certain
brain cancers. Each radiation beam is weak and hence does not damage
normal brain tissue, but when the separate beams are focused on a single
point by a collimator helmet, the equipment delivers a dosage sufficient to
be highly effective. The Gamma Knife is especially useful in the treatment of
arteriovenous malformations, but it can also be used to treat certain types of
benign tumors and even some small malignant lesions. The primary clinical
benefit of the procedure is the significant reduction in the risk associated
with traditional surgical procedures, in which the morbidity and mortality
rates are substantial, especially for patients with deep lesions. In addition to
treating cancer, it can treat functional disorders such as Parkinson’s disease
tremors and the pain that results from trigeminal neuralgia. (For more information about the Gamma Knife, including an informative video on Gamma
Knife surgery, see the manufacturer’s website at http://gammaknife.org.)
© Fou nd at ion of ACHE, 2018. Repr oduc t i o n w i t h o u t p e r mi s s i o n i s p r o h i b i t e d .
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C ase s in Health care F in a n c e
The procedure calls for a team approach, including a neurosurgeon,
radiation physicist, radiologist, and radiation therapist. The neurosurgeon
selects the patients appropriate for the procedure and performs the stereotactic process required to localize the target area. The radiation physicist
works with a computer program to calculate the appropriate dosimetry,
while the radiologist performs a computed tomography scan, a magnetic
resonance imaging scan, an angiogram, or a combination of the three to
help the neurosurgeon localize the lesion.
The dosimetry calculations are especially complex. Because differing
thicknesses of skull and brain will attenuate the beams in varying amounts,
the amount of radiation applied is highly dependent on where the lesion is
located and the size and shape of the patient’s skull. The actual application
of the radiation takes between 20 minutes and 2 hours, and the patient is
generally released after only a short period of observation.
Seattle plans to acquire a new Gamma Knife to replace its current model.
The equipment has an invoice price of $3 million, including delivery and
installation charges, and it falls into the MACRS (modified accelerated cost
recovery system) five-year class, with current allowances of 0.20 in Year 1,
0.32 in Year 2, 0.19 in Year 3, 0.12 in Year 4, 0.11 in Year 5, and 0.06 in Year
6. The manufacturer of the equipment will provide a maintenance contract
for $100,000 per year, payable at the beginning of each year, if Seattle buys
the equipment. Furthermore, the purchase could be financed by a four-year,
simple-interest, conventional (taxable) bank note that would carry an interest rate of 9 percent.
Regardless of whether the equipment is purchased or leased, Seattle’s
managers do not think the new Gamma Knife will be used for more than
four years, at which time Seattle plans to open a new radiation therapy facility.
Land on which to construct a larger facility has already been acquired, and
the building should be ready for occupancy at that time. The new facility
is designed to enable Seattle to use several new radiosurgery procedures.
Thus, the Gamma Knife replacement is viewed as a “bridge,” to serve only
until the new facility is ready. The expected physical life of the equipment is
ten years, but medical equipment of this nature is subject to unpredictable
technological obsolescence.
After considerable debate among Seattle’s managers, they concluded that
there is a 25 percent probability that the residual (salvage) value after four
years will be $800,000; a 50 percent probability that it will be $1.2 million;
and a 25 percent probability that it will be $1.6 million, which makes the
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residual value quite risky. Because the residual value is judged to have high
risk, a 4 percentage point risk adjustment will be added to the base discount
rate used on the other lease-analysis flows to obtain the appropriate rate
for the residual value flows.
GB Financing, a leasing company that is partially owned by the Gamma
Knife manufacturer, has presented an initial offer for Seattle to lease the
equipment for annual payments of $675,000, with the first payment due on
delivery and installation and subsequent payments due at the beginning of
each succeeding year of the four-year lease term. This rental price includes
a service contract under which the equipment would be maintained in good
working order. GB Financing would buy the equipment from the manufacturer under the same terms that were offered to Seattle, and GB Financing
would have to enter into a maintenance contract with the manufacturer
for $100,000 per year. (For more information on leasing healthcare equipment, see the GE Capital Healthcare Equipment Finance website at www.
gehcfinance.com.)
Unlike Seattle, GB Financing forecasts a $1.6 million residual value.
Its estimate is based on the following facts:
1.
2.
3.
There is no technology on the horizon that would make the
Gamma Knife obsolete.
The Gamma Knife has a physical life estimated to be two-and-ahalf times longer than the four-year lease term.
GB Financing is more skilled than Seattle in selling used
equipment, especially Gamma Knife.
GB Financing’s federal-plus-state tax rate is 40 percent, and, if the lease
is not written, it could invest the funds in a four-year term loan of similar
risk yielding 8.0 percent before taxes.
Randall Rhee, Seattle’s chief financial officer, has the final say on all
of the firm’s lease-versus-purchase decisions, but the actual analysis of the
relevant data will be conducted by Seattle’s capital funds manager, Vanessa
Seagle. In the past, Randall and Vanessa have more or less agreed on analytical methodologies, but in discussing this lease analysis, they ended up in a
heated discussion about the appropriate discount rate to use in the analysis.
Randall argued that the cash flows associated with performing stereotactic radiosurgery are very uncertain. He is convinced that payers are not
going to be nearly as generous in the future as they have been in the past
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C ase s in Health care F in a n c e
in reimbursing for such procedures, so the revenue stream is highly speculative. Accordingly, he thinks that a high discount rate should be used in
the analysis. Vanessa, on the other hand, believes that leasing is a substitute
for “other financing,” which is a blend of debt and equity capital. Consequently, she asserts that the lease-analysis cash flows should be discounted
at Seattle’s corporate cost of capital, 10 percent. However, it is possible that
both Randall and Vanessa are wrong.
Both Randall and Vanessa believe that lessees should not blindly accept
the first offer made by potential lessors but should conduct a complete
analysis from the viewpoint of both parties and then, using this knowledge,
negotiate the best deal possible. Thus, knowing the range of lease payments
that is acceptable to both parties is important.
There is a possibility that Seattle will move to its new radiation facility
earlier than anticipated and hence before the expiration of the lease. Furthermore, if the neurosurgeon—the primary user of the Gamma Knife—leaves
the staff and is not immediately replaced, the equipment would be useless.
Thus, Randall is considering asking GB Financing to include a cancellation clause in the lease contract. Under such a clause, Seattle would be able
to return the equipment at any time during the lease term after giving a
minimum 30-day notice. Before negotiations begin, Seattle must assess the
impact of such a clause on the riskiness of the lease to both parties and any
consequences the clause might have on the terms of the lease.
In addition, Randall is aware that many lessors are now writing per procedure leases, in which the lease payment is tied to the number of procedures
performed rather than a fixed amount. He wonders what the consequences
would be for both the lessee and the lessor if a per procedure lease were
used instead of a conventional lease. GB Financing has quoted a per procedure lease rate of $7,000 on the basis of an expected annual volume of 100
procedures. However, past experience at Seattle indicates that volume could
easily be as low as 70 procedures or as high as 130 procedures. Considering
current charges and reimbursement rates, Seattle expects to realize a net
revenue per procedure of roughly $10,000.
Seattle’s leadership has discussed obtaining tax-exempt financing for
the Gamma Knife should it be purchased. If so, the cost of tax-exempt
(municipal) debt would be only 5 percent.
GB Financing would probably obtain a $1.5 million simple-interest
loan to leverage the lease. The terms of this loan have not been finalized, but
the bank has indicated that the interest rate would be in the range of 7 to
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C a s e 16 : S e a ttle C a n c e r C e n te r
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9 percent. Such leveraging could affect GB Financing’s ability to negotiate
lease payments, so understanding the impact of leveraging from the lessor’s
perspective is important.
You were hired as a consultant to recommend a course of action for
the Gamma Knife acquisition. Prepare a report that addresses all of the
issues raised by the parties involved and that makes a final recommendation
regarding the acquisition.
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