Chapter 23 Capital Budgeting in Nonprofit Organizations 789 CASE PROBLEM Blessing & Saint Mary's Hospitals Quincy, Illinois, had been serviced by two ing. Nothing implied that the action was hospitals for as long as anybody in the acceptable. Because this transaction in- town could remember, and the town, the volved hospitals, the Health Facilities Plan- doctors, and others were concerned about ning Board and other government regula- the proposed merging of these two non- tors were informed of the intent to merge. profit institutions. Blessing Hospital was a In early 1988, Saint Mary's had a book community hospital operated for the bene value of $13 million. Under the proposed fit of the community by a board of trustees merger a new board would be formed that and was generally perceived by the commu- would run both hospitals as one. This nity as the more progressive if not slightly board was to be composed of four individ- more expensive hospital . Saint Mary's Hos- uals of Blessing's choosing and four indi- pital, owned by the Sisters of the Franciscan viduals of the Sisters' choosing. The imme Order of the Catholic Church, had a local diate mission of the board was to work out operating board for many years but due to the details of the merger. Until such an recent financial difficulty, most of the deci- agreement could be reached, the hospitals sion making had been taken back to the would continue to operate independently. central office in New York. Saint Mary's was The new board could not agree on a new more conservative, austere, and perceived name but it was implied that the Sisters as less expensive. would be compensated by the new entity In the 10 years prior to 1987 several for the assets given to the merged entity. large industries like Motorola had closed From 1988 to 1992, the new board met up shop in Quincy and the population and nothing progressed. As might be ex- base of the town was shrinking. Talk of the pected, board votes were split four to four. merging of the two hospitals began in In the same time period Saint Mary's Hos- earnest in 1987 with a filing with the Jus- pital became less and less profitable, and tice Department. Since these were the only the Sisters in New York were rethinking two hospitals to serve Quincy and the sur- the feasibility of running a hospital in rounding population there was at least the Quincy. On April 1, 1993, a sale/merger appearance that the combining of these was consummated. The Sisters agreed to two competing nonprofits would reduce sell Saint Mary's Hospital to Blessing for competition, decrease service, and/or in- $18 million. crease price. The reasons cited in the filing for the merger were to better manage cost, Case Questions to increase cost-effectiveness, to improve 1. The nonprofit mission of Saint Mary's the availability of service, and to improve Hospital was to provide health care to the quality of service. According to the Catholic and other members of the rules, the Justice Department had 30 days community in Quincy. This mission to make a review and respond in a negative would be adopted by Blessing with the manner with a "cause for concern" hear acquisition of Saint Mary's. From a philosophical point of view, what should have been the purchase price for Saint Mary's? 2. Assume that Blessing will now have to recover the $18 million paid for Saint Mary's. If Blessing has a 12 percent cost of capital, what annual dollar amount of savings is necessary to re- cover this cost in 40 years? 3. One of the benefits of the merger will be the elimination of duplicate ser- vices. Rather than each hospital oper- ating an emergency room and a mater- nity ward, the combined Blessing will run just one. List at least two nonquan- titative or qualitative disadvantages and advantages from the patient's per- spective. List two nonquantitative or qualitative advantages and disad vantages from the hospital board's perspective. 4. As a result of the acquisition, Blessing now has two hospital buildings located 8 blocks from each other and the fol- lowing projects: a. Connect the two buildings with fiber optic cable to facilitate the transfer of patient records to and from the buildings in which the ser- vice is performed, the doctors' of fices, billing, and other functions. The cost is $1,200,000 and the bene- fit is expected to be $50,000 savings annually in actual inter-building transfer expenses. Nonquantitative benefits are the timeliness and ac- curacy that will accrue to the auto- mated system. b. One helicopter will be used by both hospital buildings where previously only one hospital had helicopter service. C. Assume that 120 people earning on average $48,000 per year will be re- leased because they are deemed to be employed in services that were previously duplicated at both hospi- tals. Severance pay is expected to average $10,000 per worker. As- sume year-end cash flows for both severance and payroll savings. Assuming a 12 percent cost of capital, which of the projects should be accepted? Chapter 23 Capital Budgeting in Nonprofit Organizations 789 CASE PROBLEM Blessing & Saint Mary's Hospitals Quincy, Illinois, had been serviced by two ing. Nothing implied that the action was hospitals for as long as anybody in the acceptable. Because this transaction in- town could remember, and the town, the volved hospitals, the Health Facilities Plan- doctors, and others were concerned about ning Board and other government regula- the proposed merging of these two non- tors were informed of the intent to merge. profit institutions. Blessing Hospital was a In early 1988, Saint Mary's had a book community hospital operated for the bene value of $13 million. Under the proposed fit of the community by a board of trustees merger a new board would be formed that and was generally perceived by the commu- would run both hospitals as one. This nity as the more progressive if not slightly board was to be composed of four individ- more expensive hospital . Saint Mary's Hos- uals of Blessing's choosing and four indi- pital, owned by the Sisters of the Franciscan viduals of the Sisters' choosing. The imme Order of the Catholic Church, had a local diate mission of the board was to work out operating board for many years but due to the details of the merger. Until such an recent financial difficulty, most of the deci- agreement could be reached, the hospitals sion making had been taken back to the would continue to operate independently. central office in New York. Saint Mary's was The new board could not agree on a new more conservative, austere, and perceived name but it was implied that the Sisters as less expensive. would be compensated by the new entity In the 10 years prior to 1987 several for the assets given to the merged entity. large industries like Motorola had closed From 1988 to 1992, the new board met up shop in Quincy and the population and nothing progressed. As might be ex- base of the town was shrinking. Talk of the pected, board votes were split four to four. merging of the two hospitals began in In the same time period Saint Mary's Hos- earnest in 1987 with a filing with the Jus- pital became less and less profitable, and tice Department. Since these were the only the Sisters in New York were rethinking two hospitals to serve Quincy and the sur- the feasibility of running a hospital in rounding population there was at least the Quincy. On April 1, 1993, a sale/merger appearance that the combining of these was consummated. The Sisters agreed to two competing nonprofits would reduce sell Saint Mary's Hospital to Blessing for competition, decrease service, and/or in- $18 million. crease price. The reasons cited in the filing for the merger were to better manage cost, Case Questions to increase cost-effectiveness, to improve 1. The nonprofit mission of Saint Mary's the availability of service, and to improve Hospital was to provide health care to the quality of service. According to the Catholic and other members of the rules, the Justice Department had 30 days community in Quincy. This mission to make a review and respond in a negative would be adopted by Blessing with the manner with a "cause for concern" hear acquisition of Saint Mary's. From a philosophical point of view, what should have been the purchase price for Saint Mary's? 2. Assume that Blessing will now have to recover the $18 million paid for Saint Mary's. If Blessing has a 12 percent cost of capital, what annual dollar amount of savings is necessary to re- cover this cost in 40 years? 3. One of the benefits of the merger will be the elimination of duplicate ser- vices. Rather than each hospital oper- ating an emergency room and a mater- nity ward, the combined Blessing will run just one. List at least two nonquan- titative or qualitative disadvantages and advantages from the patient's per- spective. List two nonquantitative or qualitative advantages and disad vantages from the hospital board's perspective. 4. As a result of the acquisition, Blessing now has two hospital buildings located 8 blocks from each other and the fol- lowing projects: a. Connect the two buildings with fiber optic cable to facilitate the transfer of patient records to and from the buildings in which the ser- vice is performed, the doctors' of fices, billing, and other functions. The cost is $1,200,000 and the bene- fit is expected to be $50,000 savings annually in actual inter-building transfer expenses. Nonquantitative benefits are the timeliness and ac- curacy that will accrue to the auto- mated system. b. One helicopter will be used by both hospital buildings where previously only one hospital had helicopter service. C. Assume that 120 people earning on average $48,000 per year will be re- leased because they are deemed to be employed in services that were previously duplicated at both hospi- tals. Severance pay is expected to average $10,000 per worker. As- sume year-end cash flows for both severance and payroll savings. Assuming a 12 percent cost of capital, which of the projects should be accepted