Case 22

Northwest suburban health system

Please answer all questions in full

Begin by considering the Systems capital costs. Calculate the divisional costs of capital for SUPPORT and PROPERTIES. Compare the corporate and divisional costs of capital and explain why they differ.

2. Consider Alternative 2 (expand the printshop within the SUPPORT subsidiary). (Note: It is best to start with this alternative because it gives an anchor discount rate that can be used as the basis for the other two alternatives.)

a. What cost of capital should be applied in the analysis? Should it be the corporate cost of capital, one of the divisional costs, or some other discount rate? (Hint: The cash flows being discounted are those associated with printing operations.)

b. What is Alternative 2's NPV?

3. Consider Alternative 1 (close the printshop and use outside vendors for all printing).

a. What cost of capital should be used in the analysis? (Hint: How does the risk of this alternative compare with that of Alternative 2?)

b. What is Alternative 1's NPV?

c. Why do the NPV and IRR methods produce conflicting results? Does the MIRR also conflict with the NPV?

4. Consider Alternative 3 (expand the printshop within the PROPERTIES subsidiary).

a. What is Alternative 3's NPV without considering any revenues from commercial printing? Compare this value with the NPV of Alternative 2. Do they differ, and if so, why?

b. What is Alternative 3s NPV considering the revenues expected from outside buyers of printing services?

c. Justify the discount rate(s) applied in Questions 4a and 4b.

d. What light does the information on printshop industry profitability shed on the decision?

e. What effect would the move to a for-profit business have on printing costs for the Systems four not-for-profit hospitals? (Hint: This is a transfer pricing issue.)

5. What does exhibit 22.1 in the case reveal about the Systems contracting policy with its printers? Does it appear that printing contracts are controlled centrally? Can you think of any potential ways to reduce vendor printing charges?

6. Discuss the pros and cons of truncating a project's cash flows after five years. Be specific regarding the implications for the three analyses performed in this case.

7. What is your final recommendation concerning the printing situation?

8. In your opinion, what are three key learning points from this case?