Introduction: You manage a large hospital in Cache Valley. Linda, a senior nurse, suggests implementing a digital distribution system for patient lab results. While there are many benefits, including reduced lead time and greater visibility, you are interested in the potential cost savings, as you will not have to send out as many physical letters.

Question 1 Project Valuation

The project will cost about $120,000 to implement and take 2 years to complete. $40,000 will be required up-front to get the project started and the remaining $80,000 will be due at the end of the first year (assume all cash flows occur at the end of a year). While some system maintenance costs will arise after implementation, they can be neglected for this analysis. Savings will begin in Year 3 and last for 6 years (years 3-8). After that, systems like this will likely become mandated through healthcare reform.

Your hospitals lab currently serves about 50,000 clients each year and mails out 2.5 letters to each client (on average). Due to population growth and increased documentation requirements, the number of letters sent grows by about 5% each year. The current cost of mailing a letter is 44 cents, but you expect the cost to increase 1 cent every year (on average). You can assume there will be no mailing costs for clients who adopt the system. You cannot force clients to use the digital system and adoption estimates (based on client surveys) vary considerably. Optimistically, approximately 70% of clients will sign up for the system. Pessimistically, about 30% of clients will sign up.

Part A

(30 Points): Assuming only 30% of your clients sign-up for the system, and using an interest rate of 8%, calculate the net present value of the project if the only benefit of the system lies in reduced mailing costs. SHOW YOUR WORK.

(10 Points): The company selling the software offers to do an upfront market study for a cost of $10,000. The study would be completed before you incur any costs. The outcome of the study (which would be quick and not delay your project) would tell you with 90% certainty whether you face the optimistic (70%) or pessimistic (30%) adoption scenario. Assume there is a 50% chance of each scenario occurring (50/50). Should you take the company up on this service? Justify your answer. SHOW YOUR WORK