CASE 17 QUESTIONS

SEATTLE CANCER CENTER

Leasing Decisions

1. As a baseline, assume all cash flows have the same risk; that is, ignore residual value risk and use the same discount rate for all lessee and lessor cash flows.

a. Should the Center lease the equipment? Should GBF write the lease?

b. Who is getting the better deal? Explain.

c. What is the maximum lease payment that the Center would be willing to pay? What is the minimum lease payment that GBF would be willing to accept?

d. What factor influence whether the actual lease payment will be closer to the Center's maximum lease payment or GBF's minimum lease payment?

2. This lease is attractive to both parties because there is asymmetry of inputs between the lessee and lessor.

a. What are these asymmetries?

b. What would be the result if there were no asymmetries? Prove it.

3. The Center is considering the inclusion of a cancellation clause in the lease contract, in which it could cancel the lease at any time after giving a minimum 30 day notice.

a. What impact would a cancellation clause have on the risk of the lease to the Center and the risk of the lease to GBF? Why? No additional calculations are required.

b. What might GBF do to compensate for the change in risk? No additional calculations are required.

4. GBF has indicated that it would be willing to write a lease at a rate of $7,000 per procedure. Compare the risk of the per procedure lease to the conventional lease from the perspectives of both the lessee and lessor. (Hint: Graph the annual profit of a per-procedure lease and the annual profit of an annual lease against the number of procedures and interpret the graph.)

5. What would be the NAL to the Center if tax-exempt (municipal) debt financing was available to the Center? Would the availability of tax-exempt debt financing make leasing more or less attractive to the Center than before? Why? (Assume all cash flows have the same risk; that is, use the same discount rate on all lessee cash flows.)

6. What is the NAL to the Center after adjusting for the riskiness inherent in the residual value? Does recognition of residual value risk make leasing more or less attractive to the Center than before? Why?

7. Return to baseline assumptions. GBF will probably obtain a $1,500,000 simple interest loan from its bank at a cost of either 7 or 9 percent that it would use to leverage the lease. Should the lessor take the loan if the interest rate is 7 percent? Should the lessor take the loan if the interest rate is 9 percent? Justify your answer.

8. If the Center decides to lease, will the lease be classified as a capital lease and shown directly on the balance sheet? Show your calculations.

9. a. From the perspective of the Center, what types of financial risk are present in this decision? b. Finally, considering all relevant factors, including the possibility of obtaining a cancellation clause or a per procedure lease, what should the Center do, lease or buy? Case Questions Cases in Healthcare Finance Questions - 2

10. In your opinion, what are three key learning points from this case?