I need Help on filing the students model excel. Specially on the Discount Rates Applied. Thank You.

NEW ORLEANS HEALTH SYSTEM MAKE OR BUY ANALYSIS 21 NEW ORLEANS HEALTH SYSTEM (the System) is a large not-for- profit healthcare holding company that operates both for-profit and not-for-profit subsidiaries in New Orleans and its surrounding area. The not-for-profit subsidiaries consist of four acute care hospitals (Metropoli- tan Memorial, River Bend, Metairie Memorial, and Kenner General) and one service company (SUPPORT). SUPPORT provides various services, such as food, laundry, and medical waste disposal, to the four hospitals. The single for-profit subsidiary, PROPERTIES, operates several for-profit businesses, but its primary business line is real estate development, particularly medical office buildings. The System's chief executive officer, Susan Richards, has been thinking about the company's printing situation for some time. The System has a print shop, which currently operates under SUPPORT, that provides some of the printing required by the hospitals, but it does not have the capabilities to do all the work required. As shown in Table 21.1, the System currently (2005) spends about $830,000 a year on com- mercial contract printing, some of which could be done in-house if the System expanded its printing operation. Of the $830,000, about $132,000 represents graphics printing-annual reports, brochures, and other Promotional material. Most of the graphics printing could be moved In-house, but about 10 percent of the work (for example, the four-color annual report) would have to continue to be done by outside vendors. Conversely, only about 15 percent of the almost $700,000 in forms Printing, or just over $100,000, could be moved in-house. This is 149150 Cases in Healthcare Finance TABLE 21.1 Fiscal Year New Orleans Health 2004 2005 System: Printing Currently Done by Outside Vendors Graphics Printing Mercury $ 85,002.31 $ 7,727.86 Universal Color Graphics 16,982.44 12,588.00 Crescent Press 9,300.00 24,446.00 Southern Louisiana Printing 5,628.50 711.94 Pickett Press 3,526.14 2,337.10 Sir Speedy 1,962.58 8,939.50 French Quarter Printing 85.46 0.00 C & S Printing 1,161.00 0.00 Metairie Printing Service 0.00 75,292.83 Total graphics printing $123,648.43 $132,043.23 90% to be brought in-house $111,283.59 $118,838.91 Forms Printing Continuous $223,826.43 $239,493.82 Stock tab 77,150.41 82,550.50 Labels 68,032.88 65,965.88 Carbon snap 97,563.27 106,283.44 Envelopes 61,096.52 62,435.89 Lab mount 5,095.35 5,126.33 Flat 1/2 side 42,266.69 40,986.45 Special 39,910.37 46,295.47 Oversize 1,458.19 Special service 0.00 1,190.00 Card stock 2,743.98 21,237.40 NCR flat 21,017.01 23,479.11 22,798.19 Total forms printing $659,844.52 $698, 159.06 15% to be brought in-house $ 98,976.68 $104,723.86 Total vendor printing $783,492.95 $830,202.29 Total to be brought in-house $210,260.27 $223,562.77New Orleans Health System 151 because most forms printing requires very specialized equipment and printing forms in-house is just not cost effective for businesses, except for very large ones. The System's print contracts (both graphics and forms) with vendors increased in dollar volume by about 5 percent (2 percent volume increase and 3 percent price increase) from 2004 to 2005, and this trend is expected to continue into the foreseeable future. In fiscal year 2005, the in-house print shop handled $42,837 in hospital billings. (To avoid any potential problems with SUPPORT's not-for-profit status, the print shop currently performs work exclusively for the System's four not-for-profit hospitals.) The print shop bills for materials only, but because material costs represent, on average, 30 percent of commercial vendors' total billings, the print shop currently does about $42,837/0.30 = $142,790 in annual work on a commercial billing basis. The equipment in the print shop has a current market value of $230,000, and the print shop generates about $20,000 in annual depreciation expense for tax purposes. To move go percent of the vendor graphics printing and 15 percent of the vendor forms printing in-house, the System would have to invest in additional printing equipment. The capital investment necessary for expansion can vary significantly depending on whether new or used equipment is purchased, the type of main press selected, and whether only essential or nice-to-have equipment is purchased. Table 21.2 sum- marizes the equipment capital-investment requirements. Note that the old equipment would be retained if the print shop were expanded. Also, the new equipment would generate tax depreciation of about $25,000 per year, and the required delivery van would cost $2,000 a year to oper- ate (in 2005 dollars). The print shop is currently located in leased space adjacent to Metropolitan Memorial, the largest of the four hospitals. The cost of this site is $10 per square foot per year. The print shop occupies 2,000 square feet, and hence current building costs are $20,000 in annual lease Payments plus an additional $200 monthly in utilities and insurance. Unfortunately, this site cannot be expanded, and hence new space is required if the print shop is to increase its capacity. Suitable space in a good location can be leased at the same rental rate ($10 per square foot per year), but the new print shop would require 3,500 square feet, increasing the annual lease cost by $35,000 - $20,000 = $15,000. (Assume that lease payments occur at the beginning of each year.)152 Cases in Healthcare Finance TABLE 21.2 Estimated Cost Item New Orleans Health System: Equipment Two-color press $ 65,000 Capital Investment Two-color press (small), Model 9860 26,000 Requirements Ten-hole drill press 7,800 Futura F 20 folder system 13,000 Collator-stitcher, 12 bin 28,000 Bookmaker, Michael 1000E 5,300 Camera with processor 14,000 Paper plate, AB Dick 148 11,500 Three-knife trimmer 12,000 Infrared dryer systems (2) 5,000 Delivery van 25,000 Miscellaneous items 5,000 Total capital investment $217,600 In addition, the new space would require $30,000 in initial remod- eling costs and an additional $100 per month in utilities and insurance costs (in 2005 dollars). Note that all leases are negotiated for a five-year period, so lease payments are not affected by inflation, which is expected to average about 3 percent per year. The expanded print shop would require an increase in labor costs of $76,777; these costs are summarized in Table 21.3. Labor costs to run the current print shop amount to $50,000 annually, and all current print shop personnel would be retained if the expansion takes place. After discussing the print shop situation with her chief financial officer, Susan defined three possible print shop alternatives: 1. Close the print shop completely, and use outside ven- dors for all printing. 2. Expand the print shop as envisioned. Essentially, this means expanding the print shop and performing all feasible work in-house. Under this proposal, the print shop would remain under SUPPORT, the System's not-for-profit service subsidiary. Thus, there would be no tax consequences.New Orleans Health System 153 3. Expand the print shop as in Alternative 2. However, all printing activities would be transferred to PROP- ERTIES, the System's for-profit subsidiary. In this situation, capital expenses, such as depreciation and lease payments, would be tax deductible. The primary motivation behind this alternative is to permit the print shop to enter the for-profit commercial printing business. The System's corporate cost of capital, which is dominated by hos- pital operations, is estimated to be 8.o percent. However, the company also computes divisional costs of capital for each subsidiary. SUPPORT, the not-for-profit service subsidiary, has access to municipal debt that currently costs about 5.5 percent. Its target capital structure consists of 60 percent debt and 40 percent equity (fund) financing. Because SUP- PORT has a captive business relationship with the System's four hospi- tals, it has relatively low business risk. Consequently, it has a relatively low cost of equity, 13.0 percent. PROPERTIES, the for-profit subsidiary, cannot issue municipal debt. The bulk of its debt consists of mortgage loans provided by banks and insurance companies. Mortgage debt, which is secured by pledged property, has a relatively low interest rate for taxable debt. Currently, this rate is 7.5 percent. The subsidiary's combined federal-plus-state tax rate is 40 percent. Because PROPERTIES competes with other property development companies, its inherent business risk is high, and hence it has a relatively high cost of equity, 17.0 percent. However, its ability to Position Annual Salary TABLE 21.3 Number New Orleans Lead printer ($15.00 per hour) $ 31,740.80 Health System: Delivery person ($8.00 per hour) 16,640.00 Print Shop's Clerical assistant ($7.50 per hour) 15,600.00 Incremental Labor Costs (2005 Projected raw-labor expense $ 63,980.80 dollars) Plus: 20 percent fringe benefits 12,796.16 Total annual incremental labor costs $ 76,776.96154 Cases in Healthcare Finance use property as collateral for its debt financing gives it a relatively high debt capacity-about 75 percent. The System's capital budgeting policy guidelines calls for all cash-flow analyses to be restricted to a five-year horizon with zero end-of-project salvage values. The rationale is that estimating cash flows any further into the future is just too difficult. It is now December 2005, and the print shop analysis is due in one week. Thus, for ease, assume that all capital investment cash flows, as well as lease payments for 2006, occur at the beginning of 2006 (the end of 2005). Then, the five years of operating flows occur from 2006 through 2010. Also, the System's capital budgeting policy is to assume that all costs and prices that are not fixed by contract will increase at a 3.0 percent inflation rate. Thus, any 2005 dollar costs must be increased by 3 percent annually beginning in 2006. Furthermore, any 2005 volume amounts must be increased by 2 percent annually beginning in 2006. In regard to the feasibility of expanding the printing business should it be placed into the PROPERTIES subsidiary, Susan discussed the profitability of commercial printing businesses with Mark Stanton, president of the Pelican State Printers Association, the state trade orga- nization. Mark pointed out that the average printer in the United States has a profit margin of 5.3 percent, while the average in the New Orleans metropolitan area is just over 4 percent. Return on assets in the industry is 7.5 percent nationwide and 5.1 percent locally. If the print shop were moved into PROPERTIES, it would go after printing business external to the health system. Estimates are far from precise, but new business in zoo6 could bring in as much as $25,000 in additional pretax earnings (in 2006 dollars). This amount could in- crease to $35,000 in 2007 (in 2007 dollars), given more time to advertise and build customer relationships. Although very uncertain, the pretax earnings that stem from external business are expected to increase by 5 percent per year after 2007, including both volume growth and price inflation. Note that the pretax earnings amounts include all operating costs related to the external printing business except marketing costs, which would amount to $3,600 in 2006, and are expected to increase at the 30 percent inflation rate. Finally, the System's purchasing manager has questioned the company's policy regarding external printing contracts: What is the company's current policy, and might a change in policy have a bearing on the decision at hand? The discount rate to use in the analysis has also been an issue under discussion. Susan believes that the discountNew Orleans Health System 155 rate should reflect the divisional placement of the print shop, but some stallers have disagreed with this view. "After all," said one, "the primary lactor in choosing a discount rate is the riskiness of the cash flows being discounted." Assume that you are the administrative resident at New Orleans Health System, and you have been given the task of analyzing the print shop situation and recommending a course of action. In assigning the project, your preceptor indicated that a risk analysis was appropriate. When asked for more guidance, his response was this: "You know more about this sent of thing than I do; just do it!"