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M.D Peterson Cancer M.D Peterson Cancer Center Center Lease vs. Purchasing Lease vs. Purchasing Phil Hickmon Phil Hickmon 2005 2005
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M.D.Peterson Case Pw Pt Final

Jan 17, 2015

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Page 1: M.D.Peterson Case Pw Pt Final

M.D Peterson Cancer Center M.D Peterson Cancer Center Lease vs. PurchasingLease vs. Purchasing

Phil HickmonPhil Hickmon20052005

Page 2: M.D.Peterson Case Pw Pt Final

The Gamma KnifeThe Gamma KnifeThe Gamma KnifeThe Gamma Knife

Gamma Knife surgery is recognized worldwide as the preferred treatment for meta-static brain tumors and has successfully treated primary brain tumors and arteriovenous malformations. It is proven safe over the long term and is recognized and covered by most insurance plans.

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Advantages Of The Gamma KnifeAdvantages Of The Gamma KnifeAdvantages Of The Gamma KnifeAdvantages Of The Gamma Knife

Gamma Knife is a neuro-surgical tool designed exclusively for the treatment of brain disorders.The lesion being treated receives a high dose of radiation with minimum risk to nearby tissue and structures (non-invasive).The cost of Gamma Knife procedure is often 25 to 30 percent less than traditional neurosurgery.Patients experience little discomfort.The absence of an incision eliminates the risk of hemorrhage and infection.Hospitalization is short, typically an overnight stay. Gamma Knife technology allows treatment of inoperable lesions.

The procedure offers hope to patients who were formerly considered untreatable or at very high-risk for open-skull surgery.

Page 4: M.D.Peterson Case Pw Pt Final

The Center’s (Lessee’s) PlansThe Center’s (Lessee’s) PlansThe Center’s (Lessee’s) PlansThe Center’s (Lessee’s) Plans

Acquiring a new Gamma Knife to replace its current model.

Gamma Knife is viewed as a “BRIDGE,”“BRIDGE,” due to the opening of a new facility in four years. Thus, the center is considering a leaselease with GB financing (Finance decision and investment decision). This lease will be a contract that will obligate the medical center (the lessee) to make periodic payments to the (lessor) GB financing over the span of a lease term. However, MD is also looking at PurchasingPurchasing the Gamma Knife.

--Obtaining “Obtaining “tax-exempt” financingtax-exempt” financing should it be purchased. should it be purchased.Possibly writing in a ““Cancellation ClauseCancellation Clause.”.”Writing in a ““Per Procedure ClausePer Procedure Clause.” .”

Page 5: M.D.Peterson Case Pw Pt Final

Leasing Vs. Purchasing Leasing Vs. Purchasing Queries…. Queries….

Leasing Vs. Purchasing Leasing Vs. Purchasing Queries…. Queries….

1.1. Will this leas eliminate the risk of technology obsolescence? Will this leas eliminate the risk of technology obsolescence? 2.2. Will Leasing save the MD center money? Will Leasing save the MD center money? 3.3. Can Leasing can give the medical center the opportunity to Can Leasing can give the medical center the opportunity to

share the residual risk with the lessor and deploy their share the residual risk with the lessor and deploy their cash elsewhere? cash elsewhere?

4.4. What dollar cost analysis will give the advantage to the What dollar cost analysis will give the advantage to the Medical Center? Medical Center?

5.5. Is leasing better? Is purchasing better? How? Why? Is leasing better? Is purchasing better? How? Why?

Page 6: M.D.Peterson Case Pw Pt Final

Leasing The Gamma Knife… Leasing The Gamma Knife… Leasing The Gamma Knife… Leasing The Gamma Knife…

Will require no down paymentWill require no down payment and finances only the value of the equipment expected to be depleted during the lease term.

MD will have an option to buyan option to buy the equipment for its remaining value at lease end.

The leased equipment itself is usually all that is needed to secure a lease transaction.

MD can transfer all risk of obsolescenceall risk of obsolescence back to the lessor, as there is no obligations to own equipment at the end of the lease.

If this lease is structured as a true leaseas a true lease, the center may claim the entire lease payment as a tax deduction.

More of the cash flowof the cash flow, especially the option to purchase the GK, occurs later in the lease term when inflation makes dollars cheaper.

Page 7: M.D.Peterson Case Pw Pt Final

Purchasing The Gamma KnifePurchasing The Gamma KnifePurchasing The Gamma KnifePurchasing The Gamma Knife

Will require MD to invest a down payment in the equipment. The loan finances the remaining amount (debt financing). Usually requires the borrower to pledge other assets for collateral.

MD bears all the riskbears all the risk of equipment devaluation because of new technology.

MD may claim a tax deductionmay claim a tax deduction for a portion of the loan payment as interest and for depreciation that is tied to IRS depreciation schedules.

A larger portion of the financial obligation is paid in today's more expensive dollars.

As a result, the lease-versus-buy decision can be a As a result, the lease-versus-buy decision can be a complex one. complex one.

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or

““Debt Financing” Debt Financing”

““Finance and Finance and Investment Decision”Investment Decision”

Page 9: M.D.Peterson Case Pw Pt Final

MD’s Accounting For Lease ArrangementMD’s Accounting For Lease ArrangementMD’s Accounting For Lease ArrangementMD’s Accounting For Lease Arrangement

The life of the lease is at least 75% of the asset’s life.

The ownership of the asset is transferred to the lessee at the end of the life of the lease.

There is a “bargain purchase” option, whereby the purchase price is below expected market value, increasing the likelihood that ownership in the asset will be transferred to the lessee at the end of the lease.

The present value of the lease payments exceeds 90% of the initial value of the asset.

Page 10: M.D.Peterson Case Pw Pt Final

Lease Analysis (Residual Forecasts)Lease Analysis (Residual Forecasts)Lease Analysis (Residual Forecasts)Lease Analysis (Residual Forecasts)

Lessor (GBF)Lessor (GBF) $1,500,000 $1,500,000

Residual values:Residual values: At the end of a lease or loan term, the At the end of a lease or loan term, the gamma knife is likely to have some resale value. This value is gamma knife is likely to have some resale value. This value is

called the residual, or called the residual, or salvage value.salvage value. If the lessee renews If the lessee renews the lease, the residual value will be the amount that is that is the lease, the residual value will be the amount that is that is renewed.renewed.

Lessee (MD)Lessee (MD) 25% that the residual value (salvage) value after four years 25% that the residual value (salvage) value after four years

will be $500,000. will be $500,000. 50% that it will be $1,000,000 50% that it will be $1,000,000 25% that its salvage value will be $2,000,000. 25% that its salvage value will be $2,000,000. Most likely: $1,000,000 or EV of $1,125,000Most likely: $1,000,000 or EV of $1,125,000

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Lease Analysis Data Lease Analysis Data Lease Analysis Data Lease Analysis Data

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Modified Accelerated Cost Recovery Modified Accelerated Cost Recovery System (MACRS) System (MACRS)

Modified Accelerated Cost Recovery Modified Accelerated Cost Recovery System (MACRS) System (MACRS)

Page 13: M.D.Peterson Case Pw Pt Final

Lessee’s Dollar Cost AnalysisLessee’s Dollar Cost AnalysisLessee’s Dollar Cost AnalysisLessee’s Dollar Cost Analysis

Page 14: M.D.Peterson Case Pw Pt Final

Percentage Costs AnalysisPercentage Costs Analysis(Net Cost of Leasing vs. Owning)(Net Cost of Leasing vs. Owning)

Percentage Costs AnalysisPercentage Costs Analysis(Net Cost of Leasing vs. Owning)(Net Cost of Leasing vs. Owning)

Does this give the Center an advantage? Does this give the Center an advantage? Does this give the Center an advantage? Does this give the Center an advantage?

Page 15: M.D.Peterson Case Pw Pt Final

Lessor’s Dollar Costs Analysis Lessor’s Dollar Costs Analysis Lessor’s Dollar Costs Analysis Lessor’s Dollar Costs Analysis

$$ CASH FLOW $$$$ CASH FLOW $$

Page 16: M.D.Peterson Case Pw Pt Final

Lessor’s Leveraged Lease…Lessor’s Leveraged Lease…Lessor’s Leveraged Lease…Lessor’s Leveraged Lease…

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Comparing Dollar Costs Analysis Comparing Dollar Costs Analysis Comparing Dollar Costs Analysis Comparing Dollar Costs Analysis

What will give the medical Center the better advantage? What will give the medical Center the better advantage?

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Lessee Cancellation Clause…. Lessee Cancellation Clause…. Lessee Cancellation Clause…. Lessee Cancellation Clause….

This particular lease is an “operating lease,” often known as a rental agreement.

It has the following features: the term of the lease is usually considerably shorter than the expected useful life of the asset; and it is cancellable cancellable by the lessee at short notice with little or no additional cost or contractual penalty.

Cancellation clausesCancellation clauses in leases can allow you to end the lease at any time, simply by returning the equipment. This can be of benefit should MD decide the equipment is not what they need or if better options arise.

Usually, a fee is requireda fee is required to cancel, but not in all cases. MD should make sure that if a cancellation fee exists it is reasonable.

Page 19: M.D.Peterson Case Pw Pt Final

Tax Exempt Financing Tax Exempt Financing (purchasing the GK) …. (purchasing the GK) …. Tax Exempt Financing Tax Exempt Financing

(purchasing the GK) …. (purchasing the GK) ….

If lease payments are made over a period much shorter than the GK’s life and the MD is allowed either to continue leasing the asset at a nominal amount or to buy the asset at a price below market, the IRS may view the lease as a loan and prohibit the lessee from deducting the lease payments in the year(s) in which they are made.

Thus, this is a type of lease in which implied interest payment is non taxable to the lessor. Since the lessor gains the tax exempt status of the interest payment, GBF should therefore provide a small payment due to the lessee.

As a consequence, leasing is not automatically less costly for non for profit firms. Since this is a short term lease, applying for tax exempt Since this is a short term lease, applying for tax exempt status would probably be more costly than the actual achieved gain.status would probably be more costly than the actual achieved gain.

Page 20: M.D.Peterson Case Pw Pt Final

Lessor Per Procedure Clause…. Lessor Per Procedure Clause…. Lessor Per Procedure Clause…. Lessor Per Procedure Clause….

GBF has been writing such leases on terms of $7,500 to 9,500 per procedure.

Is this better for the Lessor or Lessee?Is this better for the Lessor or Lessee?

MD risk is reduced…..

Possibly, both parties can benefit. If GBF can write offwrite off a large number of per procedure leases.

Nevertheless, without knowing the total utilization the risk is transferred to the Lessor (GBF).

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Recommendations For M.D. Peterson Recommendations For M.D. Peterson Medical CenterMedical Center

Recommendations For M.D. Peterson Recommendations For M.D. Peterson Medical CenterMedical Center

The result of the lease versus buy analysis shows that the proposed lease agreement is is the fiscally responsible decision. the fiscally responsible decision.

Healthcare Environment:Healthcare Environment: The GK equipment lease will allow the medical center to maintain a state-of-the-art health care facility.

Increasing Technology:Increasing Technology: If executed properly, this lease will provide flexibility and shifts technology risk to the lessor. Lessors are compensated for taking risk, and the specific terms and end-of-lease details for each leasing transaction ultimately determine the cost of that flexibility.

Bottom Line: Bottom Line: The PV of owning is ($1,668,666) and the PV of leasing totals ($1,489,661). With a positive net advantage of leasing (NAL) equaling $179.006net advantage of leasing (NAL) equaling $179.006, the figure affirms that leasing creates more value than buying in this particular situation.

The lessee’s IRR is 2.5%, which is well below the initial rate of 7%.IRR is 2.5%, which is well below the initial rate of 7%. This, of course, is another positive indicator to lease the Gamma Knife.

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The EndThe End

Thank You! Thank You!

Questions and Discussion Questions and Discussion