Palms Hospital Analysis

Topics: Net present value, Internal rate of return, Discounted cash flow Pages: 6 (2128 words) Published: July 30, 2010
| Palms Hospital|
Date: [ 7/30/2010 ]
Re:Ambulatory Surgical Center
Executive Summary
The Palms Hospital is considering an expansion project that would utilize land previously purchased. By expanding into ambulatory surgical services, the hospital has the opportunity to increase revenues and capture market share in this area. Investigation in the NPV of the project and a scenario analysis reveal that the project would be profitable. Debt Financing

This project will most likely involve debt financing. This means that interest expense would occur and should be taken into account in the analysis of the project. Interest expense is a cash expense and is automatically included when the net cash flows are adjusted for the time value of money. If you added interest expense into the cash flows outlays, it would get counted twice. Interest expense affects the amount of income taxes; it must be used in calculating income tax expense before subtracting it from cash flow outlay. Thus, interest expense would be accounted for by the cost of capital since the interest expense would be a cost associated with borrowing money for the project. The 10% cost of capital includes the cost of debt financing. What to do with the Land

The $150,000 that the hospital paid for the land five years ago should be considered a sunk cost because it is a cash outlay that already occurred. Since it has been irrevocably committed, it is an outlay that is unaffected by the current decision to accept or reject the proposed ambulatory surgery center. It is a non-incremental cash flow that is not relevant to the analysis. However, now that the land is valued by the market at $200,000, it is an opportunity cost of accepting this project. If the hospital uses the land for the project, it cannot sell the land and therefore $200,000 is foregone. Additionally, if the hospital uses the land for the surgical center, it cannot be used for another project. The value of the land should not be disregarded as there is an opportunity cost inherent in the use of the property. For Palms Hospital, the opportunity cost is the cash flow that could be realized from selling the property. Thus, the ambulatory surgical center should have an opportunity cost of $200,000 charged against it. Overhead Costs

The overhead costs that should be included are incremental overhead costs for the hospital associated with the new surgical center. In this case, it states that the hospital’s cash overhead costs will increase by $36,000 annually. Thus, this would be the amount of overhead cost to be included. The case does say that an additional $25,000 would be allocated, but this is a re-distribution of administrative overhead costs and not an incremental addition. Therefore, it should not be included in the project analysis since it is not increasing the hospital’s overall overhead costs. Inpatient Surgery Cannibalization

The effect of the surgical center project will have on other business projects should be considered. When the effect is negative, it is called cannibalization, because the project is expected to reduce other revenue sources within the business. The chief of medicine reported that the surgical center would negative impact up to $1,000,000 in cash revenues annually as patients used the new surgical center instead of other services offered by the hospital. This means that the incremental revenues from the new surgical center are the revenues attributable to the new center, less the revenues lost from forgone surgery services. However, expenses should also be considered. The costs saved due to the reduction in patient volume of other surgical services would be a benefit of having the new surgical center. Hence, these cost savings should be considered in the analysis. However, if it is believed that surgical patients would be lost to another entity entering the local ambulatory surgery market, then the loss of these...
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