Ambulatory Surgical Center at Newton Community HospitalAuthor: Dr$.$ Vinita IttoopPub. Date: $2022$ UnpublishedProduct:Keywords: Marginal analysis, Sunk Cost, Free cash flow, Net Present Value analysis, Project assumptions, Scenario analysisDisciplines: Business & Management, Decision MakingAbstractLike other rural non$-$profit hospitals, Newtown Community Hospital in Desert County, Nevada $($fictional$)$ faces major challenges to its financial viability due to low reimbursements, affordability of care, and the resultant low patient volume. In response to these long$-$standing pressures, Newtown Community shuttered many health services over time to reduce costs. Now, it is evaluating a plan to dramatically cut back its in$-$hospital operating capabilities and build an Ambulatory Surgical Center $($ASC$)$ for same$-$day surgical care. Management is hopeful that the shift from in$-$hospital surgical care to an ASC will improve operating margins while allowing Newtown Community to continue effectively serving its rural community.CASELearning Outcomes$1)$ Apply the theories of marginal analysis for project evaluation$2)$ Make realistic assumptions about future Income from Operations and cost in preparationfor discounted cash flow analysis $($DCF$)\mathrm{.}3)$ Perform DCF analysis by calculating the net present value based on future free cash flowestimates$\mathrm{.}4)$ Perform scenario analysis based on a varying one of the key assumptions$\mathrm{.}5)$ Use a Spreadsheet tool for DCF analysisIntroductionNewton Community Hospital is a non$-$profit community hospital in Desert County, Nevada. It is designated as a Critical Access Hospital by the Centers for Medicaid & Medicaid. This designation is given to a hospital that$1)$ provides $24/7$ care to the community,$2)$ Has fewer than $25$ acute $($in$-$hospital$)$ beds$3)$ Is located more than $35$ miles from another hospital $1$Ambulatory Surgical Center at Newtown Community Hospital$4)$ Has an average length of in$-$patient care of $96$ hours $(4$ days$)$CAH designation is important for obtaining cost$-$based reimbursement from Medicare, instead of the standard fixed$-$amount reimbursement. Congress created the CAH program in $1997$ to explicitly address the financial vulnerabilities of rural hospitals. However, the Medicare payment rate is low, around $105\%$ over cost, and covers only the services provided to patients with Medicare.The CommunityDesert County is a prototype of other rural communities in Nevada$\mathrm{.}1)$ Desert County has a population of $800,000$ people. It is $55\%$ White, $10\%$ Black, $20\%$ Native American, and $15\%$ Hispanic. The median income is $$65,000\mathrm{.}2)20\%$ of the population is below $18$ years of age, $65\%$ between $18$ and $64,$ and $15\%$ over $65\mathrm{.}3)85\%$ of the population has medical insurance of various degrees of quality, from privateinsurance to Medicaid, and Medicare. $15\%$ are uninsured.Financial Analysis of Newtown Community HospitalMr. Robert Cruz mulled over the most recent financial reports. $($See Figure $2,$ Appendix $1$ and $2.)$ The numbers did not help relieve his anxiety about how the management team would be able to sustain the hospital and support new investments. Robert was particularly concerned about the cash flow statement. The hospital was only able to generate $$164,050$ of free cash flow in $2022.$ The short$-$term debt of $ $825,000($see Appendix $1)$ would come due over the course of $12$ to $18$ months. Consequently, cash balances would plummet significantly. He scheduled a meeting with his Chief Financial Officer, Mr$.$ Kane, and Director of Health Services Dr$.$ Lyons, to discuss their progress on a longer$-$term plan for financial viability.Fig $1$The MeetingAt the start of the meeting, Mr$.$ Cruz asked Mr$.$ Kane if no strategic investments were initiated, then how long can Newton Community continue operations. Table $12$Ambulatory Surgical Center at Newtown Community HospitalMr. Kane paused for a moment before responding,$1)$ If no strategic and operational changes were made very soon, the hospital will not be able to continue operations beyond two to three years as cash balance runs down$\mathrm{.}2)$ He stated that the low free cash flows were a result of multiple factors a$)$ lowreimbursements from insurance providers, b$)$ surgical and in$-$patient services were unprofitable $($see Appendix $2),$ c$)$ excessive costs for maintaining and operating old building structures, and d$)$ low patient volume because of high hospital charge$\mathrm{.}3)$ He noted that eliminating surgical and in$-$patient services would improve cash balances, but that would imply that the hospital was deficient in fulling its mission to serve the community$\mathrm{.}4)$ If the hospital had a viable plan to improve its financial situation significantly over the next five years, then creditors would be willing to restructure its short$-$term debt into longer$-$term obligations, thereby easing pressure on cash balances.Then Mr$.$ Cruz turned to Dr$.$ Lyons about her progress on the strategic plan for building an Ambulatory Care Center $($ASC$).$ Dr$.$ Lyons noted that her plan would substantially change the hospitals profile. She also added that from a community health perspective, the ASC would be providing much$-$needed surgical and diagnostic services to the community at affordable rates. With that, Dr$.$ Lyons offered the following recommendations$\mathrm{.}1)$ The analysis of in$-$hospital surgical procedures over the last two years indicated that $70\%$ of the procedures could be accomplished in an ASC$\mathrm{.}2)$ She recommended the closure of all in$-$hospital surgical units. Surgical cases that could not be done at the ASC should be transferred to the larger hospital center $40$ miles away$\mathrm{.}3)$ She recommended the closure of $20$ of the $22$ in$-$hospital acute. The remaining two beds would be repositioned for emergency care to be used for stabilizing seriously ill patients$\mathrm{.}4)$ This plan would not require the downsizing of current staff. They would be redirected to the emergency department and to the ASC. Similarly, suitable surgical equipment and furniture currently in use would be reused at the ASC$\mathrm{.}5)$ The range of health services to be provided at the ASC is shown in Appendix $3.$The Financial PlanMr. Kane outlined that Dr$.$ Lyons plan eliminated the two low$-$margin services that Newton Community currently provides in$-$hospital surgical and in$-$patient care services. He noted that the current facility maintenance costs would be dramatically reduced because these two services consumed the bulk of the maintenance costs.Mr$.$ Kane stated that the plan estimates were based on the following$1)$ Purchasing $$3000,000$ for the $2\mathrm{.}5$ acres of adjacent land$\mathrm{.}2)$ Constructing a new $12,000-$square$-$foot ASC facility on the adjacent land. $3$Ambulatory Surgical Center at Newtown Community HospitalInitial Investment and Financing EstimationIn $2022$ Newton Community paid $$75,000$ to civil engineering and construction firms for detailed construction blueprints consistent with Dr$.$ Lyons recommended layout $($see Appendix $3).$ Consequently, the purchase of the land and construction could begin immediately following managements go$/$no$-$go decision on the ASC. Construction can be completed in $12$ months. Construction and building costs are shown in Table $2$ below.Table $2$Mr$.$ Kane acknowledged that forecasting the future is challenging, especially $10$ years out. He stated that he used conservative assumptions to build the financial plan. However, forecast risks still remain$\mathrm{.}1)$ The building construction would be completed in $12$ months and ASC operations can begin within $15$ months$2)$ The ASC is expected to operate at full capacity in Year $3.$ Year $3$ Income from Operations is estimated to be $$6,660,000($see Appendix $4$ for more details.$)3)$ Income from Operations in Year $1$ and Year $2$ are estimated at $30\%$ and $75\%$ of Year $3$ income respectively$\mathrm{.}4)$ Operational Costs in Years $1$ and $2$ gradually grow to reach full operational levels by Year $3.($See Table $3.)5)$ Income from Operations from years $4$ through $10$ will rise annually by $1\mathrm{.}25\%,$ relative to the previous year$\mathrm{.}6)$ Operating costs from Year $3$ are forecast to increase by $3\%$ annually, relative to the previous year$\mathrm{.}7)$ Additional fixed investment in medical equipment of $$750,000$ is scheduled in Year $58)$ Marginal savings from closing current surgical and acute care facilities is estimated at$$185,000$ per year for $5$ years following ASC opening, after which the shuttered square footage will be fully depreciated. Estimation of Future Cash Flows $4$Ambulatory Surgical Center at Newtown Community Hospital$9)$ The terminal value of Newtowns equity in land and building in Year $10$ is estimated at $ $950,000\mathrm{.}10)$ The discount rate to be used for the net present value $($NPV$)$ analysis is $6\%\mathrm{.}11)$ All services at the ASC are pre$-$scheduled. Therefore, payments for services are receivedprior to the provisioning of services or approved by the patients insurance plan. Consequently, uncollected income would be negligible, unlike current experiences at Newtown Community Hospital. Table $3$Following the statement of the factors underlying the forecast, Mr$.$ Kane presented the Net Present Value $($Discounted Cashflow$)$ analysis to the executive team.After intensely scrutinizing the analysis, Mr$.$ Cruz asked Mr$.$ Kane two questions:$1)$ Does Newton Community have sufficient cash balances to cover the forecast risks in theinitial three years before ASC operations reach full capacity?$2)$ What crucial assumption if altered, could change the outcome of the analysis?$5$Ambulatory Surgical Center at Newtown Community HospitalDiscussion Questions$1)$ Using the data provided in this case, fill in the Excel worksheet template provided with this assignment$\mathrm{.}2)$ Calculate the Net Present Value$\mathrm{.}3)$ Respond to Mr$.$ Cruzs question, Does Newton Community have sufficient cash balances tocover the forecast risks in the initial three years before ASC operations reach full capacity? Note, the data used for the NPV analysis are estimates. Therefore, your answer should incorporate the risk associated with forecasting errors$\mathrm{.}4)$ Is the trend in contribution margin a source of concern for the team? Explain why$\mathrm{.}5)$ Based on your analysis offer your recommendation of whether Newtown CommunityHospital would rationally invest in the ASC$\mathrm{.}6)$ Respond to Mr$.$ Cruzs question, What crucial assumption if altered, could change theoutcome of the analysis, by a$)$ identifying one crucial assumption underlying the analysis, b$)$ changing that assumption to a more realistic value and c$)$ recalculating the Net Present Value based on the altered assumption.