Question

Introduction: In the greater Seattle-Tacoma area, an arms race continues between hospitals to gather the most modern technology available to use on their patients - currently this arms race's primary device of choice-robotic surgical systems. Why robotic surgical systems? These systems in theory allow surgeons to be more precise in performing complex surgical procedures on patients. With greater precision comes a greater chance of successfully healing the patient as well as reducing the patient's possibility for complications and recovery time. In addition to these benefits, hospitals through the use of superior technology can serve more patients and potentially reap greater benefits from insurance companies and patients for these advanced medical services The price of this superior care though comes at a cost to the patient increased charges) as well as purchase costs to the hospital. One of the most popular robotic systems is called da Vinci and is manufactured and sold by Intuitive Surgical (http://www.intuitivesurgical.com/). The da Vinci was FDA approved in July 2000 and can currently perform urologic, gynecologic, colorectal, head and neck, cardiothoracic, and other general surgery procedures. As important as the device is the surgeon that is trained in the use of the system. The more repetitions on the robotic system, the more skillful the surgeon becomes Depending on the options that a hospital chooses to purchase, the cost of a da Vinci system can range between 1 million and 3 million dollars with the associated sales taxes. As with all surgical instruments, there are also disposable items needed during a surgery associated with equipment-specifically the da Vinci which must also be purchased. These items range from $1,000 to $3,000. Finally, as with many pieces of sophisticated electronic technology. It must be $200.000 a year. In addition to these specific costs on that this equipment occupies as well as utilize all the must be m ined The maintenance costs can be upwards to addition to these specific cost hospitals must continue to maintain the surgical men occupies as well as utilize all other supplies that would be used in any utca The Deal: A local hospital in the Pupet Sound area faced a dilemma in the medical arms race. Surrounding hospitals were purchasing and willing the da Vinci robot system. Management began to worry about the erosion of patients that would seek out this modern technology over more traditional surgical procedures. To this end a strategic decision was made to acquire the da Vinci robotic surgical system. The following data was presented to an analyst in the Finance Department for review
Table Lease Term: 36 Months
Lease Payment: $68,742.10
Purchase Price: $1.900000.00
Quite often, analysts are provided leasing information by the leasing company. Hospitals may choose to purchase equipment outright or acquire equipment using a lease. Leases are generally considered operating or capital leases under current accounting rules. Hospitals may purchase equipment outright if they have sufficient capital money that can be used to purchase equipment of significant amount-usually greater than $5,000). Otherwise, they may decide that if the interest rate of payments being charged is lower than their internal cost of capital (debt financing, equity financing, etc.), they may utilize the lease directly from the equipment seller.
Given the information provided in Table :
1. What is the annual rate of interest beine charped to the hospital? The total interest paid over the entire term of the lease?
2. Given this rate of interest. give some reasons on why or why not the hospital should accept this lease contract. Is this a good deal for the lessee?
3. Why would a hospital care whether it was a collease or an operating lease? When would one be an advantage over the other?

Answer 1

Answer:

The da Vinci Surgical Equipment

1. 1. The annual rate of interest being charged to the hospital for this da Vinci surgical equipment is computed as 18.055%.  

The computed total interest that the hospital will pay over the 36 months' period = $574,715.60.

2. This rate of interest is too high.  The hospital could borrow the sum of $1,900,000 from other sources without paying as high an interest rate.  Therefore, it is not a good deal for the lessee hospital.

3. The hospital should care if the lease were either an operating or capital lease.  An operating lease means that the hospital can only use the equipment for a determined number of years, which is usually less than the useful life of the equipment.  But if it were a capital lease, the hospital is sure that the equipment becomes its own property.

Explanation:

a) Data and Calculations:

Cost of equipment = $1,900,000

Monthly lease payment = $68,742.10

Lease period = 36 months

Using an online financial calculator:

Interest Rate = 18.055%

Total of 36 Monthly Payments = $2,474,715.60

Total Interest Paid = $574,715.60