The case is about Bayside Memorial Hospital that is considering purchasing a new MRI machine. This is a medical imaging machine that will be used within the facility to generate images of the internal organs of the body which help in diagnosing the conditions that patients are suffering from. It is important that the management considers whether the purchase will fit into the budget. It is also important that the financial impact of the purchase is ascertained in order to develop the business sense of purchasing the machine. This is done through the cash flow analysis.
One of the factors that the management will need to consider is the incremental cash flow. An incremental cash flow is the additional cash inflow and outflow that an organization such as Bayside Memorial Hospital incurs after implementing a capital project (Gapenski, 2013). Incremental cash flow may either be negative or positive. The implication of a positive incremental cash flow is the organization will realize an increase in capital after investing in the project. For the case of Bayside Memorial Hospital, some of the issues that will be considered include the initial cost of the MRI, the cash flows that result from operating the MRI project and any cash flow costs that will be associated with closing the project should the organization deem fit. Incremental cash flow are important in determining the net present value and the internal rate of return.
There are times when the incremental cash flow may be difficult to determine and so the organization may consider factors such as sunken costs and opportunity costs (Baker & Drorkin, 2017). For this project, a sunken cost is considered is one that has already been incurred by the organization and can therefore not be recovered. Opportunity cost may be basically defined as the loss of potential gain that the organization would incur if it does not purchase the MRI machine. Sunken costs will not affect the future cash flows of Bayside Memorial Hospital. The other cost that is included in the analysis is inflation. Inflation is the increase in prices which results in the fall in the purchasing power of commodities. Inflation affects the costs of labor and supply chain. These costs are likely to increase when they are adjusted for inflation. Strategic value occurs when there are other profitable investments that are result from investment in the MRI machine. However, it is important to note that inflation may affect the number of patients. This is due to the uncertainty that is generated due to inflation which reduces the amount of money that people are willing to spend (Baker & Drorkin, 2017).
From the cash flow analysis it is seen that the initial cost of purchasing the system is $2,000,000 and the installation cost is $500,000. The total cost comes to $2,500,000. The analysis shows that the MRI machine will be used for a period of 5 years. The costs that have been included were developed by physicians and managers based on the volume of procedures anticipated by the physicians, reimbursement amounts that the physicians expect for each scan, labor and other costs that will be incurred in operating the machine. This is based on the initial cost and expenses, the cost of labor, the net revenue and maintenance and supply costs involved (Gapenski, 2013).
The net operating income for the years is approximated as follows: year 1: $510,000, year 2: $535,500, year 3: $562,275, year 4: $590,389, year 5: $1,369,908. Year 5 has a higher cash flow because it includes the net operating cash flow and the cash flow that the organization expects to obtain from selling the MRI machine at the end of the year. This shows that the total investment made in the project ($2,500,000) will be recovered at the end of year 5. If the cash flow presented by the management is correct then it is seen that the costs of investing in the project will be recovered at the end of the fourth year. The rest of the cash flow will now be profits for the organization. From the cash flow summary, it is seen that the net present value of the project is $82,493 since the initial rate of return is 11.1%.
From the above analysis, it is recommended that Bayside Memorial Hospital purchases the MRI machine. This is because the hospital will recover the costs of this investment. The hospital has estimated the total costs of investing in this project and the time it will take for the costs to be recovered (Gapenski, 2013). One of the important factors that the organization included is inflation. Bayside Memorial Hospital is likely to make the money faster than is anticipated in the cash flow and this therefore provides room for any interruptions in provision of care to patients. The investment looks viable and profitable and the organization will make a profit of $82,493 after the 5 years of operating the machine.
In conclusion, the case is about Bayside Memorial Hospital that desires to invest in an MRI machine. From the analysis above it is seen that the hospital should make the investment because this would result in a positive incremental cash flow and profitability for the hospital. This shows that the organization is not likely to go bankrupt from this investment because it is an investment that it can handle. The use of cash flow analysis, project risk assessment and costs of capital estimation can help Bayside Memorial Hospital and other similar organizations to make wise investment decisions.