Valuing Capital Investment
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Author: Xuanqian XieIn this chapter, we introduce the rules of valuing the relatively large investment of medical equipm

Author: Xuanqian Xie

In this chapter, we introduce the rules of valuing the relatively large investment of medical equipments. We will discuss the equivalent annual costs (EAC), procedure cost and life cycle costs and briefly extend our discussion to value the old technology and the land. In the Appendix, I present a few lines of SAS code to calculate the EAC by different ways.  

 

Equivalent annual costs

With the same present value, the medical device with longer lifespan is more economic. Therefore, although usually the capital investment is happened at the beginning of health care program, it is helpful to use EAC in the cost analysis. Wiki website defines that “equivalent annual cost (EAC) is the cost per year of owning and operating an asset over its entire lifespan.” It can be expressed in the following formula with discounting:

To estimate PV, we need think about the operating cost, maintenance cost and the residual value at the end of service life. Sometimes the maintenance cost is difficult to estimate, as no one knows exactly how much maintenance should be done before using it. We can consider using the price of purchasing the warranty service plan instead of estimating the maintenance cost. The residual value refers to the value after depreciation at the end of the service life. Residual value is slightly different from salvage value. Some researchers like to use salvage value (the resale value) to estimate the value of the medical equipment at the end of service life. I prefer the residual value, since I do not think the medical equipments can be resold, at least in the developed countries. Many medical devices also have some disposable components used for each procedure, which belongs to the marginal cost (extra cost to produce one extra unit of output). Do not forget all costs are necessary to be discounted to present values.

Now, I give you a real example to illustrate how to apply the EAC. We evaluated the radiofrequency ablation (RFA) by BÂRRX Medical Inc. for Barrett’s esophagus in 2009 (Xie et al., 2009).  The purchasing cost for the HALO 360/90 generator is $82,041. The equivalent annual cost (EAC) is $16,164 assuming a service lifespan of 6 years and annual interest rate of 5%. It is assumed that 21 sessions of RFA would be performed at MUHC per year (7 patients with an average of 2 circumferential RFA and 1 focal RFA). Therefore, the fraction of EAC attributable to each session is $770 ($16,164 divided by 21). The major costs of the RFA procedure are listed in Table 3. The total cost per patient for 3 sessions is about $11,208. The recurring budget impact would be about $78,456, with 80% of the cost being due to the cost of the disposable catheters.

In practice, we often assumed 5 to 8 years of the service life of the large medical equipments, although physically the service life can be longer than 8 years. I will use a chapter to discuss the discount rate later, so I do not introduce the details of how/why I used 5% in this case. My main consideration is the device is a high-tech product and would be depreciated quickly.   

 The flowchart of cost estimate process

Not always, but usually, we prefer to know the cost procedure, because we want to compare the procedure costs by one intervention with that by alternatives.

 

 

 

Life cycle cost

 

Life cycle cost is the sum of all costs associated with the asset throughout its life, including planning, acquisition, installation, operation, maintenance and disposal costs (New South Wales Treasury, 2004). When the operating cost and maintenance cost are rather high, it is misleading to simply present the initial capital cost.

 

Valuing the old equipment

There are some different approaches to value the used equipments. Most large institutes have their own methods to estimate the residual values of the used machines/equipments. You can consult the accounting department of the hospitals for it. Also, you may invite the exporters to guess the current market value of it.     

 

Renting the equipment

Sometimes, we may rent the expensive healthcare equipment. And when there are many uncertainties of the volume of health care services, the hospitals prefer to rent, not purchase the equipments. Also, they can both buy and rent some device, such as Table 6 of VAC for negative press wound therapy (page 38, Xie & McGregor, 2010). In this condition, you need consider both renting and purchasing in procedure cost estimate.   

 

Value of land 

Some health care programs need purchase land as part of capital investment. The value of the land can be changed over time. In practice, if the duration of the health program does not last very long, we can assume the value of land does not change in the cost analysis, since the land for health program is unlikely to be resale for business at the end of this program. 

 

 

Reference:

 

Xie X, McGregor M, Dendukuri N. Radiofrequency ablation for treatment of Barrett’s esophagus: A systematic review and cost analysis. Montreal (Canada): Technology Assessment Unit (TAU) of the McGill University Health Centre (MUHC); 2009 Nov 12. Report no. 46. 37 p. Available from:

Link: https://secureweb.mcgill.ca/tau/sites/mcgill.ca.tau/files/BARRETTs_ESOPHAGUS_REPORT.pdf

New South Wales Treasury. 2004. Life Cycle Costing Guideline.

Link: http://www.treasury.nsw.gov.au/__data/assets/pdf_file/0005/5099/life_cycle_costings.pdf

Xie X, McGregor M. Negative Pressure wound therapy (NPWT): update of report 19. Montreal (Canada): Technology Assessment Unit (TAU) of the McGill University Health Centre (MUHC); 2010 Jun 25. Report no. 48. 49 p. Available from:

https://secureweb.mcgill.ca/tau/sites/mcgill.ca.tau/files/NPWT_FINAL.pdf

 

 

 

Appendix: SAS program for calculating the EAC

 

options nodate pageno=1 ps=120 ls=80;

options mprint mlogic symbolgen;

 

%let n=10; /*N of year*/

%let rate=0.05; /*discount rate*/

%let be=1; /*Be=1, no discount for the first year; Be=0, discount for the first year.*/

%let Cap=50000;  /*Capital investment */

 

 

/*solution 1: */

data _null_;

do y= 1 to &n;

div=(1+&rate)**(y-&be);

dd=(1/div);

temp+dd;

output;

end;

call symputx("asd",put(temp,10.6));

EAC=put (&Cap/symget("asd"), 10.0);

put "EAC=" EAC;

run;

 

/*solution 2: */

data bb;

do y= 1 to &n;

div=(1+&rate)**(y-&be);

dd=(1/div);

output;

end;

run;

 

proc sql noprint;

select sum (dd) into: asd1

from bb;

quit;

 

%put &asd;

%put &asd1;

 

data _null_;

EAC1= put (&Cap/&asd1, 10.2);

put "EAC=" EAC1;

run;

 

 

/*solution 3: */

data _null_;

format EAC2 8.2;

if &be=0 then EAC2=(&Cap * &rate) /( 1- 1/(1+&rate)** &n);

if &be=1 then EAC2=(&Cap * &rate) /( 1+ &rate - 1/(1+&rate)**(&n-1));

put "EAC=" EAC2;

run;