Joint Venture Ambulatory Surgery Center( Case Study )

Introduction:

Community Hospital has reached near capacity in its on-campus surgical suites and has begun to explore options to add addition O.R. capacity. Concurrently, a number of its busiest surgeons have expressed an interest in developing and owning an ambulatory surgical center (ASC). Representatives of both groups have recently met and have agreed to explore together the feasibility of a jointly-owned ASC. Before committing substantial resources to the venture, they have requested your help in determining the preliminary financial feasibility of the project with the expectation that they will make a creeping commitment commit more resources as planning crystallizes. Accordingly, you have been asked to compile a financial proforma based on assumptions provided by them.

Facility Issues:

While the Hospital and surgeons would prefer a green field project (newly-constructed building), they recognize the entry cost would be less if they were to rent and retrofit existing space. They have identified approximately 16,000 sq.ft. nearby and are reasonably confident they can enter into a five-year lease with two five-year options at an initial lease cost of $32 per square foot with 5 % annual increases thereafter.

Retrofit and Equipment Costs:

The projects architects have recommended the joint venture partners plan on providing a high degree of patient, physician, and employee amenities in the space. This will increase fit and finish costs from what might otherwise be the case. Based on preliminary volume estimates (see below), the initial planning assumes four operating rooms and two pain rooms.

The architects estimate that the tenant improvements and build-out costs will be $207 per square foot, and the costs to equip the operating rooms (and pain rooms) another $3.5 million.

Volume and Average Reimbursement per Case:

The ASC will be a multi-specialty facility with emphasis on orthopedic surgery and pain management. The Hospital and surgeons have been deliberating about anticipated volume and have agreed to be conservative with respect to this key assumption. They collectively estimate surgical and procedure volumes as:

Year Procedures

Year 1 3,076

Year 2 4,248

Year 3 4,510

Because the facility is off campus and not Hospital-controlled, outpatient procedures will be reimbursed at approximately 65% of current Hospital outpatient reimbursement rates. This is of concern to the Hospital and is a matter they want your views on. The partners estimate the ASC will be reimbursed at an average per procedure of $1,790 in Year 1, increasing 2% in Years 2 and 3, respectively.

Start-Up Costs:

Like with any substantial undertaking, it is not practical to assume that the ASC will be revenue producing during the planning, construction, start-up, and shake-out period. A management company will be engaged to help with the planning (and retained thereafter); among other things, the management company will begin to recruit and train employees and promote the ASC. These Year 0 start-up costs are estimated at $500,000. Fortunately, the landlord has agreed to waive rent until operations commence, which will also be the effective date of the space lease.

Variable Costs:

While certain salary and wage costs are variable and others fixed, the partners have agreed to assume that only medical, drug, pharmacy, and related costs are variable. They estimate these costs at 16% of net patient service revenue.

Salaries, Wages, and Fringe Benefits:

Conventional wisdom suggests approximately 5 FTEs per 1,000 cases. The Hospital and physicians want highly-skilled and motivated employees and agree on an average salary of $60,000 per FTE. They agree fringe benefits will approximate 25% of salaries and wages. Pay increases of 5% annually are expected.

Depreciation:

The build-out and equipment costs (see above) will be depreciated/amortized using the straight-line method over the initial lease period and one option renewal.

Other Expenses:

The management companys contract provides for annual compensation of $200,000 (post start-up) with 3% annual increases.

Other expenses (including maintenance, office supplies, insurance, utilities, advertising, marketing, telephone/communications, etc.) are anticipated to aggregate $505,000 in Year 1, increasing 3% annually thereafter.

Interest Expense:

The partners are willing to invest $200,000 in the aggregate in the ASC. All start-up, build-out, equipment costs, and initial losses, if any, will be financed with a non-amortizing bank loan bearing interest at 7% annually. They expect you to determine the amount of the necessary borrowing.

Income Taxes:

By law, the ASC will be a for-profit entity and as such, will be subject to income taxes (which you can ignore in this preliminary phase).

Assignment:

You have been asked to compile a projected income statement (proforma) for Years 0, 1, 2, and 3, in the traditional income statement format ending with income (margin) before taxes. You are to also prepare a proforma cash flow statement for the four years.

Upon completion, compute EBITDA and provide your views on the initiative from an investment perspective. Also, provide your views on whether this joint venture opportunity makes strategic and tactical sense for the parties. What issues/matters have you considered in shaping your views?

Ambulatory Surgery Center Case Study

		YEAR
		0		1		2		3
				(000's)
Net Patient Service Revenue
Expenses:
Supplies
Salaries & wages
Fringe benefits
Management fee
Other
Interest
Lease
Depreciation
Total Expenses
Income Before Taxes
Cumulative:
EBITDA
Cumulative:

Ambulatory Surgery Center Case Study

Proforma Cash Flow Statement

For years 0-3

(000s)

Beginning cash

Cash flow from operating activities:

Income before taxes

Add depreciation

Cash used in investing activities:

Purchase of property, plant & equipment

Cash flow from financing activities:

Joint venture partners capital contributions

Proceeds from bank loan

Ending cash