A Special Project for Orthopedic Center

Mr. Jimmy Smith has recently become the director of special projects at a local hospital. Jimmy has a masters degree from Binghamton University and has served at the hospital for the past ten years, at various levels. Now as the director of special projects he has authority and responsibility to look for opportunities to grow the hospital and make sure some of the current services will continue with timely financial support.

This year, the hospital has been in a better financial condition than in the recent past. They have a cash surplus of $500,000 from operations. This was a result of numerous positive conditions but they are not expecting the trend to continue. They feel they would be lucky if they do not run into any losses in the coming years. In addition, the endowments coming into the hospital have been generous and there is about $250,000 coming into their accounts every year from the interest on those funds. The hospital administration has a policy of using only the interest and not touching any of the principal of the endowment funds. They are confident that they will have at least $250,000 of interest a year for the near future.

Jimmy has talked to the administration about opening a new orthopedic center. They were thinking about it, but there was no serious planning so far because of lack of funds. The current positive flows have made them think of starting such a center. Jimmy has been discussing this with all the concerned executives. It is felt that the future may not yield any positive flows from operating revenues.

The administration would like to start the project at the end of four years from now. The staff of the special projects has done some data collection and analysis, and the general consensus is that it would take about $2,000,000 to start the center. Once the construction starts, the construction would go on for one year before the center servicing the patients. Further analysis into patient volumes and revenues indicate that once the center starts the services, it would generate a net annual income of $500,000 for the first four years and $600,000 for the fifth year. The hospital policy is to consider the costs and revenue flows only for the first five years of operation for feasibility of any major project. Another unwritten policy is to take up major projects only if the rate of return is equal to or more than 5% (IRR 5%).

At a recent meeting of the executives, the CFO expressed his reservation about the project saying that under the current circumstances, it would not be possible to get the required investment of $2,000,000 in the next four years. However, the CEO says that they should take this as a challenge and raise enough endowment this year such that the extra income from interest from this additional endowment for the next four years would enable them to have enough funds for the center. She says she will be eager to join any fund raising effort.

Jimmy Smith is excited to see that at last the administration is seriously thinking about constructing an orthopedic center. There would be a good deal of satisfaction to know that the local patients need not go to near by cities for any orthopedic problems. He will be happy to work with all the departments, especially the fundraising.

Jimmy and the manager of fund raising met at the Starbucks the following Monday morning. The manager is enthusiastic about the new project and new challenge and asked Jimmy how much money needs to be raised to make the orthopedic center happen.

Jimmy is feeling quite upbeat about the whole thing. Perhaps, this can be pulled off. However, he wants to revisit all the computations to make sure there are no major mishaps. He remembered CFOs caution that such analysis should be done at different time values of money to make sure the plan is robust. So far, all the computations were done at a time value of 4%.

Your team has to work from the perspective of Jimmy Smith and his special projects office.

Analyze the case and your findings should include:

1. If the hospital can go ahead with the proposed project.
2. How much money the fundraising department has to raise if the annual interest from the fund needs to support the start of the project in the next four years.
3. How sensitive the analysis is for the selected time value of money.