Fair Lakes Hospital Corporation has been operating ambulatory surgery centers in Groveton and Stockdale, two small communities each about an hour away from its main hospital. As a cost control measure the hospital has decided that it needs only one of those two centers permanently, so one must be shut down. The decision regarding which center to close will be made on financial considerations alone. The following information is available:
a. The Groveton center was built 15 years ago at a cost of $5 million on land leased from the City of Groveton at a cost of $40,000 per year. The land and buildings will immediately revert back to the city if the center is closed. The center has annual operating costs of $2.5 million, all of which will be saved if the center is closed. In addition, Fair Lakes allocates $800,000 of common administrative costs to the Groveton center. If the center is closed, these costs would be reallocated to other ambulatory centers.
If the center is kept open, Fair Lakes plans to invest $1 million in a fixed income note, which will earn the $40,000 that Fair Lakes needs for the lease payments.
b. The Stockdale center was built 20 years ago at a cost of $4.8 million, of which Fair Lakes and the City of Stockdale each paid half, on land donated by a hospital benefactor. Two years ago, Fair Lakes spent $2 million to renovate the facility. If the center is closed, the property will be sold to developers for $7 million. The operating costs of the center are $3 million per year, all of which will be saved if the center is closed. Fair Lakes allocates $1 million of common administrative costs to the Stockdale center. If the center is closed, these costs would be reallocated to other ambulatory centers.
c. Fair Lakes estimates that the operating costs of whichever center remains open will be $3.5 million per year.
The City Council of Stockdale has petitioned Fair Lakes to close the Groveton facility, thus sparing the Stockdale center. The Council argues that otherwise the $2 million spent on recent renovations would be wasted. Do you agree with the Stockdale City Council’s arguments and conclusions? In your answer, identify and explain all costs that you consider relevant and all costs that you consider irrelevant for the center-closing decision.
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