Delta Star

Capital Budget Case- Delta Star Incorporated

Description of the Company:

Delta Star Incorporated is a family owned and operated convalescent care facility and the family owns other convalescent care facilities and non-related businesses. The owners want to expand their business and are considering constructing a new twenty six bed convalescent unit in a new area where the demand and reimbursement returns are similar to their present business. The second investment option being considered by Delta Star Incorporated is the construction of a new twenty six bed maximum care facility that would specialize in a maximum care equipment and care for patients requiring total respiration support and maintenance. The patient reimbursement rates are 20 percent higher in the maximum care facility, however the federal requirement for nursing hours per patient are 5 percent higher than a convalescent unit. The plan is to operate the new business venture for 10 years and then liquidate all assets.

Beside the dilemma of investing in a convalescent facility or maximum care facility, the company is plagued by sloppy management and the owners believe that dietary and laundry operating costs are higher than necessary. The pro forma income statement for 1989 has not been adjusted upward for inflation for laundry and dietary services under the assumption that the future management will be more efficient and achieve a 3 percent reduction in these expenses which could affect the projected income. Some other potential issues that can affect the company’s earnings include a change in the reimbursement rates, change in the federal nursing hours per patient, and litigation.

Analysis of Investment Alternatives

Investment Option 1 Convalescent Unit:

The first option is to construct a twenty-six bed convalescent facility in a new area where the demand and price structure was similar to those currently experienced by the company. This is the business that they are experienced with and...