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Homework answers / question archive / UNIVERSITY OF VIRGINIA MEDICAL CENTER       QUESTIONS START AT ROW 88               Long Term Acute Care Hospital Free Cash Flow Projections                                                       Revenue and Cost Assumptions     Results-No NWC Recovery Results-NWC Recovery                 Number of Beds 50   NPV $5,687 NPV $10,425 (000 ommited)             Year 1 Utilization 26%   IRR 17

UNIVERSITY OF VIRGINIA MEDICAL CENTER       QUESTIONS START AT ROW 88               Long Term Acute Care Hospital Free Cash Flow Projections                                                       Revenue and Cost Assumptions     Results-No NWC Recovery Results-NWC Recovery                 Number of Beds 50   NPV $5,687 NPV $10,425 (000 ommited)             Year 1 Utilization 26%   IRR 17

Finance

UNIVERSITY OF VIRGINIA MEDICAL CENTER

     

QUESTIONS START AT ROW 88

             

Long Term Acute Care Hospital

Free Cash Flow Projections

                     
                             
 

Revenue and Cost Assumptions

 

 

Results-No NWC Recovery

Results-NWC Recovery

             
 

Number of Beds

50

 

NPV

$5,687

NPV

$10,425

(000 ommited)

         
 

Year 1 Utilization

26%

 

IRR

17.6%

IRR

21.2%

             
 

Year 2 Utilization

60%

 

                     
 

Annual Increase in Utilization

4%

 

                     
 

Operating Expense (% of Revenue)

7.0%

 

                     
 

K-wacc

10%

                       
                             
       

Year

1

2

3

4

5

6

7

8

9

10

VOLUME

                         
 

Patient Day Capacity

     

18,250

18,250

18,250

18,250

18,250

18,250

18,250

18,250

18,250

18,250

 

Utilization

     

26%

60%

62%

65%

67%

70%

73%

76%

79%

82%

 

Patient Days Used

     

          4,745

                       10,950

       11,388

       11,844

       12,317

       12,810

       13,322

       13,855

       14,409

       14,986

 

Average Patient Census per Day

     

              13

                             30

             31

             32

             34

             35

             36

             38

             39

             41

 

Average Length of Stay

     

              30

                             27

             27

             27

             27

             27

             27

             27

             27

             27

 

Number of Patients per Year

     

            158

                            406

           422

           439

           456

           474

           493

           513

           534

           555

 

Full-Time Employees/Census

     

             4.8

                            3.5

            3.5

            3.5

            3.5

            3.5

            3.5

            3.5

            3.5

            3.5

 

Full-Time Employees

     

              62

                            105

           109

           114

           118

           123

           128

           133

           138

           144

                             

INSURANCE PAYER

Patient Mix

                       
 

Medicare

36%

   

              57

                            146

           152

           158

           164

           171

           178

           185

           192

           200

 

Medicaid

29%

   

              46

                            118

           122

           127

           132

           138

           143

           149

           155

           161

 

Commercial Payers

24%

   

              38

                             97

           101

           105

           109

           114

           118

           123

           128

           133

 

Other

9%

   

              14

                             37

             38

             39

             41

             43

             44

             46

             48

             50

 

Indigent

2%

   

                3

                               8

              8

               9

               9

               9

             10

             10

             11

             11

         

            158

                            406

           422

           439

           456

           474

           493

           513

           534

           555

                             
   

Billing

 

Annual Incr

                   
 

Medicare—bill per patient

$27,795

 

0.0%

          1,583

                         4,058

        4,220

         4,389

         4,565

         4,747

         4,937

         5,135

         5,340

         5,554

 

Medicaid—bill per patient

$35,000

 

1.3%

          1,605

                         4,170

        4,337

         4,510

         4,691

         4,878

         5,073

         5,276

         5,487

         5,707

 

Commercial Payers—bill per day

$2,800

 

5.0%

          3,189

                         7,726

        8,035

         8,357

         8,691

         9,039

         9,400

         9,776

       10,167

       10,574

 

Other—bill per patient

$38,500

 

1.3%

            548

                         1,424

        1,480

         1,540

         1,601

         1,665

         1,732

         1,801

         1,873

         1,948

 

Indigent—bill per patient

$35,000

 

1.3%

            111

                            288

           299

           311

           323

           336

           350

           364

           378

           394

 

Total Revenue

(000 omitted)

 

        7,035

                      17,665

     18,372

     19,107

     19,871

     20,666

     21,493

     22,352

     23,246

     24,176

 

Less Uncollectable

1%

 

 

              70

                            177

           184

           191

           199

           207

           215

           224

           232

           242

 

Total Net Revenue

(000 omitted)

 

        6,965

                      17,489

     18,188

     18,916

     19,672

     20,459

     21,278

     22,129

     23,014

     23,935

                             

EXPENSES

   

Annual Incr

                   
 

Salary, Wage, Benefits (based on $ per employee)

$60,250

 

3%

          3,760

                         6,516

        6,980

         7,477

         8,009

         8,580

         9,190

         9,845

       10,546

       11,297

 

Supplies, Drugs, Food (% net revenue)

16.3%

   

          1,135

                         2,851

        2,965

         3,083

         3,207

         3,335

         3,468

         3,607

         3,751

         3,901

 

Management Fees (% net rev)

8%

   

            557

                         1,399

        1,455

         1,513

         1,574

         1,637

         1,702

         1,770

         1,841

         1,915

                             
 

Operating Expenses (fixed  + 7 % net rev)

$1,200,000

 

NA

          1,688

                         2,424

        2,473

         2,524

         2,577

         2,632

         2,689

         2,749

         2,811

         2,875

 

Land Lease per year

$200,000

 

3%

            200

                            206

           212

           219

           225

           232

           239

           246

           253

           261

 

Depreciation (straight line 30yrs)

$15,000,000

   

            500

                            500

           500

           500

           500

           500

           500

           500

           500

           500

 

Total Expenses

(000 omitted)

 

          7,840

                       13,896

       14,585

       15,316

       16,092

       16,915

       17,789

       18,717

       19,702

       20,749

                             
   

 

 

 

                   
 

 

 

 

 

  

  

  

  

  

  

  

  

  

  

                             
 

Total Expenses

     

        7,840

                      13,896

     14,585

     15,316

     16,092

     16,915

     17,789

     18,717

     19,702

     20,749

                             

Operating Profit

     

(804)

3,769

3,787

3,791

3,779

3,751

3,703

3,635

3,544

3,427

 

Operating Margin

     

-11.4%

21.3%

20.6%

19.8%

19.0%

18.1%

17.2%

16.3%

15.2%

14.2%

                             

Net Working Capital

Notes:

                       
 

Accounts Receivable

30 days

   

572

1,437

1,495

1,555

1,617

1,682

1,749

1,819

1,892

1,967

 

Inventory Supplies, Drugs, Food

60 days

   

187

469

487

507

527

548

570

593

617

641

 

Accounts Payable

30 days

   

93

234

244

253

264

274

285

296

308

321

 

Net Working Capital

     

666

1,672

1,739

1,808

1,880

1,956

2,034

2,115

2,200

2,288

 

Change in NWC

     

666

1,006

67

70

72

75

78

81

85

88

                             

Free Cash Flows Calculation

                         
 

Operating Profit

     

(804)

3,769

3,787

3,791

3,779

3,751

3,703

3,635

3,544

3,427

 

Add Depreciation

     

500

500

500

500

500

500

500

500

500

500

 

Less Capital Expenditures

   

(7,500)

(7,500)

0

0

0

0

0

0

0

0

0

 

Less Increase in Net Working Capital

 

 

 

(666)

(1,006)

(67)

(70)

(72)

(75)

(78)

(81)

(85)

(88)

 

Free Cash Flows

(000 omitted)

(7,500)

(8,470)

3,263

4,220

4,221

4,207

4,176

4,125

4,054

3,959

3,839

                             
 

NPV (no recovery in year 10)

$5,687

(000 ommited)

                   
 

IRR (no recovery in year 10)

17.6%

                       
                             
       

Year

1

2

3

4

5

6

7

8

9

10

 

NWC Recovery

     

0

0

0

0

0

0

0

0

0

$2,288

 

Sale of Facility at Book Value

     

0

0

0

0

0

0

0

0

0

$10,000

                             
 

NPV with Year 10 Recovery

$10,425

(000 ommited)

(7,500)

(8,470)

3,263

4,220

4,221

4,207

4,176

4,125

4,054

3,959

16,127

 

IRR with Year 10 Recovery

21.2%

                       
                             
 

Net Profit (Operating Profit - Interest)

 

(000 ommited)

(2,004)

2,569

2,587

2,591

2,579

2,551

2,503

2,435

2,344

2,227

 

Net Profit/Net Revenue

     

-28.8%

14.7%

14.2%

13.7%

13.1%

12.5%

11.8%

11.0%

10.2%

9.3%

                             

 

Study the above analysis carefully, examining the inputs, outputs, and formulas used to do the calculations.

               
                             

Q1a

Mulroney did not use working capital cash flows in her original analysis. The analysis above

                 
 

includes incremental investment in working capital. Discuss why she was either correct or incorrect not to

               
 

include them.

                         
 

Here it is required to consider incremental working capital since it is a case of project appraisal. Hence, incremental investment

               
 

 in working capital would be a correct choice. When project grows, there will be required more investment on working

               
 

capital and incremental working capital cashflows will be considered to serve that purpose. Since the incremental working

               
 

 capital is used to generate the sales, hence it will be considered cashflows in investment appraisal.

 

               
 

An accurate approach would be to include NWC recovery in the project appraisal since here a relevant cash flow is taken into

               
 

consideration of the project appraisal analysis.

 

 

 

 

 

               

 

           

 

             

Q1b

Compare the decision metrics NPV & IRR for the "no recovery of NWC" and "recovery of NWC" scenarios,

 

             
 

stating which scenario best captures reality. Based on your answer, give the project a green or red light.

 

             

 

NPV of LTAC project is $5,687,000, and IRR is 17.6% in Without NWC recovery scenario while the NPV of LTAC project is $10425000,

               
 

and IRR is 21.20% in with NWC recovery scenario. Now we can assess that NPV and IRR of the project in with NWC recovery

 

 

 

 

 

               
 

scenario is greater than NPV and IRR of the project in without NWC recovery consideration because there will be more cash flows

 

 

 

 

 

               
 

at the project end in the with NWC recovery scenario in comparison to that of without NWC recovery scenario.

 

 

 

 

 

               
 

 

 

 

 

 

 

               
 

The scenario of “no recovery of NWC" fits the reality. The working capital as well as the whole balance may be not realized at the

 

 

 

 

 

               
 

The scenario of “no recovery of NWC" fits the reality. The working capital as well as the whole balance may be not realized at the

 

 

 

 

 

               
 

project end as anticipated by the company. In this case, there is a possibility that the company might not recover the value of Account

 

 

 

 

 

               
 

receivables, and sell off the inventories as anticipated. Hence no recovery of NWC scenario promises more reliable appraisal.

 

 

 

 

 

               
 

Also, in without recovery of NWC at the project end, the NPV of the project is positive along with IRR greater than discount rate.

 

 

 

 

 

               
 

By the above analysis, it can be said that project is good choice to go ahead.

 

 

 

 

 

               
             

 

             

Q1c

Examine the decision metric 'profit margin', and explain if it leads to a green or red light for this project.

 

             
 

Even though the board of directors uses this metric, it is defective. Explain why. HINT: FCF definition.

 

             
 

Operating profit margin is an accounting measure.  Operating profit margin metric evaluates the profitability of

               
 

the project. It measures the operating profit as a percentage of sales of the project. For the first year, operating profit

               
 

margin of the LTAC Hospital Project is negative (11.4%), and for the next nine years operating profit margin is positive

               
 

(21.3%, 20.6%, 19.8%, 19.0%, 18.1%, 17.2%, 16.3%., 15.2%, and 14.2%). The average operating profit margin of

               
 

the project is 15.00% (Average of 10 Years’ operating profit margin. As the operating profit margin is positive and greater than

               
 

hardle rate of 5%, the project can be said as acceptable. High operating profit margin of the project provide green signal with

               
 

respect to acceptability of the project.

 

 

 

 

 

               
 

 

 

 

 

 

 

               
 

 

 

 

 

 

 

               
 

Even though the board of directors uses profit margin metric for evaluation and appraisal of the project, using profit margin

               
 

metric for project evaluation and appraisal is defective. Decision based on the profit margin metric may result in inaccurate

               
 

decision making.  The pitfalls of the profit margin metric project investment decisions are as follows.

 

               
 

 

 

 

 

 

 

               
 

a) Net profit margin is a measure of profit. Profit margin ratio focuses on profit return rather than cash return. The concept of

               
 

of income is vague, whereas the concept of cash flow return is absolute. The long term feasibility of the project can be better

               
 

judged with cash flows not operating profit.

 

 

 

 

 

               
 

b) Net income is subject to manipulation by accounting treatment and change in accounting policies. But, cash flow is not

               
 

subject to manipulation by accounting treatment and change in accounting policies.

 

 

               
 

c) Net profit margin is not related to wealth maximization rather than profit maximization. The ultimate goal of the company

               
 

it to maximize the shareholders’ wealth.  Free cash flows used for NPV analysis, and IRR analysis, are more related to the

               
 

concept of maximizing shareholders' wealth.

 

 

 

 

 

               
             

 

             

Q1d

Reconcile your answers to Q1b and Q1c.

         

 

             
 

Profit margin metric evaluates a project through operating profit margin ratio. NPV and IRR evaluate a project through

               
 

free cash flow (FCF) from the project. Operating profit is used as an input in the calculation of free cash flow (FCF).

               
 

Thus there may be a consistency in the results of Profit margin metric, and NPV & IRR metric otherwise the company 

               
 

engages in over trading which cause to positive operating profit but negative free cash flows.

 

               
 

 

 

 

 

 

 

               
 

From the 'Schedule of Free Cash Flow Calculation' it is seen that in the first year operating profit of the company is negative.

               
 

This negative operating profit leads to negative free cash flows in Year 1 after adjustment of depreciation, change in NWC,

               
 

and capital expenditure. In the subsequent years, operating profit of the company is negative and this positive operating

               
 

profit leads to positive Free Cash Flows (FCF) after adjustment of depreciation, change in NWC, and capital expenditure.

               
 

 

 

 

 

 

 

               
 

Consistency in the result leads to consistency in the decision making. All Profit margin metric, and NPV & IRR metric suggest

               
 

that LTAC project is feasible and should be accepted.

 

 

 

 

               

 

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