SOLUTION TO CASE QUESTION 6

SOLUTION TO CASE QUESTION 6 The focus of this case is the analysis of some of the common operating challenges that a growing company may encounter in the course of its expansion and operating life, INEVESU Hospital Plc was an outgrow of a private company which emerged from the merger of three owner-managed private clinics of its founders. The need to be listed on the Stock Exchange was precipitated by capital requirement to construct another hospital at the Federal Capital Territory in order to capture the emerging market of health delivery in the city. This opportunity was made possible by the relocation to Abuja, of some top civil servants and major customer of this classic health delivery private hospital The narration in the case touched, on the following nine issues among others which could serve as eye-opener to reader the major thrust of the case. The composition of the management team mainly medical doctors and two Chartered Accountants of the status of Fellow and the knack of the hospital for dealing with experts in any held, they needed assistance. The immediate realization of the management of the declining trend of the company's performance, the cause of the decline and the solution require to stern the tide. The investment strategy of the management i. The company threat each hospital as autonomous legal entity ii. Diversification into pharmaceutical business by 80% equity ownership of Utombon, a company which also has 20% equity ownership in another company that is a major supplier of pharmaceutical products iii. The strategic focus made them to obtain court order that same Jokesam Pharma Stores Ltd. From forced liquidation iv. The execution of share buy back option within the companies of statutory provision. The behaviour of Mr. Marcus-the General Manager who wrongfully exploited the weakness of internal control on cash management, in overt use of cheque exchange and approval of advance to himself without seeking necessary approval. The weakness in reporting line and the position of Internal Auditor, who was made responsible to the General Manager on whose activities the Internal Audit report should cover. This privilege was abused by the General Manager by suppressing the report that would have implicated him. The apparent forced resignation of Mr. Marcus, the denial by the Chairmen Of Inevesu Hospital Plc to pay him the legally contracted entitlement under the company's retirement and pension scheme and the threat of reporting him to ICAN for disciplinary action if he should continue to lay Claim for his entitlement. The registration of the hospital under the National Health Insurance Scheme and the likely effect on its overall revenue. The new billing system which appear to encroach on the liberty of consultant doctors in the area of charging patient on consulting hours spent with doctors which will indirectly constitute a check in the efficiency of each doctor. STARRY GOLD ACADEMY +2348023428420, +2347038174484, info@starrygoldacademy.com, www.starrygoldacademy.com Page 1

The high profile outlook of the hospital and their need to exploit lower income market in health delivery in order to boost the company's overall income. ANALYSIS OF QUESTIONS Question 1.1 The question requires the following: (a) Identification and outline of major reasons mentioned in the case for the declining revenue of the hospital. (b) Understanding of simple arithmetical principle of calculating marginal increase - incremental change. (c) Computation of break even point based on data in Schedule II. Question 1.2 - Requires the basic understanding of the calculation of capital allowance and its effect on the company's profit if compare with a situation in which there is no capital allowance. Question 1.3 - Requires simple calculation of net present value and internal rate of return to generate the cost of capital that would be compared with the company benchmark rate of 20%. Question 1.4 The question tests the ability to employ the understanding of the calculation of dividends from own operation and that of subsidiary to ascertain cross dividend accruable to the shareholders of the holding company - Inevesu Hospital Plc. Question 1.5 Requires the preparation of mechanical bill using the new billing system and to evaluate its effect on revenue generation compared with old system which was not given in the case. Question 1.6 a. Requires evaluation of the revenue based on the existing change out rate and the rate to be paid By HMO using the capitation system b. Proper understanding of the difference between mission statement and vision statement. STARRY GOLD ACADEMY +2348023428420, +2347038174484, info@starrygoldacademy.com, www.starrygoldacademy.com Page 2

Question 1.7 a. Specific knowledge of the provision of section 387 (i) and section 254 (i) of companies and Allied Matters Act 1990 is required to answer the question. b. Requires specific understanding of the provision of section 161 and 162 of CAMA on share by bank, and the implication of reduced number f shareholders on dilution of control. Question 1.8 This question requires the knowledge of major issues raised in the case note and their implications on listed as highlighted on the areas in which specific comment is required point 4-6 in the tutorial captioned these issues. Suggested solution 1.1 a. The following are the causes of the pessimism expressed in the heath care business. i. Erosion of purchasing power with the economy which called for choice of less expansive health care delivery services ii. iii iv. The hospital management had concentrated attention on the serving of Top Civil Servants.. The Top Civil Servants which are the target market are moving to Ajabu City, hence a severe drop in patronage at Ajeki City Drop in patronage at Ajeki City caused the hospital to look for the possibility of constructing another 100 bed hospital at Ajabu City which is a drain on their resources and exposure to the public for financing. v. It was not the intention of the hospital to cater for other categories of workers which is a matter to be viewed very seriously by the management if survival is to be sustained. b. Incremental increase analysis STARRY GOLD ACADEMY +2348023428420, +2347038174484, info@starrygoldacademy.com, www.starrygoldacademy.com Page 3

Year Ajeki Ajabu Cumulative Marginal Increase Effect 1. 267,600 100,000 367,600-2 252,300 112,400 364,700-3 166,600 160,820 327,420 (33,380) 4. 175,800 185,300 361,100 29,780 5. 175,400 206,380 381,780 22,680 19,080 STARRY GOLD ACADEMY +2348023428420, +2347038174484, info@starrygoldacademy.com, www.starrygoldacademy.com Page 4

From the above analysis, it can be concluded that the National Health Insurance Scheme with a standard capitation system would result into a marginal improvement in the revenue based on INVEVESU Hospital Plc. (c) Calculation of Break Even Point (BEP) in patients BEP = Fixed Cost C Where BEP = Break Even Point C = Contribution Where Fixed cost = N5,000,000 C = 24,400 BEP = 24,000 = 205 Therefore, the hospital would have to treat a minimum of 205 patients to break even within a short period. SUGGESTED SOLUTION 1.2 COMPUTATION OF CAPITAL ALLOWANCES FOR AJABO HOSPITAL PLC LAND & BUILDING PLANT & MAGI HOSP EQUP FURN & EQUIP FURN & FITTING TOTAL Rates % IA 5 50 50 50 50 AA 10 25 25 25 25 Cost 1800,000 60,000 30,000 20,000 10,000 300,000 (N000) 1996 IA 27,000 30,000 15,000 5,000 STARRY GOLD ACADEMY +2348023428420, +2347038174484, info@starrygoldacademy.com, www.starrygoldacademy.com Page 5

AA 15,300 (42,300) 7,500 (37,500) 3,750 (18,750) 3,000 (8,000) (4,000) (110,550) WDV 137,700 22,500 11,250 12,000 6,000 180,450 1997 AA (15,300) 7,500 (3,750) (3,000) (1,500) (31,050) WDV 122,400 15,000 7,500 9,000 4,500 158,400 1998 - - 72,000 72,000 Additions IA 36,000 AA (15,300) (7,500) 12,750 (48,750) (3,000) (1,500) (76,050) WDV 107,100 7,500 30,750 6,000 3,000 154,350 Where: I.A. = Initial Allowance A.A. = Annual Allowance WDV = Written Down Value EFFECT ON EARNED PROFIT 1999 N000 N000 N000 Profit Before Tax 62,500 Add: Depreciation 50.000 Adjusted Profit 112,500 Less: capital Allowance 110,550 Restricted 66 2 / 3 % of Earned Income (75,000) {75,000) unrelieved capital Allowance 35,550 Taxable Profit 37,500 corporate tax 30% 11,750 Education Tax 2 % 2,250 (13,500) Profit After Tax 24,000 STARRY GOLD ACADEMY +2348023428420, +2347038174484, info@starrygoldacademy.com, www.starrygoldacademy.com Page 6

1997 N000 Profit Before Tax 70,250 Add: Depreciation 20,000 Adjusted Profit 90,250 Less: Capital Allowance 31,050 Unrelieved Capital Allowance 35,550 66,600 Restricted to 66 2 / 3 % of Earned (60,167) (60,167) Income Unrelieved c/f 6,433 - Taxable Profit 30, 083 Corporate Tax 30% 9,025 Education Tax 2% 1,805 (10,083) Profit After Tax 20,000 1998 profit Before Tax 90,250 Add: Depreciation 27.200 Adjusted Profit 117,450 Less: Capital Allowance 76.050 Add: Unrelieved Capital Allowance 6,433 82,483 Restricted 66 2 / 3 % of Earned Income (78,300) (78,300) Unrelieved c/f 4,183 - Taxable Profit 39.150 Corporate Tax 30% 11,745 Education Tax 2% 2,349 (14,094) Profit After Tax 25.056 STARRY GOLD ACADEMY +2348023428420, +2347038174484, info@starrygoldacademy.com, www.starrygoldacademy.com Page 7

SUGGESTED SOLUTION 1.3 Year Cash Flow 20% Discount Factor Net Present Value 15% Discount Factor Net Present Value 12% Discount Factor Net Present Value N N N N 0 (300,000) 1,0000 (300,000) 1,0000 (300,000) 1.0000 (300,000) 1 70,250 0.8333 52,081 0.8696 54,350 0.8728 55,800 2 70,250 0.6944 48,782 0.7562 53,116 0.7922 56,003 3 90,250 0.5787 52,238 0.6575 59,339 0.7118 64,239 4 103,550 0.4823 49,942 0.5718 59,209 0.6355 65,806 5 115,330 0.4019 45,351 0.4972 57,342 0.5674 65,438 (50,616) (16,644) 7,286 Internal Rate of Return of Project = 12.0 + 37,286 23,932 x 3 1 % = 12.0 + 0.91 = 12.91% The project would yield a lower Internal Rate of Return than the expected 20 percent. SUGGESTED SOLUTION 1.4 Calculation of dividend payable to the shareholders INVESU AJUBA UTOBOM TOTAL STARRY GOLD ACADEMY +2348023428420, +2347038174484, info@starrygoldacademy.com, www.starrygoldacademy.com Page 8

HOSPITAL PLC HOSPITAL PLC PHARMA LTD (N000) (N000) (N000) (N000) Proposed dividend 31/12/95 27,740-42,600 70,340 Proposed dividend 31/12/96 29,200 32,500 121,200 Proposed dividend 31/12/97 25,480 36,650 59,500 142,310 Proposed dividend 31/12/98 31,420 46,930 80,300 174,450 Proposed dividend 31/12/99 25,220-96,100 25,220 139,060 115,960 278,500 533,520 92,768 30% (92,768) Payable to shareholders in 23,192 INVEVESU Hospital Plc 20% (23,192) Utonom Pharma Limited - Ajuba Hospital Plc 301,692 INEVESU Hospital Plc 241,3500 80%(241,354) Minority - 60,338 Total dividends 473,178 20% (60,338) SUGGESTED SOLUTION 1.5 INEVESU HOSPITAL PLC STARRY GOLD ACADEMY +2348023428420, +2347038174484, info@starrygoldacademy.com, www.starrygoldacademy.com Page 9

Mr K. Koyen Kings Street Ajeki-City 5, Independence Ajeki - City MEDICAL BILL Consultation fee (0.5 hours for 5 hours @48.78 per 0.5 hour) 487.80 Building depreciation (14 days @ N21 per day) 294.00 Tenement (14 days @ N5.50 per day) 77.00 Overhead cost-auxiliary nurses (14 days @ N7 per day) 98.00 Nursing staff (2) (14 days @ N91.43 per day per nurse) 2,560.04 Other fixed (14 days @ N1,030 per day) 144,420 Other overhead cost (14 days @ N3 per day) 42,000 Drugs and consumables 150,000,00 5 Surgical operation hrs x 1 days x N620,000 4,305.56 24 30 Special consultation (7 days x N48.78) 341.46 Total medical bill payable 158,350.06 The objective of the standard medical billing system is to ensure proper time Management, it is introduced for the recovery of consultants doctors' time spent with the patients and to recover their remuneration, in addition to the other standard overheads. These would be in addition to the cost of drugs and consumables and cost of surgical operations. However, the efficiency of the new billing system could not be ascertained for Mr. Koyen because it is impracticable to compare the result of the medical bill of Mr. Koyen (as determined above) with the old billing system. This is because under the old billing system, patients were charged for medicare on their cards without reference to any predetermined standard rate. The old billing rate for Mr. Koyen was not provided. SUGGESTED SOLUTION 1.6 STARRY GOLD ACADEMY +2348023428420, +2347038174484, info@starrygoldacademy.com, www.starrygoldacademy.com Page 10

(a) INEVESU Hospitals Plc should contract out of the National Health Insurance Scheme because it would earn higher revenue since it has shown that there would be excess of over N100,9m if it could maintain to charge the patients at standard fees. The table below showed the steady decline of patients but the higher rate per patient would compensate the decrease in volume. COMPARATIVE PERFORMANCE TABLE Year No. of Patient Standard Fee Revenue N 000 1995 8,920 N30,000 267,600 1996 8,410 N30,000 252,300 1997 7,120 N30,000 213,600 1998 7,060 N30,000 211,800 1999 6,510 N30,000 195,300 Total revenue 1,140,600 Deduct Revenue under the Scheme 1,039,700 Excess Revenue 100,900 The decision to contract out of the scheme would yield additional revenue of N100.9 million provided the decree establishing the scheme provides for such decision. (b) INEVESU HOSPITALS PLC VISION STARRY GOLD ACADEMY +2348023428420, +2347038174484, info@starrygoldacademy.com, www.starrygoldacademy.com Page 11

The vision of the Hospital can be briefly summarized as follows: To provide the best possible Medicare in every community of its operation, making a difference in health care services, enhancing the future of all patients, breaking new grounds in health care delivery achieving excellence, advancing professional capability and changing the world in which we live, providing expectations for the patients and family, rebuild hope, confidence and self respect. MISSION The mission statement of Inevesu Hospital Plc can be stated thus: To create and maintain a reputation based on responsiveness, high standards and effective systems of quality assurance and to provide clinical expertise to benefit patients though creative and progressive techniques while at the same time fulfilling its responsibility of providing investors with high rate of return on their investment through consistent growth and profitability. SUGGESTION SOLUTION 1.7 (a) (v) (vi) Section 387 (1) of companies and Allied Matters Acts, (CAMA) 1990 provides that the following persons shall not be appointed or act as receivers or managers of any property or undertaking of any company. (i) An infant; (ii) Any personal found by a competent Court to be of unsound mind; (iii) A body corporate (iv) An undercharged bankrupt, unless he shall have been given leave to act as a receiver or manager of the property or undertaking of the company by the Court by which he was adjudged bankrupt. a director or auditor of the company any person convicted of any offence involving fraud, dishonesty, official corruption or moral turpitude and who is disqualified under Section 254 of this Act Section 254 (1) provides that where (i) a person is convicted by a High Court of any offence in connection with the promotion, formation or management of a company, or (ii) in the course of winding up a company it appears that a person has been guilty of any offence for which he is liable (whether he has been convicted or not) under Section 513 of this Act, or has otherwise been guilty, while an officer of the company of any fraud in relation to the company or any breach of his duty to the company If Mr. Roberts was found to have been disqualified under any of the above listed situations or conditions, any acts by him shall be null and void and he shall not be qualified to become the Receiver Manager of Jokesen Pharma Stores limited. STARRY GOLD ACADEMY +2348023428420, +2347038174484, info@starrygoldacademy.com, www.starrygoldacademy.com Page 12

(b) (i) implications on the Shareholders to concentrate control in the hands of the directors of the company (may lead to reduction in the number of shareholders) the buy back has no direct effect on the wealth of the shareholders (ii) (iii) (iv) (v) Implication on the Stock Exchange regulation the buy-back arrangement Will reduce the percentage of public shareholdings to 20% as against the minimum listing requirement of 25% of total share capital by the Nigerian Stock Exchange, It should be noted however that structure of the company's share holding is defective ab-initio because it violates the provisions of Section 162 of Companies and Allied Matters Act (CAMA), 1990 which requires a public holding of at least 85% of the company's shareholding. The foreign investors may consider the share-buy-back as an attempt to discourage foreign investment in the country. The responsibilities of the External Auditors is to invite the attention of the Directors to the legal implication of the transactions in the light of the provisions of Sections 161 and 162 of Companies and Allied Matters Act (CAMA), 1990 in their letter of weakness - management letter. The buy-back of the shares of according to Section 161 (a) of Companies and Allied Matters Act (CAMA), 1990 can be made out of: existing profit (reserves) which could have been used for dividend; or through proceeds of fresh issue of shares made for that purpose. STARRY GOLD ACADEMY +2348023428420, +2347038174484, info@starrygoldacademy.com, www.starrygoldacademy.com Page 13

SUGGESTED SOLUTION 1.8 (a) What led to the resignation of Mr. Marcus among other things include the following: (i) Abuse of power (ii) Suppression of information (iii) Non-compliance with internal control procedures by his action which are: Obtaining of cheque exchange above the authorised limit, Obtaining of loan of N70,000 without approval from Top-Management. Issuance of personal cheques which was later dishonoured, and this was viewed as fraudulent by Ton-Management Comment: As a fellow of ICAN, he is supposed to know the implications of his action and the effect on his professional career. (b) Action Taken and Threat The refusal of the management to pay Mr Marcus his entitlements is wrong and the threat to report him to ICAN is punitive. The right step to take would have been to terminate the appointment of Mr Marcus, settle his entitlements less any indebtedness or alternatively put him on suspension and thereafter prosecute him according to the law for fraudulent activities. (c) Mr Marcus no longer has any integrity. By his fraudulent action he has compromised his professional integrity. (d) The management structure is wrong. The internal auditor is supposed to report directly to the Medical Director and not the General Manager in order not to impair his independence. (e) The Medical Director may feel disappointed because he looked at the Internal and External auditors as professionals. However he must realise that the Top-Management created the loophole via the management structure, which directed the internal auditor to report to the General Manager (who suppressed the information) rather than to the Medical Director, it is not the duty of the external auditor to look for fraud, though during the course of his duty, if he discovered any, he can report it in the management letter to the management. STARRY GOLD ACADEMY +2348023428420, +2347038174484, info@starrygoldacademy.com, www.starrygoldacademy.com Page 14