Objective Central Hospital, established in 1904, is the premier hospital in Oklahoma City specializing in cardiology. Patients travel from all over the county to be diagnosed for rare heart conditions and receive treatment from Central's leading staff of doctors and nurses. The hospital receives an influx of over 25,000 visitors each year and has grown rapidly since its establishment. In an effort to diversify, Zach Moore, CEO, is considering a $12 million investment to acquire an existing clinic. The institution will be renamed Thatcher Clinic, in memory of Central's late UCO President, Richard Thatcher, and treat the public for general illnesses and diseases. The appropriate WACC of the project is 15%. Central Hospital is a forprofit company and has a marginal tax rate of 40%. Should Central Hospital proceed with the Thatcher Clinic project? Operating Cash Flows - All revenues and expenses occur at year-end and begin at the end of the first year Revenues: One of the key features of the target clinic is its enormous space. The clinic is capable of treating 70,000 patients a year and is expandable to accommodate 90,000 patients through the use of foldout beds and more efficient use of the waiting areas. In order to estimate future profitability, Moore looked at previously recorded patient counts at the clinic. Moore predicts that in the year of Thatcher Clinic's initial opening (t=1), the number of patient visits will be between 50,000 and 60,000 with the most likely number being 53,000. Of these, 40% (60%) are expected to be children (Adults). For the next 5 years (till t=6), the growth in patient base should be between 2% and 6% with the most likely number being 4%. After that (till perpetuity), the growth rate for Thatcher Clinic is expected to be 3% until the clinic reaches capacity. Although the number of patients is expected to grow each year, the proportion of adult and child patients will remain constant. Thatcher Clinic will provide general patient-care that includes three types of services: 1) simple procedures, 2) in-house lab tests, and 3) routine checkups. Last year, Central Hospital paid Phillips Consulting $250,000 to conduct market research on the services demanded by patients. Based on their analysis, Moore estimates that 25% of all adult patients are expected to go in for simple procedures, 35% are expected to have in-house lab tests done, and the remaining go in for routine checkups. For children, Moore estimates that 10% are expected to go in for simple procedures, 20% are expected to have in-house lab tests done, and the remaining children have routine checkups. The demand for all patient lab test and simple procedures are normally distributed with standard errors of 2% and 3% respectively. Moore will use these patient behavior trends to forecast its varying revenue streams. This information along with the price of each of these three forms of patient care are available in the chart below. Clinic Services Offered/Prices Proportion of Adults Proportion of Children Charged Demanding Services Demanding Services Simple Procedures.....$180 25%; std. dev: 3% 10%; std. dev: 3% Vaccinations & splints In-House Lab Test ...$135 35%; std. dev: 2% 20%; std. dev: 2% Urinalysis & blood tests Routine checkups......$140 Remaining % Remaining % Regular annual exams For forecasting purposes, Moore assumes that each patient will incur only one of the above services per visit. Private and public funding for the clinic are an additional source of revenue for Thatcher Clinic, however, Moore will ignore them for the time being due to the extreme volatility of the monetary amounts. Expenses The variable cost of each of the above services for sterile needles, tongue depressors, dressing gowns, etc. average out to $55 per simple procedure, $30 per in-house lab test, and $35 per routine checkup. These costs incurred are the same for both adults and children. The labor force at the clinic is comprised of 4 doctors, 6 physician's assistants, 12 nurses, 1 Clinic Director, and 4 office staff employees. The doctors, physician's assistants, and director are salaried workers, where as 310 days out of the year, the 12 nurses work 8 hours at a rate that is always double the current minimum wage and the 4 office staff members make: Hourly Workers: The prevailing minimum wage is $7.25. Office staff make $13.00/hr. Salaried Workers: As the only salaried employees at the clinic, the 4 doctors, 6 physician's assistants and single Clinic Director earn $130,000, $65,000, and $150,000, respectively. Uniform performance bonuses are allocated equally to all salaried employees and occur at the end of the year. FICA and benefits for all employees are expected to be 20% of their salary and pay. All medical facilities pay a high premium for malpractice insurance, and Thatcher Clinic is no different. Moore expects that each doctor will cost the clinic $25,000 in premiums per year and each physician's assistant will cost the clinic $10,000 in premiums per year. In accordance to EMTALA (1986 Emergency Medical Treatment and Active Labor Act), hospitals and clinics are required to provide care to anyone needing emergency healthcare treatment regardless of citizenship, legal status, or ability to pay. Moore expects that this unfunded mandate will result in uninsured patient costs that consume 20% of total revenue. G&A expenses are fixed at $430,000 per year. Investments in Fixed Assets and Net Working Capital As stated previously, the acquisition cost of the clinic amounts to $12 million. It will be depreciated on a straight-line basis over the next 30 years. In addition to the initial acquisition cost, in each year starting from t=1, Thatcher estimates that upgrades and maintenance to the facility will require annual capital expenditures of 12% of revenues which will be tax deductible expenses. The total net working capital requirement at the beginning of the project for accounts receivables and inventory items such as cotton balls, swabs, band-aids, etc. will be $1,700,000. QUESTIONS For the entire analysis, assume that Thatcher Clinic will be taxed at 40%. As was implicit in all the discussions in class, assume any tax breaks from operating losses can be completely recuperated. To answer these questions you will be using several excel functions. 1. Capacity Constraint: What is the maximum number of years it will take the Thatcher Clinic to reach its capacity of 90,000 patients? 2. Base-case Analysis: Under the base-case/expected demand, revenues, and costs, estimate the total cash flows the clinic will generate from year 0 to year 10. Also calculate the NPV of Thatcher Clinic. Is it a profitable project? The best way to accomplish this goal and answer the subsequent questions is to build an excel-based model that can calculate the NPV of Thatcher Clinic under any feasible set of values of the input drivers. To accomplish this goal, the following hints will be useful. 1. Identify all the input drivers in the model. Separate out the input drivers whose values are known with certainty and those whose value are not known with certainty. 2. In building the model, put all the input drivers at the top left of the sheet. You might find it useful to group (in a logical way) all the input drivers whose values are not known with certainty together at the top. Below those you can group (again, in a logical way) all the input drivers whose values are known for certainty. 3. Below the input drivers, set up the formulas to calculate the cash flows of the project for each year till T+1 where T is the year capacity is reached. 4. Right below where you have calculated the cash flows for year T, set up the formula to calculate the terminal value of the project at T. 5. Set up the formula to calculate the NPV. 3. Scenario Analysis: Copy the model onto a new spreadsheet and calculate expected project NPV of Thatcher Clinic for a best and worst case. What is the expected NPV, the standard deviation of NPV and the Coefficient of Variation? Based on the analysis thus far, explain your results. 4. Investment Decision: Do you think Moore should proceed with the Thatcher Clinic project? Explain.