Case Study:

In my professional experience in the healthcare sector, expanding a hospital's facilities to meet rising patient demand was a big financial choice that required the application of capital budgeting techniques. The management of the hospital was contemplating building a new wing to house more patient rooms, operating rooms and specialized treatment spaces. We used the Internal Rate of Return (IRR) and Net Present Value (NPV) methodologies to assess the financial viability of this expansion project (NIH, 2023). Expenditures associated with construction, running expenditures, and predicted growth in patient revenue over the following ten years were all incorporated in the estimated cash flows. The hospital's cost of capital was taken into account in the NPV calculation, which used a discount rate of 8%. The enlargement project had a positive NPV of $2.5 million and an IRR of 12%, according to the research. This showed that the investment was anticipated to increase the value of the hospital overall and create returns more than the cost of capital (NIH, 2023). The predicted 5-year Payback Period further emphasizes how long it will take to recoup the initial expenditure.

As a manager, I would opt to use the Net Present Value (NPV) method when deciding whether to purchase a cutting-edge MRI machine for the hospital. The NPV technique provides a thorough analysis of both the upfront costs and possible revenue streams over the machine's useful life by discounting future cash flows to account for the time value of money. This is consistent with the intricate financial issues faced by the healthcare sector, where resources are scarce and investments last for many years (Franklin et al., 2019). The inclusion of opportunity cost in NPV as well as its alignment with financial objectives further demonstrates its applicability. NPV's comprehensive approach allows a more accurate assessment of the investment's long-term influence on the financial situation and sustainability of the hospital, even when other approaches like Payback Period and Accounting Rate of Return offer insights.

The Net Present Value (NPV) method has a thorough analysis and is in line with the complexity of the healthcare industry, thus I would choose it above other options. By discounting future cash flows, NPV takes into account the time value of money and provides a clear picture of investment profitability over the life of the MRI machine (Franklin et al., 2019). In contrast to the Payback Period, which focuses primarily on the amount of time needed to recoup expenses, NPV explores the entire cash flow timeline, which is crucial for long-term investments in healthcare. In addition, NPV incorporates opportunity cost, which reflects the organization's cost of capital and improves decision-making in healthcare settings with limited resources. The Accounting Rate of Return (ARR) method, in contrast, does not take time value of money into account, potentially leading to skewed profitability estimates (Walden University, 2021). By choosing NPV, I can address the inherent market uncertainties and assure alignment with the hospital's strategic objectives. Thus, NPV stands out as the approach that comprehensively evaluates the financial implications of the MRI investment against the backdrop of changing healthcare dynamics and scarce resources.

References

Franklin, M., Graybeal, P., & Cooper, D. (2019). 11.4 use discounted cash flow models to make capital investment decisionsLinks to an external site. Links to an external site.. In Principles of accounting, volume 2: Managerial accounting. OpenStax. https://openstax.org/books/principles-managerial-accounting/pages/11-4-use-discounted-cash-flow-models-to-make-capital-investment-decisions

Questions:

• Ask a clarifying question about your colleague's example and/or analysis.
• Provide a different perspective on which method your colleague, as a manager, could use to make the decision.
• Offer an insight you gained from your colleague's analysis of why they would choose one particular method over the others.