Question

INPUT DATA:				KEY OUTPUT:
Land initial cost			$150,000	NPV	$1,408,166
Land opportunity cost (and salvage value)			$200,000	IRR	14.7%
Building/equipment cost			$10,000,000	MIRR	12.9%
Build/equipment salvage value			$5,000,000	Payback	4.0
Procedures per day			20
Average net revenue per procedure			$1,000
Labor costs			$696,000
Utilities costs			$50,000
Incremental overhead			$36,000
Supply cost ($/procedure)			$200
Inflation rate on charges			3.0%
Inflation rate on costs			3.0%
Tax rate			40.0%
Revenues lost from inpatient surgeries			$1,000,000
Reduction in inpatient surgery costs			$500,000
Cost of capital			10.0%
MODEL-GENERATED DATA:
Depreciation Schedule:
		MACRS	Deprec.	End of Year
	Year	Factor	Expense	Book value
	1	0.20	$2,000,000	$8,000,000
	2	0.32	3,200,000	4,800,000
	3	0.19	1,900,000	2,900,000
	4	0.12	1,200,000	1,700,000
	5	0.11	1,100,000	600,000
	6	0.06	600,000	0
Net Cash Flows:
			Project Cash Flows
			0	1	2	3	4	5
Land opportunity cost			($200,000)
Building/equipment cost			(10,000,000)
Net revenues (including inpatient loss)				$4,000,000	$4,120,000	$4,243,600	$4,370,908	$4,502,035
Less: Labor costs				696,000	716,880	738,386	760,538	783,354
Cost savings on inpatients				(500,000)	(515,000)	(530,450)	(546,364)	(562,754)
Utilities costs				50,000	51,500	53,045	54,636	56,275
Supplies				1,000,000	1,030,000	1,060,900	1,092,727	1,125,509
Incremental overhead				36,000	37,080	38,192	39,338	40,518
Depreciation				2,000,000	3,200,000	1,900,000	1,200,000	1,100,000
Income before taxes				$718,000	($400,460)	$983,526	$1,770,032	$1,959,133
Taxes				287,200	(160,184)	393,410	708,013	783,653
Project net income				$430,800	($240,276)	$590,116	$1,062,019	$1,175,480
Plus: Depreciation				2,000,000	3,200,000	1,900,000	1,200,000	1,100,000
Plus: Net land salvage value								180,000
Plus: Net building/equipment salvage value								3,240,000
Net cash flow			($10,200,000)	$2,430,800	$2,959,724	$2,490,116	$2,262,019	$5,695,480
Cumulative net cash flow			($10,200,000)	($7,769,200)	($4,809,476)	($2,319,360)	($57,341)	$5,638,139
(For payback calculation)
Profitability and Breakeven Measures:
Net present value (NPV)				$1,408,166
Internal rate of return (IRR)				14.7%
Modified IRR (MIRR)				12.9%
Payback				4.0
(Question)

What is “incremental cash flow”? Because the project, at least constructively, will be financed in part by debt, should the cash flows include interest expense? Think about why or why not . . .

The hospital already owns the site for the center, so should any cost be attributed to the land? Why or why not . . .

What overhead costs should be included in the analysis?

How should the cannibalization of inpatient surgeries be handled?

What is the project’s payback? What is the economic interpretation of payback? What type of information do decision-makers get from the payback?

What is the project’s net present value (NPV)? Think about the economic rationale behind this profitability measure.

What is the project’s internal rate of return (IRR)? Think about the economic rationale behind IRR. Do the NPV and IRR always lead to the same conclusion about a project’s profitability?

What is the project’s modified internal rate of return (MIRR)? How does MIRR differ from IRR? Which one is a better measure of a project’s true rate of return?

To give the board a better feel for the impact of inflation on the outpatient surgery center, you may wish to construct an inflation impact table.

You may wish to conduct a sensitivity analysis—creating a table and/or graph that shows the sensitivity of NPV to procedures per day, average charge, and salvage value. Assume that each variable can deviate from its base case value by +/-10, +/-20, and +/-30 percent. Think about the advantages and disadvantages of sensitivity analysis.

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