You are hoping to establish a new simulation center at your hospital. Your first initiative will be offering central line placement simulations. You work with a reimbursement specialist in the finance department and estimate that, due to reductions in infection rates resulting from your simulation program, the hospital will save $2,500 per year. (These savings will come primarily through reductions in length of stay.)

You plan to purchase 3 CVC placement mannequins for $2,000 each. The only additional cost you will have to account for is a once-annual purchase of replacement tissue for the simulation mannequins. The replacement tissue will be a $700 annual cost. You will not need to make and additional tissue purchase at the time you purchase the mannequin.

Assume the discount rate your organization uses for projects of this nature is 10%. Begin with year 0, which is the time at which you purchase the mannequins. Assume that at year 0 your only financial effect is the mannequin purchase. Savings and additional tissue purchases start a year later (label this year 1). Make you projections for years 1-5.

1. Using the information, what is the NPV of the project?

2. What is the IRR of the project?

3. What is the payback period of the project

4. You present your findings to you director (from whom you are hoping to get approval for project funding). Your director says this is a great project. It costs $6,000 to take on and it will return $1,800 per year ($2,500 in savings - $700 in additional tissue replacement costs) for 5 years. Thats a return ofhmm let me think(1800*5)/6000thats the same as 9,000/6,000 and thats 150%. Thats a great return!

Do you agree with your directors calculation of the projects return? Does it agree with your IRR calculation? If not, what is the director forgetting about?

5. You continue conversations with your department director. Now, your director looks at your estimates and says This looks good, but to purchase the mannequins the hospital will need additional funding. We were already planning to take out a loan at 9% interest per year for other equipment purchases. We could add $6,000 to that to fund mannequin purchases, but your calculations dont consider the additional borrowing required and the interest this project would generate. Is this true? Explain why or why not.

Now, lets analyze a different problem. Suppose you are a hospital administrator considering purchasing a new type of hand sanitizer which is marketed to be better at reducing infections because it smells wonderful and this makes hospital employees more likely to use it (forgive the ridiculous example). The new hand sanitizer is more expensive and the additional cost is estimated to be $3,000 per year. The savings associated reductions in infection rates are estimated to be $3,500 per year. Using this information answer the following question:

6. Do you need to calculate the NPV and IRR to decide whether or not to switch to the new, delightful smelling, hand sanitizer? Why or why not?