- 15 Marks
Question
The Faith Specialist Hospital (FSH) is a special government health facility under the Ghana Health Service (GHS) that provides specialized medical scans for complex health conditions. Management of FSH is planning to install an ultra-modern imaging machine that will improve the quality and accuracy of scans. The new installation will require an additional capital investment of GH¢420,000. The GHS policy on capital projects is that all new projects should achieve an internal rate of return of at least 30%.
Forecast demand for the services of this new machine over its five-year useful life are as follows:
| Year | Number of Scans |
|---|---|
| 1 | 1,250 |
| 2 | 2,700 |
| 3 | 3,500 |
| 4 | 1,400 |
| 5 | 675 |
Projected charge per scan: GH¢650
Variable costs per scan:
- Consumables: GH¢330
- Labour and overheads: GH¢176
Operating fixed costs per year: GH¢264,000 (includes depreciation on a straight-line basis)
Apart from the financial forecasts above, it is also envisaged that the project will produce non-financial benefits in several forms. Although it is hard to place a precise value on this, expert opinion suggests that this could approximate GH¢70,000 per annum.
Required:
i) Using cost-benefit analysis (CBA) computations, evaluate if the project should be undertaken.
ii) Enumerate TWO limitations of evaluating projects in the public sector.
Answer
Computation of Net Cost/Benefit
Contribution per Scan:
| GH¢ | |
|---|---|
| Charge per Scan | 650 |
| Less: Consumables | (330) |
| Less: Labour and Overheads | (176) |
| Contribution per Scan | 144 |
Net Cashflows Computation
| Year | Sales Volume | Contribution @ GH¢144/unit | Fixed Costs (Cash) | Net Cashflow | Non-Cash Benefits | Net Benefits |
|---|---|---|---|---|---|---|
| 1 | 1,250 | 180,000 | (180,000) | 0 | 70,000 | 70,000 |
| 2 | 2,700 | 388,800 | (180,000) | 208,800 | 70,000 | 278,800 |
| 3 | 3,500 | 504,000 | (180,000) | 324,000 | 70,000 | 394,000 |
| 4 | 1,400 | 201,600 | (180,000) | 21,600 | 70,000 | 91,600 |
| 5 | 675 | 97,200 | (180,000) | (82,800) | 70,000 | (12,800) |
Present Value Calculation @ 30%
| Year | Net Benefits (GH¢) | Discount Factor @ 30% | Present Value (GH¢) |
|---|---|---|---|
| 0 | (420,000) | 1.000 | (420,000) |
| 1 | 70,000 | 0.769 | 53,830 |
| 2 | 278,800 | 0.591 | 164,770.80 |
| 3 | 394,000 | 0.455 | 179,270 |
| 4 | 91,600 | 0.350 | 32,060 |
| 5 | (12,800) | 0.269 | (3,443.20) |
| Total Present Value (NPV) | 6,487.60 |
Conclusion: Since the NPV is positive (GH¢6,487.60), FSH should undertake the project.
ii) Limitations of Evaluating Public Sector Projects
- Difficulty in Quantifying Benefits – Many public sector projects provide social benefits that are not easily measurable in monetary terms.
- Unpredictable Flow of Funds – Public sector projects often face funding delays or budgetary constraints, which can affect project implementation.
- Uncertain Project Life Span – Some projects may have long-term or indefinite durations, making it difficult to determine useful life for evaluation.
- External Factors – Government policies, political changes, and economic conditions can impact project success and expected benefits.
- Tags: Capital Budgeting, Cost-benefit analysis, Investment Appraisal, IRR, Public Sector
- Level: Level 2
- Topic: Introduction to capital budgeting
- Series: Nov 2024
- Uploader: Salamat Hamid