WMBA 6608 Week 6 Capital Project Appraisal Example

One More CT Scanner Beside the Emergency Department: $1.9 Million, Seven Years, a Net Present Value of About $725,000 at 7 Percent, and a Volume Assumption That Decides Whether It Pays

Student Name

Walden University

WMBA 6608: Healthcare Financial Management and Economics

Instructor Name

Month Day, Year

One More CT Scanner Beside the Emergency Department: $1.9 Million, Seven Years, a Net Present Value of About $725,000 at 7 Percent, and a Volume Assumption That Decides Whether It Pays

The Project

Prairie Ridge Medical Center, the invented Iowa hospital this course follows, has one CT scanner serving its emergency department, inpatients and outpatients. Emergency patients wait a median of 52 minutes from order to scan in the evening, and outpatient CT is booked eight days out. The radiology department proposes buying a second scanner, placed beside the emergency department, at a cost of $1.9 million including installation and room renovation. The scanner's useful life is seven years. The appraisal asks whether the incremental cash it generates justifies the outlay.

CT use in emergency departments grew substantially over the past three decades (Larson et al., 2011), and Prairie Ridge's scan count has risen roughly 4 percent annually for five years. The project is justified only by the incremental volume a second scanner makes possible, mostly outpatient scans now lost to an independent imaging center because of the wait, plus emergency scans completed faster.

Assumptions

Table 1

Assumptions

Composite figures for a classroom case.

Cash Flow Schedule

Because Prairie Ridge is tax-exempt, depreciation has no tax effect. It is a non-cash expense of about $271,000 a year on the hospital's income statement, but it does not appear in the cash flows below, which count the $1.9 million outlay once, when it is spent.

Table 2

Incremental Cash Flows by Year

Revenue and costs are incremental to the existing scanner; figures are rounded.

The Discount Rate

Even without shareholders, a nonprofit hospital's capital is not free. Prairie Ridge finances about 31 percent of its capital with tax-exempt bonds, which cost about 4.2 percent, and about 69 percent with its own net assets. Money invested in the scanner is money not held in the hospital's investment portfolio, which has a long-term target return of about 8 percent. Weighting the two gives about 6.8 percent, rounded to 7.0 percent. Reiter and Song (2021) describe this approach for not-for-profit providers: equity capital carries an opportunity cost even without owners.

Results

At 7 percent, the net present value is about $725,000. The internal rate of return is about 16.8 percent, comfortably clear of the 7 percent hurdle. The payback period is about 4.2 years.

Each measure adds something. Net present value shows the dollars the project adds to the hospital's value and is the measure that should decide. The internal rate of return shows the margin of safety above the cost of capital. Payback shows how long cash is tied up, which matters to a hospital whose days cash on hand fell this year. Brealey et al. (2023) caution that payback ignores both timing and everything earned after the cutoff, which is why it should inform rather than decide.

Sensitivity

The result depends on volume far more than on anything else.

Table 3

Sensitivity of Net Present Value

Each row changes only the items named.

Net present value reaches zero at about 2,900 scans in year 1, about 15 percent below the forecast. The discount rate matters much less: even at 9 percent, the project adds about $545,000.

What the Appraisal Leaves Out

Three effects are outside the numbers. The first is the emergency department benefit already mentioned: faster imaging for stroke and trauma patients has clinical value and may reduce costly delays, but it is hard to price reliably. The second is downtime protection. With one scanner, any breakdown sends emergency patients elsewhere or delays their care; a second scanner removes that single point of failure. The third is cannibalization: some scans counted as incremental may simply move from the existing scanner's evening queue, adding speed but not revenue. The assumptions count only outpatient referrals now lost to the competitor and emergency growth, but the department should audit the first year's volume to confirm that the scans are truly new.

Recommendation

Approve the scanner, conditional on evidence that the volume will arrive. The weakest assumption is that 3,400 incremental scans will materialize, about 2,100 of them outpatient referrals now going to the independent center. Before purchase, radiology should confirm referral commitments from the three largest referring practices and track outpatient wait times monthly. If those practices will not commit to returning referrals, the project's value falls toward zero. The emergency department benefit, faster scans for patients with possible stroke or trauma, is real but not priced here; it strengthens the case without being needed to justify it if volume holds.

References

Brealey, R. A., Myers, S. C., & Allen, F. (2023). Principles of corporate finance (14th ed.). McGraw Hill.

Larson, D. B., Johnson, L. W., Schnell, B. M., Salisbury, S. R., & Forman, H. P. (2011). National trends in CT use in the emergency department: 1995-2007. Radiology, 258(1), 164-173. https://doi.org/10.1148/radiol.10100640

Reiter, K. L., & Song, P. H. (2021). Gapenski's healthcare finance: An introduction to accounting and financial management (7th ed.). Health Administration Press.