Question

Mr. Reynolds has asked each member of the committee to carefully review the data related to Mr. Meek's proposal, and then send him an email message letting him know your initial thoughts. In your message, you might want to take into consideration the following information:

• The current and projected patient volumes and payer mix.
• The present and projected financial position of the system.
• The effectiveness of similar approaches to improving patient service revenue, lowering costs, and achieving economies of scale.
• The appropriateness of the proposed services given current demographic trends.
• The ability of the system to support proposed changes to the existing business model.
• The political climate at the state and federal level; g) the likelihood of receiving state approval on a certificate of need (CON), if needed.
• The prevailing economic climate at the local, state, and federal levels; i) the emergence of direct and indirect competitors.
• The availability of technology.

This is not intended to be an "all inclusive" listing of the kinds of information that you might want to take into consideration when assessing the feasibility of a capital budgeting proposal. In the case study, the years go from 1994 through 1998, so you're asked to use the range of years going from 2015 through 2019.

Using the case study below:

Regional Health System: The Satellite Health Park Strategy. In this case, we see the Florida-based, free standing hospital later became an integrated delivery system (IDS) following its implementation of a Board approved restructuring. This restructuring came about as the organization began to experience a decline in patient service revenue as the federal government cut Medicare reimbursements in an attempt to lessen the federal deficit. The payer mix is heavy weighted to Medicare, since roughly 45% of the hospital's primary and secondary markets is comprised of persons 65+, which is disproportionately larger than the national average of 13%.

By all accounts, the restructuring has resulted in an improvement in the bottom line performance of the system. The Chief Executive Officer has remained concerned that long-term financial solvency of the system could be at risk if additional steps aren't taken to secure the company's future. He has come up with the idea of developing a satellite health park that will provide an array of outpatient services outside the hospital setting. The CEO believes the park will increase patient service revenue and reduce overhead and other costs, while achieving economies of scale; however, he would like to reconvene the system's strategic planning committee to take a deeper look into the viability of this proposal. Mr. Michael Reynolds, SVP and CFO, is chairing the committee and you and some of your colleagues have been assigned to serve as a member.

The case study provides relevant data, which was used, in part, to pull together the financial projections. Here is some additional information that you may find helpful. The system's cost of capital is 8.25%. This is how much it costs the company to raise a dollar of capital to invest in projects such as the satellite health park. So, with a cost of capital of 8.25% (or .0825), that means it costs the firm 8.25 cents to raise 1 dollar of investment capital. The net present value (NPV) of Mr. Meek's proposal comes to $6,939,411. The NPV represents the present value of all future cash inflows minus the cash outflows (initial investment). The internal rate of return (IRR) is the anticipated profit for every dollar of invested capital. In this case, the IRR is 15%, which means that for every dollar of capital invested in the proposal (project), the system anticipates receiving 15 cents in profit. To determine if the IRR is good, we need to compare it to the firm's cost of capital, which is 8.25%. The profitability index is $1.17, which means that the system projects that for every dollar of invested capital, it will receive a profit of 17 cents. The discounted payback period for this proposal is 3.3 years, which assumes that the cash flow projections are accurate.

Answer 1

The CEO's Proposal should be accepted considering following :

- The NPV of the project is positive. NPV indicates that against initial capital investment the discounted future cash flow is positive by 6,939,411

- The discounted payback period of 3.3 year. The payback period is comparatively smaller which indicates low risk. If there is higher payback period, it come with number of uncertainties like change in regulation, change in demand & supply which actually increase risk of the project.

- The IRR of the project is 15%. It is quite higher than cost of borrowing of 8.25% hence it makes sense to go for borrowing to invest in project

- The profitability index of 1.17 corroborates the finding that project will generate positive discounted cash flow against investments