Question

Established in 1987, ABC Community Hospital not-for-profit is an acute care hospital located in an east coast Metropolitan area. With a staff of nearly 200 physicians and specialists, 800 employees and 100 volunteers, they offer a full range of healthcare services. They are accredited by the Joint Commission on Accreditation of Healthcare Organizations. The hospital has been profitable for the last 5 years with a profit margin of 3-4%. The mission of ABC Community Hospital is to provide accessible and comprehensive healthcare services in a convenient and cost-effective manner to the people who live in our community.

At the last Board meeting, hospital administration and the Board of Directors began to discuss a proposal to build a new wing devoted to a Cancer Center and ancillary services devoted to the treatment of cancer. The new wing would have 30 acute care beds, four surgical operating rooms, intensive care unit and extensive support services, including physical therapy and hospice care. All patient rooms would be private. There is no Cancer Centers within a 200 mile radius of the hospital service area.

Now, the Board of Directors has come back with more questions that they want you to add to the original plan with 2-3 pages of new content:

• Compare and contrast the kinds of decisions that are made in the Cancer Center capital investment decision analysis for ABC Community Hospital.
• What information is needed by the CFO to evaluate the Cancer Center capital investment project? Use the classification of capital expenditures and justification of capital expenditures for this project, and include working capital management.  
• Who, internally from the healthcare system and externally, should be involved in the capital investment decision process to determine the feasibility of the Cancer Center?

Answer 1

Information Needed to Evaluate the Cancer Center Capital Investment Project In the evaluation of capital investment, there is crucial information that is necessary to carry out the process. The evaluation process is done using various approaches which include the payback period, internal rate of return and the net present value ( Greenwood, 2002) . Payback period is done by determining the time it takes for the initial investment to be recouped into the project. The investment is recouped in the form of expected future expected cash flows. Under this approach, the information required is the cost of equipment purchased and the estimated useful life of the resource ( Greenwood, 2002) . The cancer center project will include the purchase of equipment for treating cancer and thus they will need to keep the records of cost to help in the evaluation of the capital investment using this approach. Net present value, on the other hand, is used in the computation of the monetary benefits expected from the project and discounting them into the current value in time. This entails the use of rate of return and in most cases the minimum is the required. This minimum is also known as the discount rate or the cost of capital. This is important in the case where debt financing is the source of money. This method requires the initial net investment and the annual cash inflows for the project ( Greenwood, 2002) . The internal rate of return is a model which is under the discounted cash flows. It is used to determine the internal rate of return or the discounting rate where the expected cash inflow`s present value is the same as the expected cash outflow`s present value. This method requires one to have the expected annual cash of the project and the present value annuity factor.

After determining cash flows and the cost of capital, managers can begin to evaluate various capital investment alternatives. The most commonly employed technique for evaluating investment alternatives is the net present value technique. Variations of this technique include the profitability index and the internal rate of return.

How to determine today’s net present value

The net present value (NPV) technique is based on the concept that you prefer receiving cash today rather than in the future. One obvious reason for this preference is the fact that cash received today can earn interest through the purchase of government securities or other types of bonds. Therefore, any future cash you receive needs to be discounted by an appropriate interest rate.

If all the capital investment project’s expenditures occur during the current year, the project’s net present value (NPV) equals where CFt represents the net after-tax cash flow in year t, r is the cost of capital, and I is the capital investment project’s cash outlay assumed to occur in the current year, or year 0.

CFL NPV t t t-11r OP

STRATEGIC FINANCIAL PLANNING In the center cancer project, information on the opportunities created by the project regarding technology would be paramount. Such information includes the technological changes that occur in the hospital once the treatment cancer equipment is bought. The employees become more productive when they have better equipment as compared to when they treat workers with old stuff ( Greenwood, 2002) . Internal and External Stakeholders in Decision Making Internal Stakeholders, Project manager, Procurement Officer, Board of Directors External Stakeholders, The community, External auditors