Dr. Michael Bakerwood is Managing Director of Southeast Medical Associates, a leading private medical

clinic in the south shore of Boston. Its specialty includes internal medicine, cardiology, with more

recently, significant concentration in out-patient angioplasty. However, for many years, the clinic has

contracted out for both x-ray and blood workups, sending a multitude of their patients to facilities that

specialize in each of these services, and in return, receiving a nominal referral fee.

Dr. Bakerwood has often wondered if undertaking the x-ray and blood testing facilities, in-house, could

prove to be more financially prudent.

As a financial consultant, you have been engaged to undertake a feasibility study to determine if such a

move is in the best interest of the clinic.

The facts are as follows:

The referral fees received from these outside services are expected to amount to $65,000/yr

over the next five years. The cost of the x-ray equipment and blood testing equipment is

estimated at $450,000, including taxes, delivery, installation and training. The depreciable life of

the equipment, for tax purposes, is based on a 5 yr. M.A.C.R.S. schedule, as follows:

Year 1

20.0%

Year 2

32.0%

Year 3

19.2%

Year 4

11.52%

Year 5

11.52%

Year 6

5.76%

While MACRS permits full depreciation without the need to provide for salvage value in the

calculation of depreciation, were to they purchase the equipment, it is estimated that the equipment

would generate a $50,000 salvage value at the end of the 5th year, when the clinic intends to acquire

more technically advanced equipment. A medical technician would have to be hired at an annual

salary at a cost of $80,000 per year. Support costs, including films, supplies, additional electrical

consumption, etc. are estimated at $40,000 annually. The projected annual fees derived from these

facilities becoming "in-house" are $360,000 per year. The clinic agrees that an appropriate expected

return on equity would be 20%. A combined federal and state corporate tax rate of 30%

In addition to the above MACRS, Michael has inquired about 179 depreciation and its applicability.

to the decision. Further, given the year 2009, you may definitely assume that the equipment would

be placed into service at the beginning of 2009, with 2009 being the first full year of the intended

transition. See 179 Bonus Depreciation information attached.

Thus, should the clinic undertake the investment in the x-ray and blood testing equipment? How much wiggle

room does Michael have on his revenue estimates before the project become unattractive? What performance

metrics would you provide the doctor to warrant a decision.

Were the clinic to agree that they should undertake this expansion, they have been offered two financing

alternatives, in addition to direct cash purchase:

1) A five year, secured financing arrangement with the interest rate at 10.0% and no down

payment, payments made annually, at the end of each year.

2) a five year lease arrangement, to include an upfront security deposit of $50,000, with annual

payments of $94,000 made at the end of each of the next five years, with the return of the security

deposit upon return of the equipment back to the Lessor at the end of the lease term.

Show all necessary calculations.