Questions

1. Put all cash flows for the first 36 months (plus month zero) in an Excel spreadsheet
2. Calculate the NPV on the initial ($200,000 maximum) investment by the shareholders. If additional capital will be needed during the 37 months identify when and how much. If $200,000 is insufficient and additional funding will be required explain identify when and how much will be needed. There is no need to determine whether that funding will be debt or equity, or some combination.
3. Calculate IRR for the project at the annual level (not monthly). Summarize and interpret the calculated result you obtain.
4. Several assumptions were made in this case; however, many other threats to the business or opportunities for greater success may occur during the 3 years of running the new operation. Discuss other threats and opportunities that might occur and the effect of these events on your calculations.

Information:

Current Situation

Sierra Surgical Services Center, LLC (S-3-C) is a limited liability company offering ambulatory surgical services to its patients. Located in a medium-sized city (pop. 217,000) in east-central California near the Sierra Nevada Mountains, it draws patients from both CA and some nearby Arizona communities. S-3-C has ten physician shareholders who, by tradition hold equal interest in the company. When new physicians are admitted to the business, the shares are redistributed over a two-year period to maintain equality. Similarly, when physicians leave the shares are redistributed at the end of the fiscal year. S-3-C has a medical staff totaling 42 people, including RNs, NPs, PAs, lab assistants, and two certified registered nurse anesthetists (CRNAs). In addition, there are eight administrative staff, including receptionists, accounting and billing personnel, a human resource manager, and an IT support person.

S-3-C started out in 1999 as a general surgery practice, then expanded in 2012, when they added orthopedic surgery with the admission of an orthopedic surgeon. That proved to be a positive experience and they have subsequently been looking for the appropriate way to expand once again. They were recently approached by a local dermatologist about joining the company and adding dermatologic surgery to the services offered.

You are the accounting partner from S-3-Cs professional services firm (accountants, tax specialists, management consultants) and you were invited to a recent meeting of the physician shareholders where expansion was discussed. At the conclusion of the meeting you were asked to assemble a team from your company and prepare an analysis of the opportunity. Given your familiarity with the finances of the practice and its key personnel, as well as the importance of S-3-C as a client, you agreed to conduct the study and report back to the group within 60 days.

You were given the following guidelines within which to perform the assignment:

1. The physician shareholders do not want to borrow money to finance the expansion they intend to self-fund but want to understand how much will be required and the timeframes for contributing the capital.
2. They expect the practice to achieve accounting breakeven within 18 months, then rapidly begin contributing profits to the overall practice.
3. They believe there is sufficient space in the current building to support the new practice but know that there will be some remodeling and equipping required for it to function.
4. Overhead costs are allocated to each physician and will be to the dermatologist in a similar fashion

Your Approach

As the partner, you assemble your team and identify key contacts with S-3-C who can provide detailed information. The team begins by preparing a list of steps it will go through to meet the objective. Certainly, one of the first will be to estimate and analyze all the anticipated future cash flows for three years (at the monthly level). The following data are presumed to be reasonably accurate at the time you make your initial assessment.

Initial Case Assumptions

1. Based on the current allocation methodology, fixed costs for the new practice will be $21,250 per month. This includes a pro rata share of the facility costs (e.g., utilities, security, insurance), administrative staff, information technology, etc. Allocation expense will begin one month prior to seeing the first patients.
2. Remodeling existing space to make it suitable for the new practice must occur immediately and is estimated at $168,500.
3. A newer version of the Mohs surgical equipment is expected to become available at the start of year 3 of the practice and will improve outcomes. The new equipment will be leased originally for $570 per month, plus 0.85% of billed charges, then may be purchased one year later at the sole discretion of the physician. The purchase price will be finalized six months prior to the purchase eligibility date
4. Remodeling is expected to take four weeks and services will begin immediately afterwards. The goal is to begin identifying and enrolling patients prior to opening so that the site will be busy within the first weeks of operation. The dermatologist is expected to retain the majority of her existing patients so no lapse in service volume is anticipated.
5. One month before seeing patients at the new site one new full-time administrative employee will be hired to begin implementing business, accounting, contracting with payers, and administrative functions solely for the dermatology practice. The employee cost will average $48,000 per year, including benefits. At some point as yet undetermined that employee will become part of the overall overhead but this will occur beyond the 36-month analysis.
6. Variable costs of supplies for all procedures performed are 9.5% of revenue.
7. Fixed costs of three new FTE medical support staff (a PA, and 2 NPs) will begin two weeks ( month) before the remodeling is completed at an average annual salary of $59,500 per employee, including benefits.
8. The required rate of return for the new practice is 12%. This is the discount rate and is stated on an annual basis
9. Revenue from dermatologic surgery services is estimated using the following conservative assumptions. Note that all numbers are averages:
   1. Eight billable patient procedures / day
   2. Surgeries are preformed 12 days per month
   3. Average total revenue per surgical procedure $1,100
10. The number of procedures performed is expected to grow at a 10% annualized rate beginning in month 13. Revenue per procedure is expected to grow at 5% annually beginning year 2.
11. All expenses, including salaries and benefits, and allocated overhead, are expected to grow at 2.5% per year after year 1
12. The five shareholders will contribute up to $200,000 capital to start the project. If less is needed that should be noted. Similarly, if this amount is insufficient and additional funding will be needed this too should be noted in the recommendation with projections on the amount and timing of the additional cash. The LLC (the physician shareholders) intend to withdraw $75,000 per month during the second year of operation, and $80,000 per month during the third year, assuming the new practice is able to sustain these levels of outflow.

A table of key assumptions follows the Requirements section. Note that you are free to make additional assumptions you feel are necessary to complete the analysis and meet the requirements. Such additions should be reasonable and must be documented in your analysis.

Summary of Key Assumptions $ 255,000 $ 168,500 $ 570 1 $ 48,000 9.5% Current fixed cost share per yr Remodeling Y. Equipment update per month No. of administrative staff Avg. Adm salary and benefits per yr Variable cost % of revenue No. of medical staff Avg. Medical salary and benefits / yr Growth rate for expenses/yr Discount rate / Cost of capital / yr Procedures per day Work days per month Revenue per case Annual visit growth rate Annual revenue growth rate Partner withdrawals per mo Y2 Partner withdrawals per mo Y3 Mohs equipment charge on revenue $ 59,500 3.0% 12.0% $ 1,100 10.0% 5.0% $ 75,000 $ 80,000 0.85% Summary of Key Assumptions $ 255,000 $ 168,500 $ 570 1 $ 48,000 9.5% Current fixed cost share per yr Remodeling Y. Equipment update per month No. of administrative staff Avg. Adm salary and benefits per yr Variable cost % of revenue No. of medical staff Avg. Medical salary and benefits / yr Growth rate for expenses/yr Discount rate / Cost of capital / yr Procedures per day Work days per month Revenue per case Annual visit growth rate Annual revenue growth rate Partner withdrawals per mo Y2 Partner withdrawals per mo Y3 Mohs equipment charge on revenue $ 59,500 3.0% 12.0% $ 1,100 10.0% 5.0% $ 75,000 $ 80,000 0.85%