Twin Falls Community Hospital

This is a risk analysis of the project by ambulatory surgery center. The purpose of the analysis is to predict the outcome of the project. This will be done by calculating the payback, net present value and internal rate of return of the project. The cash flows for year four and five are shown in the table below.

		YEAR 4	YEAR 5
Land opportunity cost	($500,000)
Building/equipment cost	(10,000,000)
Net revenues		5,463,635	5,627,544.05
Less: Labor costs		874,181.60	900,407.05
Utilities costs		54,636.35	56,275.44
Supplies		2,185,454	2,251,017.62
Incremental           overhead		39,337.76	40,517.89

Net income		2,310,025.29	2,379,326.05
Plus: Net land salvage value
Plus: Net building/equipment salvage value
Net cash flow		2,310,025.29	2,379,326.05

 

The Net Present value of the project

NPV= Cash outflow + Cash inflow/ (1+r)

Year 1= $2,114,000/1+0.1=1,921,818.18

Year2= $2,177,420/ (1+0.1) ^2=1,799,520.66

Year3=$2,242,743/ (1+0.1) ^3=1,685,006.01

Year4=2,310,025.29/ (1+0.1) ^4=1,577,778.16

Year5=2,379,326.05/ (1+0.1) ^5=1,477,374.28

Total=8,461,497.29

Net Present Value= 15,500,000 - 8,461,497.29=7,038,502.71

The Internal Rate of Return of the project

-15,500,000+1,921,818.18/ (1+R) + 1,799,520.66/ (1+R) ^2+1,685,006.01/ (1+R) ^3+1,577,778.16/ (1+R) ^4+1,477,374.28/(1+R)^5=0

IRR= 10%

The payback of the project.

If the cash flow remains constantly progressive every year, the anticipated payback would be seven years.

Overhead costs.

The overhead costs, are expenses that a business incurs in the day to day activities. The above cash flow analysis is not of an existent business but rather an analysis of whether the proposed project would be profitable if it was actually established. This being the case, the $10,000 overhead costs cannot be added to this cash flow.

Handling of cannibalization.

One should first gather backdated cash flow statements of the inpatient surgery unit prior to the opening of the outpatient surgery unit to current cash flow statements of the inpatient surgery unit, which should be compared to the outpatient cash flows (analysis) statements so as to identify the rate of declining inflows in the internal surgery unit to the rise of inflows in the outpatient surgery unit. This will also enable comparison of other details such as the price difference in services offered by the two units in relation to the inflow rates. Such details can enable the analyst to find a solution and recommend appropriate changes in the inpatient surgery ward e.g. reset prices of service, opening hour’s etc. This would change the handling of cannibalization since one would have to carry out a scenario analysis of a third surgical unit which would trigger a change in all current statements in the inpatient and outpatient cash flow statements as well.

Scenario analysis.

Scenario=250 DAYS (YEAR)*(1000)*

The expected scenario of the project is:

250 DAYS (YEAR)*(1000*20)

Salvage price= 5 million at 70% rate an average net income of $5,000,000 per day.

NPV= 7,941,176.47

The best case scenario of the project is:

250 days (year) * (1000*25)

Salvage price= 7million at 15% rate and average net income of $6,250,000 per day.

NPV= 12,434,782.61

The worst case scenario of the project is:

250 DAYS (YEAR)*(1000*15)

Salvage price= 3 million at 15% rate and average net income of $3,750,000 per day.

NPV= 6,260,869.56

The worst case value helps in assessing the hospitals ability to bear the risk of this investment since; one is able to compare it with the capital and general financial health of the entire project.

The new NPV of the project after a three percentage point risk adjustment would be:

NPV (3%RISK) =7,038,502.71 * 0.03

NPV=211,155.08

Recommendation

The hospital should consider maximizing the inpatient surgery ward first and if the need arises, they should go ahead with the out patient unit but look for better prices of machinery or explore other sources of machinery like leasing.