Expert answer:Discussion/Critical Thinking
Solved by verified expert:Capital budgeting (aka capital expenditure or just CAPEX) is significant in the healthcare industry when considering the volatility of reimbursements and the vast amount of property, physical plant, and equipment required to provide high-quality health care. Thus, the ability to accurately evaluate the potential financial returns to the organization for any investment is a fundamental skill for healthcare leaders at all levels. It is also critically important to be able to understand the methods through which prospective projects can be evaluated for the risk of potential deviation from the originally formed plan.For this discussion, do the following:Locate at least one online resource (a link, article, or book, for example) pertaining to capital budgeting and/or risk analysis in the capital budgeting process either within a broad industry context or within the healthcare field. In your discussion, examine the content and then share the resource (post your resource and use APA style). Summarize the resource(s) and what you find useful about it. Once your material is posted, be sure to review and comment on the materials posted by at least two of your peers. NOTE: Resources cannot be duplicated, so be sure to get into the conversation early. **The above is just a discussion and needs to be 1 page long****The second is a critical thinking assignment and needs to be in Xcel format**
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HCM565
Module 4 CT
Chapter 11 Problem 1
Winston Clinic is evaluating a project that costs $52,125 and has expected net cash flows of
$12,000 per year for eight years. The first inflow occurs one year after the cost outflow, and the
project has a cost of capital of 12 percent.
a. What is the project’s payback?
b. What is the project’s NPV? Its IRR?
c. Is the project financially acceptable? Explain your answer.
Chapter 11 Problem 3
Capitol Health Plans, Inc., is evaluating two different methods for providing home health
services to its members. Both methods involve contracting out for services, and the health
outcomes and revenues are not affected by the method chosen. Therefore, the incremental
cash flows for the decision are all outflows.
Here are the projected flows:
Year
0
1
2
3
4
5
Method
A
$300,000
-$66,000
-$66,000
-$66,000
-$66,000
-$66,000
Method
B
$120,000
-$96,000
-$96,000
-$96,000
-$96,000
-$96,000
a. What is each alternative’s IRR?
b. If the cost of capital for both methods is 9 percent, which method should be chosen? Why?
Chapter 11 Problem 5
Assume that you are the CFO at Porter Memorial Hospital. The CEO has asked you to analyze
two proposed capital investments: Project X and Project Y. Each project requires a net
investment outlay of $10,000, and the cost of capital for each project is 12 percent. The
project’s expected net cash flows are as follows:
Year
Project
X
Project
Y
0
1
2
3
4
$10,000
$6,500
$3,000
$3,000
$1,000
$10,000
$3,000
$3,000
$3,000
$3,000
a. Calculate each project’s payback period, net present value (NPV), and internal rate of return
(IRR).
b. Which project (or projects) is financially acceptable? Explain your answer.
Chapter 11 Problem 7
California Health Center, a for-profit hospital, is evaluating the purchase of new diagnostic
equipment. The equipment, which costs $600,000, has an expected life of five years and an
estimated pretax salvage value of $200,000 at that time. The equipment is expected to be used
15 times a day for 250 days a year for each year of the project’s life. On average, each
procedure is expected to generate $80 in collections, which is net of bad debt losses and
contractual allowances, in its first year of use. Thus, net revenues for Year 1 are estimated at 15
X 250 X $80 = $300,000.
Labor and maintenance costs are expected to be $100,000 during the first year of operation,
while utilities will cost another $10,000 and cash overhead will increase by $5,000 in Year 1.
The cost for expendable supplies is expected to average $5 per procedure during the first year.
All costs and revenues, except depreciation, are expected to increase at a 5 percent inflation
rate after the first year.
The equipment falls into the MACRS five-year class for tax depreciation and hence is subject to
the following depreciation allowances:
Year
1
2
3
4
5
6
Allowance
0.2
0.32
0.19
0.12
0.11
0.06
The hospital’s tax rate is 40 percent, and its corporate cost of capital is 10 percent.
a. Estimate the project’s net cash flows over its five-year estimated life.
b. What are the project’s NPV and IRR? (Assume that the project has average risk.)
(Hint: Use the following format as a guide.)
0
Equipment cost
Net revenues
Less:
Labor/maintenance costs
Utilities costs
Supplie
s
Incremental overhead
Depreciation
Operating income
Taxes
Net operating income
Plus: Depreciation
Plus: After-tax equipment salvage
value*
Net cash flow
1
Year
2
3
4
5
*
Pretax equipment salvage value
MACRS equipment salvage value
Difference
Taxes
After-tax equipment salvage value
Chapter 12 Problem 3
Consider the project contained in Problem 7 in Chapter 11 (California Health Center).
a. Perform a sensitivity analysis to see how NPV is affected by changes in the number of
procedures per day, average collection amount, and salvage value. Remember supplies vary
with number of procedures.
b. Conduct a scenario analysis. Suppose that the hospital’s staff concluded that the three most
uncertain variables were number of procedures per day, average collection amount, and the
equipment’s salvage value. Furthermore, the following data were developed:
Equipment
Number of Average
Salvage
Scenario Probability Procedures Collection Value
Worst
0.25
10
$60
$100,000
Most
likely
Best
0.50
15
$80
$200,000
0.25
20
$100
$300,000
c. Finally, assume that California Health Center’s average project has a coefficient of variation of
NPV in the range of 1.0 – 2.0. (Hint: Coefficient of variation is defined as the standard deviation
of NPV divided by the expected NPV.) The hospital adjusts for risk by adding or subtracting 3
percentage points to its 10 percent corporate cost of capital. After adjusting for differential risk,
is the project still profitable?
d. What type of risk was measured and accounted for in Parts b. and c.? Should this be of
concern to the hospital’s managers?
Chapter 12 Problem 5
Allied Managed Care Company is evaluating two different computer systems for handling
provider claims. There are no incremental revenues attached to the projects, so the decision
will be made on the basis of the present value of costs. Allied’s corporate cost of capital is 10
percent. Here are the net cash flow estimates in thousands of dollars:
Year
0
1
2
3
System
X
-$500
-$500
-$500
-$500
System
Y
-$1,000
-$300
-$300
-$300
a. Assume initially that the systems both have average risk. Which one should be chosen?
b. Assume that System X is judged to have high risk. Allied accounts for differential risk by
adjusting its corporate cost of capital up or down by 2 percentage points. Which system should
be chosen?
Chapter 12 Problem 10
Michigan Home Health is considering opening an office in a new market. The organization has
identified the number of home visits, revenue per home visit, and the level of fixed costs of the
new office as being the major sources of uncertainty in the investment decision. To get a better
understanding of the sensitivity of the new office NPV to these variables, the following data
have been assembled:
Change
from
base
case
NPV
Number Revenue Level of
of home per
fixed
home
visits
visit
costs
-30%
-20%
-10%
0%
10%
20%
30%
-$814
-$515
-$216
$82
$381
$680
$979
-$57
-$11
$36
$82
$129
$176
$222
$82
$82
$82
$82
$82
$82
$82
Construct a graph to show the sensitivity of the new office NPV to each variable.
…
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