British Journal of Radiology 74 (2001),735-744 © 2001 The British Institute of Radiology
Radiotherapy equipment—purchase or lease?
A Nisbet, PhD, MIPEM1 and
A Ward, BSc, CPFA2
1Department of Medical Physics and Bio-Engineering and 2Finance Department, Raigmore Hospital, Highland Acute Hospital NHS Trust, Old Perth Road, Inverness IV2 3UJ, UK
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Abstract
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Against a background of increasing demand for radiotherapy equipment, this study was undertaken to investigate options for equipment procurement, in particular to compare purchase with lease. The perceived advantages of lease are that equipment can be acquired within budget and cashflow constraints, with relatively low amounts of cash leaving the NHS in the first year, avoiding the necessity of capitalizing the equipment and providing protection against the risk of obsolescence associated with high technology equipment. The perceived disadvantages of leasing are that the Trust does not own the equipment, leasing can be more expensive in revenue terms, the tender process is extended and there may be lease conditions to be met, which may be costly and/or restrictive. There are also a number of technical considerations involved in the leasing of radiotherapy equipment that influence the financial analysis and practical operation of the radiotherapy service. The technical considerations include servicing and planned preventative maintenance, upgrades, spare parts, subsequent purchase of "add ons", modification of equipment, research and development work, commencement of the lease period, return of equipment at the end of the lease period and negotiations at the end of the lease period. A study from Raigmore Hospital, Inverness is described, which involves the procurement of new, state-of-the-art radiotherapy equipment. This provides an overview of the procurement process, including a summary of the advantages and disadvantages of leasing, with the figures from the financial analysis presented and explained. In addition, a detailed description is given of the technical considerations to be taken into account in the financial analysis and negotiation of any lease contract.
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Introduction
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A recent report by the Royal College of Radiologists [1] provides a survey of the changes in workload and megavoltage treatment facilities in UK radiotherapy departments. This report recommends that extra linear accelerators, supporting staff and infrastructure are needed urgently and that future planning should include a rolling programme of replacement of 10% of linear accelerators in the UK each year. It also recommends that the current system for procuring and maintaining major capital equipment for radiotherapy needs urgent review. A similar document also addresses the situation in Scotland [2].
Against this background of increasing demand for radiotherapy equipment we have addressed the question of whether to purchase or lease. A case study from Raigmore Hospital, Highland Acute Hospitals NHS Trust is presented, which involves the procurement of state-of-the-art radiotherapy equipment including a multimode linear accelerator, simulator with CT extension and associated building work. A full financial analysis of purchase vs lease is presented. This provides an overview of the procurement process, including a summary of the benefits and disadvantages of leasing. In addition, a detailed description is given of the technical considerations to be taken into account in the financial analysis and negotiation of any lease contract. Although a number of articles have appeared in the literature on the cost of radiotherapy [3–6], and Sedlmeier [7] has published a general discussion on lease or buy with regard to the USA, we are unaware of any publication in the literature that specifically addresses radiotherapy equipment procurement.
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Materials and methods
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The procurement process
The question of whether to purchase or lease radiotherapy equipment needs to be addressed within the whole context of equipment procurement. The procedures and approval process for radiotherapy equipment are described in the Health Service Guideline (HSG (95) 48) "Information management and technology (IM&T) procurement and private finance" [8]. Within this framework it is necessary to evaluate the most economically advantageous solution to meet the strategic aims of the radiotherapy department. That does not mean the cheapest option, but any decision involving a more expensive option must be justified. HSG (95) 48 sets out the various steps in the equipment procurement process (Figure 1
). There are a number of steps involved relating to the lease of equipment that must be carried out before the award of contract (Figure 2). Once the final package of equipment has been chosen and approved, an advert needs to be placed in the Official Journal of the European Community (OJEC) inviting tenders for the financing of the package. In circumstances where time is a constraint, it is possible to tender for the equipment and finance concurrently, although contracts cannot be placed until the equipment package is known. It is more usual to seek tenders for the chosen package of equipment alone. It must be recognized, however, that the final decision on equipment must be justifiable to the competing suppliers. Approval needs to be obtained from the Trust's Executive Group, the appropriate Health Board and, in Scotland, from the Management Executive of the Scottish Executive where pool capital (capital funding from a central source) is required.
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Figure 1. Flowchart of information management and technology procurement for projects following Health Service Guidelines (95) 48 [8]. OJEC, Official Journal of the European Community.
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On receipt of the financing tenders, a financial analysis of lease vs purchase should be carried out. However, there are a number of technical considerations involved in the lease of radiotherapy equipment and it is important that the costs of these are taken into account during thefinancial analysis of purchase vs lease. Furthermore, it is essential that appropriate technical staff are involved in the discussion and detailed negotiations on the elements of any lease contract, as these may directly impinge on the technical and practical aspects of the radiotherapy service.
The leasing option
Essentially, there are two types of lease, which are defined in the Statement of Standard Accounting Practice 21 (SSAP 21) "Accounting for leases and hire purchase contracts" [9]. A finance lease "is a lease that transfers substantially all the risks and rewards of ownership of an asset to the lessee. It should be presumed that such a transfer occurs if at inception of a lease the present value of the minimum lease payment, including any initial payment, amounts to substantially all (normally 90% or more) of the fair value of the leased asset. The present value should be calculated by using the interest rate implicit in the lease." An operating lease is defined simply as "a lease other than a Finance Lease." In essence, an operating lease is a contract for the hire of an asset where the lessor retains substantially all the risks and rewards associated with ownership, including legal title. It normally involves the lessee hiring the asset for a period substantially less than the economic life of the asset. In addition, operating leases should not be capitalized, which makes them the usual type of lease that the NHS commonly uses for medical equipment such as linear accelerators. The above categorization of leases is currently under review by the Accounting Standards Board, but final details of a new approach have not yet been released. However, it is widely believed that the distinction between operating and finance leases will be removed. The implications of this are uncertain but it may well result in a requirement for all leases to be capitalized on the balance sheet, which could change the current approach to leasing within the NHS.
The practical application of SSAP 21 is that a lease will meet the off balance sheet criteria if the rental charges for the primary term, when discounted at the implicit rate of interest within the lease, represent less than 90% of the equipment fair market value. However, one should be aware that during the time delay between the tendering stage and the day the lease contract is signed, the interest rate is likely to have changed, which will have an effect on the rentals payable. However, this is unlikely to have an impact on the lease classification because, if the rate of interest implicit in the lease is used to determine the net present value (NPV) of the rentals, an increase in the money market rates will bring about both an increase in the rental and an increase in the implicit rate.
The above can be seen to be somewhat subjective as both the interest rate and residual value are variable. Commonly, within the NHS a more objective test discount rate of 6% plus inflation is used as a basis for establishing the 90% rule. This is, strictly speaking, incorrect in relation to SSAP 21 but it does help to provide an objective standard.
Application of SSAP 21 is illustrated in Table 1. The lease is over 7 years and annual payments have been normalized to £200 000 to maintain confidentiality. Year 0 includes commissioning. The lease payments have been discounted by the implicit rate of interest to arrive at the NPV. The discount factor may be calculated from
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Table 1. Statement of Standard Accounting Practice 21 (SSAP 21) operating lease test- Name of hospital: Highland Acute Hospitals
- Item of equipment: Radiotherapy equipment
- Capital value (£ excl. VAT): 1,350,000
- Lease payment (£): 200,000 (primary term)
- Equipment lifetime: 10 years
- Appraisal rate: 8.5%
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where 
is the discount rate (i.e. implicit rate of interest) and n is the number of years. Discount factors and NPV may be obtained from statistical tables [10].
This shows that payments of £200 000 annually in advance result in a NPV as a percentage of purchase cost of 82.28%. This will therefore meet the SSAP 21 requirements as this percentage is well below 90%. The fact that the lease is for less than the equipment lifetime also helps confirm the position, as the lessor will bear the risk of the residual value of the equipment. The overriding test of an operating lease is whether risk and reward remain with the lessor.
To substantiate risk transfer to the lessor and the existence of an operating lease, the following factors should be considered in addition to the 90% rule. The answer to the bulk of the following questions must be negative for an operating lease to exist. If the lessee can cancel the lease will he bear any losses associated with the cancellation? Will the lessee gain or lose from any fluctuations in the market value of the residual value of the equipment? Does the lessee have the ability to continue the lease for a secondary period at a nominal rental? Is the expected lease term equal to substantially all of the assets' expected useful life? Are the leased assets of a specialized nature so that only the lessee (or a limited number of close parties) can use them without major modification being made?
One criterion to note is that for an operating lease to exist it must not cover the full lifetime of the equipment. Therefore, it is critical for a lessee to ensure that the long-term cost is minimized. This is especially true where long life equipment is concerned. In order to do this it is common to put a cap on the cost of extensions to minimize payments on an extension period. Above all, the lessee should have various options rather than a commitment on expiry of the primary period.
In addition to the SSAP 21 test it is necessary to establish that a lease offers value for money. That is, the benefits of leasing need to exceed the financing cost for leasing to be the best value for money. However, this is a somewhat grey area as the benefits are not all financial. The host Health Authority should also be involved and feel comfortable with the final decision. This mathematical test is conceptually similar to the SSAP 21 test whereby the rental payments are discounted by a statutory appraisal rate of 8.5% rather than the implicit rate as used in the SSAP 21 test.
Table 2 illustrates this with an example from Raigmore Hospital. Annual payments have been normalized to £200 000 to maintain confidentiality. The lease is over 7 years, with a 4 year extension at an assumed realistic cost. The payment type is annually in advance and the appraisal rate is 8.5%. By discounting for the interest rate, one works out the NPV. At the end of the lease period, although £1 760 000 has been paid, the actual NPV is £1 296 380, which is less than the purchase cost of £1 350 000 and therefore meets the value for money criteria.
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Table 2. Operating lease—value for money assessment- Name of hospital: Highland Acute Hospitals
- Item of equipment: Radiotherapy equipment
- Capital value (£ excl. VAT): 1,350,000
- Lease payment (£): 200,000 (primary term)
- Equipment lifetime: 10 years
- Appraisal rate: 8.5%
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When conducting financial analyses of leases, capital charges and VAT should be omitted, as there are no cash flows out of the treasury.
To compare lease with purchase, the question must be asked, "why lease?" There are a number of perceived advantages of leasing, as follows. (a)The equipment can be acquired within budget and cashflow constraints, i.e. the costs can be spread over a number of years so that revenue can be matched against expenditure. There is no initial capital outlay, thus allowing other national priorities to be addressed, as traditionally linear accelerators are purchased with pool capital. (b)Operating leases avoid capitalizing the equipment and showing it as an asset, i.e. one does nothave to pay capital charges as the lease contains an element that covers the cost of finance. (c) Leasing provides protection against the risk ofobsolescence associated with high technology equipment by allowing upgrades to be incorporated within the lease. It also potentially allows equipment replacement earlier than traditionally happens within the NHS, which helps keep up to date with new technology and hence, it can be argued, leads to improved patient care.
There are also a number of perceived disadvantages of leasing, as follows. (a) The department does not own the equipment and, therefore, any value of the equipment on de-commissioning is not available. (b) Leasing can be more expensive in revenue terms and requires careful economic appraisal. This is because one has to pay for the cost of risk transfer plus the profit margin on the lease. (c) The tender process is extended as one has to tender twice, initially with regard to the equipment and secondly with regard to the leasing package. In addition, careful re-negotiations of the lease may be required at the termination of the primary term. (d) Early equipment replacement will lead to disruption in the department and to an overall increase in revenue costs. There may also be staffing implications—installation, acceptance and commissioning of a multimode linear accelerator may take up to a year, and is work that must be carried out on top of routine duties. (e) Finally, there may be lease conditions to be met, which may be costly and/or restrictive with regard to the practical use of the equipment.
Technical considerations
It is important that the costs of technical considerations are taken into account during thefinancial analysis of purchase vs lease. Furthermore, it is essential that appropriate technical staff are involved in the discussion and negotiation of the details of any lease contract, as these may directly impinge on the technical and practical aspects of the radiotherapy service.
Different lease companies or equipment suppliers may have different prerequisites on leased equipment and hence it may be useful to obtain the suppliers' requirements at an early stage of the procurement process.
The ability to upgrade the equipment is one of the stated advantages of leasing. One can either re-negotiate the terms of the lease on acquiring the upgrade or one can build upgrades into the lease in the form of step payments. The latter option will require the agreement of the Finance Department, as upgrades will generally have an associated revenue consequence. It should be noted that in both cases justification for upgrading the equipment is likely to be required. However, it may be argued that acceptance of the need to upgrade is more likely with leased equipment as the additional cost is spread over the remaining life of the equipment.
With regard to servicing and planned preventative maintenance, it may be a prerequisite of leasing that a service contract is purchased from the equipment supplier up to a certain level. This is restrictive if one has the facilities, staff and desire to perform in-house servicing, which is cost effective. There may also be a requirement that service staff are ISO9000 [11] accredited if in-house servicing is to be used.
Another consideration is that certain spare parts/components of the equipment may be obtained less expensively, but of similar quality, from sources other than the original supplier. It should be ascertained if the leasing company/equipment supplier require all components to be purchased from the original supplier.
It is also possible that the Trust may be required to purchase modifications that would increase the functionality/capability of the equipment. This should remain an option and the ownership of such modifications should be agreed pre contract. It may also be necessary to modify the equipment for various reasons, and enquiries should be made whether such modifications are allowed without financial penalty at the end of the lease contract. It should also be pointed out that to optimize and develop treatments a certain amount of research and developmental work will be carried out on the equipment.
The exact time when the lease period starts needs to be specified, given the length of time between delivery and initial clinical use. As previously stated, installation, acceptance testing and commissioning may take up to a year for a multimode linear accelerator. In addition, costs and responsibilities for decommissioning equipment should be considered, in particular with regard to dismantling, packaging, storage and transport. For example, it is highly unlikely that a base plate for a simulator or linear accelerator may be removed in a usable condition and any financial penalty for this should be agreed. It may also be possible that a certain amount of building work may be required to remove the equipment intact from a bunker. Moreover, the requirements for maintaining equipment in the state in which it was delivered, considering fair wear and tear, should be clearly defined with regard also to modifications to the equipment and individual components. Certain components have a finite lifetime and therefore reasonable wear and tear on specific components needs to be clearly defined, e.g. waveguides, magnetrons, targets and general cabling. Furthermore, given the time-scale to gothrough the procurement process and the commissioningof radiotherapy equipment, it is essential that discussion with the lease company be entered into before the end of any lease period. This is essential to ensure smooth continuation of the radiotherapy service, as one must decide whether to take out a secondary lease or begin the procurement process to replace the equipment. For this to be achieved, Trusts should have effective lease management systems, especially for longer term leases, as it is essential to receive quality decision support information given that there is every likelihood that staff connected with the original decision will have moved on during the life of the lease.
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Results and discussion
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Financial analysis
The financial analysis from Raigmore Hospital has been carried out over 10 years to correspond with the assumed economic lifetime of the equipment [1]. This is presented in Table 3.
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Table 3. Summary analysis of Highland Acute Hospitals NHS Trust procurement project
1a. Economic appraisal of purchase with in-house maintenance and 219k endowment donation
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The capital cost of the purchase option totals approximately £2.6 million. The capital costs include design costs, i.e. the architect's fees, the building costs and equipment costs. Revenue costs include identified additional training, rates, power, information technology maintenance, the cost of spare parts plus the lease payments for thelease option. An additional item included in the revenue costs is the capital charge, which iseffectively a depreciation charge plus a 6% element of interest to represent a return on capital employed. These charges are applied to both the equipment and any building works. They are not applied to off balance sheet operating leases as this charge is effectively contained within the costs of the lease.
Negotiation with the lease company
In negotiation with the chosen supplier of the radiotherapy equipment for Raigmore Hospital and the preferred lease company, the following agreements were arrived at with regard to the technical considerations previously mentioned. In-house servicing is allowed provided that it iscarried out by "adequately trained staff", as defined by the Trust. Furthermore, there is no requirement for ISO9000 accreditation. Future upgrades may be incorporated within the lease with the result of an increase in remaining rentals. Spare parts may be obtained from sources other than the original supplier, although it is expected that any are to be of equivalent quality. "Add ons" will become the property of the lease company on completion of the lease and modifications are permitted, but the lease company expects the Trust to make good any damage that may adversely affect the residual value of the equipment at the end of the lease contract.
The lease commences on delivery, and it is stated that the equipment should be in the same working order and in similar condition, allowing for fair wear and tear, at the completion of the lease period. However, it is not expected that components having a finite lifetime be returned as delivered. The Trust is responsible for properly disassembling, crating and preparing the equipment for transport. Indicative costs obtained at tender suggest a cost of £20 000 for this. The Trust is also responsible for shipping the equipment 200 miles in a straight line and is responsible for paying handling, insurance, packing and transportation costs involved up to a maximum sum of £30 000. It has also been stated that the Trust's maximum storage period for the equipment is 30 days after the lease ends.
It has also been agreed that negotiations will begin between the Trust and the lease company 2 years before the end of the lease period to ensure continuation of the radiotherapy service.
Two further issues to point out are that the Trust shall, from the date of acceptance, bear therisk of loss or damage whether insured or not,and that financial penalties relating to unscheduled downtime are not applicable with leased equipment. 
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Conclusion
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In the case study presented for Raigmore Hospital, the lease option met the practical application of the Operating Lease Test as indicated in Table 1. In addition, Raigmore Hospital is a small, one linear accelerator site, therefore the benefits of leasing, i.e. the ability to upgrade the equipment and the potential for more frequent replacement of the equipment, were felt to make leasing a cost effective alternative to traditional purchase with exchequer capital. For these reasons it was felt that in the case of Raigmore Hospital the lease of radiotherapy equipment was the preferred option.
Although the principles and arguments described in this paper are applicable to all situations, it must be recognized that the final conclusion only applies strictly to the case study presented. Each radiotherapy centre must assess whether or not the benefits of leasing outweigh the additional financial cost of leasing. In particular, larger centres with a rolling programme of replacement equipment would expect to keep up to date with technological advances, and the conclusion reached for Raigmore Hospital may not apply.
One general conclusion applicable to all centres, however, is that it is essential that technical staff are involved in the discussion and detailed negotiations on the content of the lease, and ideally the financial aspects of these considerations should be taken into account during the financial analysis of purchase vs lease.
Received for publication August 14, 2000.
Accepted for publication December 21, 2000.
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References
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The Royal College of Radiologists. Equipment, workload and staffing for radiotherapy in the UK 1992–1997, RCR Report BFCO (98) 2. London: Royal College of Radiologists, 1998.
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The Royal College of Radiologists. Equipment, workload and staffing for radiotherapy in Scotland 1992–1997, RCR Report BFCO (00) 1. London: Royal College of Radiologists, 2000.
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Sedlmeier ME. Lease or buy: optimising capital equipment procurement. Healthc Financ Manage 1997;51:76–8.
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NHS Executive. Health Service Guidelines (95) 48. Information Management and Technology (IM&T) Procurement and Private Finance. 1995.
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Statement of Standard Accounting Practice 21 (SSAP 21). Accounting for leases and hire purchase contracts, Accounting Standards 1999/2000. The Institute of Chartered Accountants, in England & Wales, 1999.
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Abstract
Introduction
