UNDERSTANDING HEALTHCARE FINANCIAL MANAGEMENT Chapter 12 - Project Risk Analysis PROBLEM 3 Consider the project contained in Problem 7 in Chapter 11 (California Health Center). a. Perform a sensitivity analysis to see how NPV is affected by changes in the number of procedures per day, average collection amount, and salvage value. Remember supplies vary with number of procedures. b. Conduct a scenario analysis. Suppose that the hospital's staff concluded that the three most uncertain variables were number of procedures per day, average collection amount, and the equipment's salvage value. Furthermore, the following data were developed: Equipment Number of Average Salvage Scenario Probability Procedures Collection Value Worst 0.25 10 $60 $100,000 Most likely 0.50 15 $80 $200,000 Best 0.25 20 $100 $300,000 CO c. Finally, assume that California Health Center's average project has a coefficient of variation of NPV in; the range of 1.0 - 2.0. (Hint: Coefficient of variation is defined as the standard deviation of NPV divided by the expected NPV.) The hospital adjusts for risk by adding or subtracting 3 percentage points to its 10 percent corporate cost of capital. After adjusting for differential risk, is the project still profitable? d. What type of risk was measured and accounted for in Parts b. and c.? Should this be of concern to the hospital's managers?UNDERSTANDING HEALTHCARE FINANCIAL MANAGEMENT Chapter 11 - Capital Budacting PROBLEM T California Health Center, a for profit hospital, is evaluating the purchase of new diagnostic equipment. The equipment, which costs $600,030, has an expected life of five years and an estimated pretax salvage value of $200,030 at that time. The equipment is expected to be used 15 times a day for 250 days a year for each year of the project's life. On average, each procedure is expected to generate $80 in collections. which is net of bad debt losses and contractual allowances, in its first year of use. Thus, net revenues for Your 1 are estimated at 15 X 250 X $80 - $300 000. Labor and maintenance costs are expected to be $100,030 during the first year of operation, while wilitics will cast another $10,030 and cash overhead will increase by $5,000 In Year 1. The cost for expendable supplies is expected to average $5 per procedure during the first year. All costs and revenues, except depreciation, are expected to increase at a 5 percent inflation rate after the first year. The equipment falls into the MACKS five-year class for tax depreciation and hence is subject to the following depreciation allowances! Allowance 0.2 0.31 3 0.19 0.12 0.11 0.06 The hospital's tax rate Is 40 percent, and its corporate cost of capital is 10 percent. .. Estimate the project's net cash flows over its five-year estimated life. b. What are the project's NPY and IRK? (Assume that the project has average risk.) (Hint: Wee the following format as a guide ) 2 4 Equipment cost Net revelvues 313010100 330750.001 347247.50 364651.88 Previous year*5%% inflation Labor/maintenance costs 105010.00 110250.061 115762.50 121350.63 Previous year*5%% inflation Utilities costs 10000.00 10500.00 11025.00 11576.25 12135.06 Previous year*5% inflation Supplies 18750.00 19687.50 20671.86 21 705.47 22790.74 Previous year*5%% inflation Incremental overhead 5000 00 $290100 5512 501 $7KK. 13 6077 53 Previous year*5%% inflation Depreciation 1200 00.0 192000.00 114000.00 72000.00 64000.00 Equipment cost* MACRS Operating income 46250.00 69290.63 120435.16 136077.91 Revenue-operating expenses -6975.00 27716.25 18182.06 $4431.17 Operating income"Tax (0.4) Net operating income 27750.00 -10462.50 41574.381 12273.09 $1646.75 Operating income-Tax Plus: Depreciation 120060.00 192080.00 114000.00 72000.00 56000.00 (+)MACKS Depreciation Plus: After-tax equipment salvage value" 134400.00 (See formula below) Net cash flow -$600,003.00 5147,750.00 5181,537.50 5155 574.36 5144 273.09 $282 046.75 Net income+Depreciation + salvage value