Requirements: When the project was mentioned briefly at the last meeting of the
ID: 2768938 • Letter: R
Question
Requirements:
When the project was mentioned briefly at the last meeting of the hospital's board of directors, several questions were raised. In particular, one director wanted to make sure that a complete risk analysis, including sensitivity and scenario analyses, was performed prior to presenting the proposal to the board. Recently, the board was forced to close a day care center that appeared to be profitable when analyzed two years ago but turned out to be a big money loser. They do not want a repeat of that occurrence.
One of the directors stated that she thought the hospital was putting too much faith in the numbers: "After all," she pointed out, "that is what got us into trouble on the day care center. We need to start worrying more about how projects fit into our strategic vision and how they impact the services that we currently offer."
Conduct a sensitivity analysis. As part of your analysis, create a table and a graph that shows, by each service line, the sensitivity of NPV to number of procedures, average revenue, and allowable amount. Assume that each variable can deviate from its base case by ±10, ±20, and ±30 percent. You must do this analysis on the Gross Revenue & Adjustments Tab. You can copy this table into your Excel file:
Number of Procedures
Charge per Procedure
Allowable amount per Procedure
Number of Procedures
Charge per Procedure
Allowable amount per procedure
-30%
-30%
-30%
-30%
0
0
0
-20%
-20%
-20%
-20%
0
0
0
-10%
-10%
-10%
-10%
0
0
0
0%
0%
0%
0%
0
0
0
10%
10%
10%
10%
0
0
0
20%
20%
20%
20%
0
0
0
30%
30%
30%
30%
0
0
0
To develop the data needed for the risk analysis, the hospital's director of capital budgeting, met with department heads of surgery, marketing, and facilities. After several sessions, they concluded that three input variables are highly uncertain: number of procedures, charge per procedure, and allowable amount per procedure. If another entity entered the local ambulatory surgery market, the number of procedures could be as low as 3,000 per year. Conversely, if acceptance is strong and no competing centers are built, the number of procedures could be as high as 4,000 per year, compared to the most likely value of 3,602 per year.
The charge per procedure amount, with an expected average value of $3,712, is a function of the types of procedures performed and the amount of managed care penetration. If surgery severity were high (i.e., if a higher number of complicated procedures were performed than anticipated) and managed care penetration remained low, then the average revenue could be as high as $4,000. Conversely, if the severity were lower than expected and managed care penetration increases, the average revenue could be as low as $3,000.
Finally, if contract negotiations go well, the average allowable amount could be as high as $2,200, but if negotiation fall through, the allowable amount could be as low as $2,000, compared to an expected value of $2,139.
Conduct a Scenario analysis using the following data (you can copy and paste this into the Gross Revenues & Adjustments tab):
Number of
Avg Charge
Avg Allowable Amount
Case
Probability
Procedures
per Procedure
per Procedure
NPV
Worst
25.0%
3,000
$3,000
$2,000
Most Likely
50.0%
3,602
3,712
2,139
Best
25.0%
4,000
4,000
2,200
100.0%
To help with the risk-incorporation phase of the analysis, you consulted with the hospital’s chief financial officer, about both the risk inherent in the hospital's average project and how the hospital typically adjusts for risk. He told you that based on historical scenario analysis data that use worst, most likely, and best case values, the hospital's average project has a coefficient of variation of net present value (NPV) in the range of 1.0 to 2.0 and that the hospital typically adds or subtracts 4 percentage points to its 10 percent corporate cost of capital to adjust for differential project risk.
Determine the level of risk in this project and adjust your cost of capital accordingly. Discuss the impact in your write up.
Number of Procedures
Charge per Procedure
Allowable amount per Procedure
Number of Procedures
Charge per Procedure
Allowable amount per procedure
-30%
-30%
-30%
-30%
0
0
0
-20%
-20%
-20%
-20%
0
0
0
-10%
-10%
-10%
-10%
0
0
0
0%
0%
0%
0%
0
0
0
10%
10%
10%
10%
0
0
0
20%
20%
20%
20%
0
0
0
30%
30%
30%
30%
0
0
0
Explanation / Answer
charitable deduction is decrease in 2018 compare with 2017
bad debt is increased in 2018 compare with 2017
Canibalization stable.
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