# Hcmba cohen finance week 3 and 4 assignment

Week 3 Assignment
Case UVa Health System: The Long-Term Acute Care Hospital Project

Wk 3 is the first of two consecutive weeks on CAPITAL BUDGETING.

You will learn the three steps in capital budgeting:
1 Identify relevant incremental cash flows
2 Calculate cost of capital (k-wacc) to use as the discount rate
3 Calculate the  metrics of capital budgeting: Net Present Value, Profitability Index,
Internal Rate of Return, and Payback Period.
Then, you will apply the metrics and information in the case study to make a recommendation
whether to accept or reject the LTAC project.
The essence of the capital budgeting process is to make sure, BEFORE an investment is made,
that its prospective rate of return is high enough to justify the investment.

Reading Cohen Finance Workbook chapter 4 is a review of Time Value of Money, which you covered in a previous course.
Review it as necessary, but defer the review until you look at the TVM applications in chapter 5 beginning on p 79.
You need to know TVM to understand the capital budgeting metrics of NPV, PI, and IRR. Make sure you
have that context in mind before reviewing the TVM chapter 4 (only if you need to).

Give the Uva Health Care System: The Long-Term Acute Care Hospital Project Case a quick read to understand what is going on – about
calculating k-wacc and the decision metrics for the project, to give it either a green light or a red light.

Wk 3 gives you practice on the basics. You won’t have a full understanding of what the LTAC Project case is about at
the end of Wk3. In Wk4, you will return to the case, analyze the project, and make a recommendation.

Look at the Wk 3 assignment questions in the Q1, Q2, Q3 tabs.

Read Cohen Finance Workbook chapter 5 selectively. Focus on:
See the FLOW DIAGRAM in GREEN depicting the CAPITAL BUDGETING template.
See the IS/BS Model in GREEN depicting the connection between PPE (BS) and operating expense (IS).
Read pps 61-65 as a general introduction to capital budgeting.
Read pps 70-76 on weighted average cost of capital to answer Q1.
Read bottom p 67 to 69 on Net Working Capital to answer Q2.

Questions
See tabs for Q1, Q2, Q3
THESE QUESTIONS MUST BE ANSWERED USING EXCEL.
MAKING CALCULATIONS OUTSIDE THE SPREADSHEET AND ENTERING THE RESULTS IS NOT USING EXCEL.
YOU MUST USE EXCEL FORMULAS FOR MAKING CALCULATIONS!
______________________________________________________________________________________
Week 4 Assignment
UNIVERSITY OF VIRGINIA MEDICAL CENTER
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.
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.
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.

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Q2a Calculate the K-wacc for HCA using the template above. Enter the data that you  have in the case and the table above. If you need additional data, assume it using your good judgment from what you have learned so far in the course. In the answer box, cite your result, compare it to the K-wacc used in the Q1 analysis, and explain how your revised K-wacc would change the Q1 results.

Q2b If LATC was a project in a for-profit hospital like HCA above, would the NPV be higher or lower? Explain ‘analytically’ by examining all relevant inputs to NPV.
Q2c If LATC was a project in a for-profit hospital like HCA above, would the IRR be higher or lower? Explain. HINT: To avoid getting trapped by this question, make sure your answer is’analytical’, i.e., examine all relevant inputs and output.
Q2d Can a non-profit hospital accept projects that a for-profit hospital would reject?

Q3a The analysis above is identical to the one on the Q1 tab. Do a sensitivity analysis by systematically changing certain assumptions in the spreadsheet above:  1 change the K-wacc to 8.3%
2 change year 2 utilization to 45%
3 change commercial payers to 30% of patient mix
Use the answer box to prepare a summary of the original (Q1) results and the revised (Q3) results, i.e., a summary table.

Q3b Revise the decision you made in Q1 based on the above sensitivity analysis, comparing Mulroney’s assumptions and the sensitivity analysis assumptions to expectations stated in the case. Be sure to consider both ‘hard quantitative data” from decision metrics and ‘soft qualitative information’ from the case.

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