HERC: Determining VA Capital Costs
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Determining VA Capital Costs

Capital-- the cost of buildings and equipment-- is an important part of healthcare costs. In 1997, capital payments made up 11.1% of the Medicare payments to U.S. hospitals covered by the Prospective Payment System (Medicare ProPAC, 1997). Economic analysis must consider this cost, which includes both depreciation and financing.

To estimate the cost of capital needed for a specific intervention, an analyst can estimate the rental cost of capital by finding comparable leasing costs. An equipment manufacturer can be asked for the annual cost of leasing the equipment, including the cost of maintenance support. A commercial real estate rental agency can be asked for information on the monthly cost of leasing medical office space.

A more specific method of finding the rental cost of capital requires information on the acquisition cost of the equipment, the length of its useful life (L), and the real rate of return (r). The useful lifetimes for capital goods are described in the regulations of the U.S. Internal Revenue Service. These are used to calculate depreciation for taxation purposes. The lifetime of equipment generally ranges from 3 to 10 years. Buildings are depreciated over a 30 year lifetime. The real rate of return on U.S. capital has been found to be 11.5% (Feldstein, Dicks-Mireaux, & Porterba, 1983).

A simple approach to find the rental cost of a single piece of equipment would be to calculate the payment on a loan to acquire the equipment over its lifetime. This could be done using the PMT function in MS Excel.

The more exact approach is to find the real (inflation adjusted) rental cost of capital. The rental cost (C) is this rental rate (R) multiplied by the real value of the capital stock (K). The capital stock is the acquisition price, less the cumulative depreciation. By real capital stock, it is meant that the value of the capital stock has been adjusted for inflation. It is transformed from a nominal value to a real value by adjusting for inflation, that is, multiplying the nominal value by the base year price index and dividing by the current year price index.

To find the "rental rate" for capital (R) requires information on the rate of return (r), the lifetime of the capital good (L), and the price index for the year in question (P). The formula for the rental rate is:

Formula for rental rate

where e is the base of the natural logarithm (~2.71828).

VA capital costs

VA accounting of assets only considers the purchase price, not the cost of financing a purchase. This is because the financing cost is borne by another Federal Agency. VA calculates the depreciation of assets, but does not estimate the cost of financing their acquisition. The U.S. Treasury Department sells bonds to raise money to make these purchases. The treasury pays interest on these bonds--an economic cost that should not be ignored.

VA assets data

The VA budget for major capital purchases is separate from its operating budget for medical care. VA maintains a database of capital acquisitions, called the Fixed Asset Package. These data can only be accessed by VA researchers who obtain appropriate permission. They are kept as a text file at the national VA computer center in Austin, Texas. This file is periodically distributed on CD-ROM to VA financial officers. The database includes the name of the assets, when they were purchased, where they are located, their useful lifetime, their current year's depreciation, and the balance of their remaining undepreciated value. The Fixed Asset database is the source of the annual depreciation costs used to find MCA costs.

References

Feldstein, M., Dicks-Mireaux, L., & Porterba, J. (1983). The Effective Tax Rate and the Pre-tax Rate of Return. J Public Econ, 21(2), 129-158.

Medicare Prospective Payment Commission ProPAC (1997). Medicare and the American healthcare System: Report to Congress. June 1997.