BZ202 Financial Management: Report on Health Matter Hospital
Case Study
Health Matters Private Hospital is a small, 75 bed private hospital located south of Brisbane. The hospital management team is considering three possible alternative uses for some of its currently ‘underutilized’ space.
The space could be left as a passive relaxation area, furnished with casual furniture, a wide-screen television, computer, board games and library books for use by patients and visitors. The estimated set up costs would be $15,000.
Annual maintenance, replacement and cleaning costs are anticipated to be quite minimal and should be approximately $1,000 per year.
The space could be subleased to a small coffee shop with a budgeted annual lease receipt of $30,000 each year for the next five years. An initial outlay of $35,000 would be required to fit out the area. Only hot and cold beverages and cakes and snack items would be available. No other cooking facilities or food preparation areas would be provided. All profits (or losses) of the coffee shop would return to the independent operator. The only income for the hospital would be the annual lease receipt and no other annual expenses are anticipated to be incurred directly by Health Matters.
- The area could be fitted out for an additional 2 private patient rooms. This option would incur an initial cost of $60,000. Such an upgrade would potentially increase revenue from patient stays. Based on expected occupancy rates the anticipated additional revenue is expected to be:
Year 1 - $30, 000 Year 2 - $30, 000 Year 3 - $35, 000 Year 4 - $35, 000 Year 5 - $40, 000
Required:
Prepare a formal business report to the hospital management team, outlining an analysis of each of the alternatives, and then making a clear recommendation as to your preferred use for the space.
Include in your analysis, consideration of both financial and non-financial factors for each alternative. You may make any assumptions and include any other information you feel relevant.
Assume a rate of return of 8% for any net present value calculations. Your detailed financial calculations should be included in appendices to the report.
Answer:
Cover Letter
The Management
Health Matter Private Hospital,
Australia
Dear,
In this report, three investments are analysed on the basis of financial factors and non-financial factors. Report has been prepared for the management and to make them understand different factors financial and non-financial factors in all three investment option.
First section of this report includes executive summary, in which crux of findings and analysis has been made. In second section, report has introduction, in which different options and their related outcome has been analysed. Then most important section of this report is stated i.e. findings and analysis of all three investment options. All three options has been analysed on the basis of financial factors and non-financial factors related to different options.
At last, conclusion and recommendations has been made to the management about selection of best investment option among three options.
Yours sincerely,
Introduction
In this business report, analysis of three investment options has been taken place. Analysis of different investment options and selecting one of them requires systematic analysis of investment options. Investment options can be analysed by using both financial factors and non-financial factors involve with different investment options. In this business report, Health Matter Private Hospital is the report for which investment options has been analysed. Option 1 is related to non-financial considerations only as there is no financial inflow but there is cash outflow. Option 2 is related to sub-leasing the underutilised capacity of Health Matter Private Hospital and in this case, NPV method and other non-financial factors have been for making analysis. Last option in this report is related to building new patient rooms i.e. capital project. Capital budgeting methods i.e. NPV, payback period and IRR is used to analyse the same.
Findings and Analysis
Option (a)In this case or option only non-financial factors will be considered for decision making process since in this option there is no cash inflows for the Health Matter Private Hospital. In this option, underutilised space can be used for development of passive relaxation area for patients. In order to make this space passive relaxation area for patients, there is initial set up cost of $ 15,000 which is required to be paid at very starting point. Annual maintenance and recurring cleaning and replacement cost is $ 1,000. There is no direct cash inflow or profit in this case, but there will be some non-financial benefits for hospitals that should be considered here (Stretcher., Johnson & Funck, 2013). Following are some non-financial benefits of this option to Health Matter Private Hospital:
Improved Reputation: This option will improve reputation or goodwill of Health Matter Private Hospital in the market. Relaxation area will definitely provide positive impact on patients / customers of Health Matter Private Hospital in terms of their health improvement. On the other hand, this will add on one more feature of Health Matter Private Hospital. This will create better customer relationship and customer engagement for hospital (Borgers, 2015).
Matching Standards: For hospitals there are many standards and regulations that governing body formulate and needs to be followed by hospitals. According to laws, every hospital needs to maintain relaxing area in their hospitals for patients. Therefore this is improving compliance with rules and regulations (Rousos & Lee, 2012).
Better customer relationship: Although this option will not reflect profit or benefit immediately but benefits can be seen in long term. Patients / customers of Health Matter Private Hospital will get satisfied with this additional relaxation area facility within hospital and they will turnaround. In other words, this option will decrease customer / patient turnover and in this case, management will get benefit of improved profitability in long run.
Option (b)In this option, Health Matter Private Hospital can provide underutilised space on lease to outside vendor i.e. to develop and operate canteen. In this option, all the expenses of canteen will be borne by canteen operator. In this case, there are both financial benefits and non-financial benefits for Health Matter Private Hospital. Financial benefit in this case is cash inflows that Health Matter Private Hospital will receive from canteen operator and there is no cost that Health Matter Private Hospital is required to incur. In order to analyse cash profits or cash inflows, net present value method is used measure real or inflation adjusted cash inflows to Health Matter Private Hospital (Calcerrada & García, 2015).
Financial benefit of this option:
Statement showing net inflows for Health Matter Private Hospital in next five years:
|
Years |
0 |
1 |
2 |
3 |
4 |
5 |
|
Cash inflow |
- |
$ 30,000 |
$ 30,000 |
$ 30,000 |
$ 30,000 |
$ 30,000 |
|
Cash outflow |
($ 35,000) |
- |
- |
- |
- |
- |
|
Net cash flows |
($ 35,000) |
$ 30,000 |
$ 30,000 |
$ 30,000 |
$ 30,000 |
$ 30,000 |
|
P.V. Factor @ 10% |
1 |
0.926 |
0.857 |
0.794 |
0.735 |
0.681 |
|
Present value |
($ 35,000) |
$ 27,780 |
$ 25,710 |
$ 23,820 |
$ 22,050 |
$ 20,430 |
|
Net present value / Real profit |
$ 84,790 | |||||
(Bennouna, Meredith & Marchant, 2010)
Analysis: From the statement it can be analysed that, in this option there will be overall cash inflow in all five years in present value terms will be $ 84,790. This has been calculated by using net present value concept of capital budgeting process (Brunzell, Liljeblom & Vaihekoski, 2013). In this concept, real cash flows are used to make decision in terms of accepting or rejecting the undertaken project. The only cash outflow is $ 35,000 and there is no other cash outflow or cost in this option. Therefore financial benefit for Health Matter Private Hospital in next five years from this option or canteen will be $ 84,790 and this will improve financial position or performance (Rigopoulos, 2015).
Non - Financial factors
Add-on facility for customers: Subleasing to small coffee and snacks shop or canteen will add one more faculty to the Health Matter Private Hospital. Customers will be able to buy coffee and snacks within hospital only and they need not to go outside the hospital (Gamsakhurdia & Maisuradze, 2015). Therefore this will create one facility for patients and their family members and can enjoy benefit of canteen. This engage more customer with the hospital as food and coffee facility is essential for customers of Health Matter Private Hospital.
Developing competitive advantage: In this option, Health Matter Private Hospital will be having new canteen facility which many hospitals in Australia lack with. Therefore it can treat as new competitive advantage for Health Matter Private Hospital and will be beneficial for Health Matter Private Hospital in long run. This option will improve revenues of Health Matter Private Hospital in long term basis and build customer engagement.
Cultural factor: Developing canteen within Health Matter Private Hospital will improve culture in the hospital as, now customers served with food and beverage facilities. Apart from customers, staff members of Health Matter Private Hospital will also enjoy benefit of canteen. This will develop strong culture within Health Matter Private Hospital within customers / patients and staff members (Favato, 2013).
Option (c)In this option, 2 private patient rooms will be built and this will provide both financial and non-financial benefits to Health Matter Private Hospital. There will be initial outlay of $ 60,000 in this option and cash inflows fluctuate in next five years. In order to analyse this option, capital budgeting techniques will be used and calculation of different methods of capital budgeting technique will be used. Following are financial and non-financial consideration in this option that shall be taken care of:
Financial consideration
Net present value method: According to NPV method, profit and loss is calculated by taking inflation rate into account. Cost of capital is the inflation rate that issued in this option, and nominal cash flows are converted into real cash. If NPV is positive then it shows profit in the project and on the other hand if NPV is negative then there will be loss in the project (Ghiami & Beullens, 2016). Following is the calculation of NPV:
Statement showing calculation of net present value:
|
Years |
0 |
1 |
2 |
3 |
4 |
5 |
|
Cash inflow |
- |
$ 30,000 |
$ 30,000 |
$ 35,000 |
$ 35,000 |
$ 40,000 |
|
Cash outflow |
($ 60,000) |
- |
- |
- |
- |
- |
|
Net cash flows |
($ 60,000) |
$ 30,000 |
$ 30,000 |
$ 35,000 |
$ 35,000 |
$ 40,000 |
|
P.V. Factor @ 10% |
1 |
0.909 |
0.826 |
0.751 |
0.683 |
0.621 |
|
Present value |
($ 60,000) |
$ 27,270 |
$ 24,780 |
$ 26,285 |
$ 23,905 |
$ 24,840 |
|
Net Present Value |
$ 67,080 | |||||
Decision: On the basis of NPV, project of building 2 private patient rooms should be accepted (Wiesemann & Rustem, 2010).
Payback period
In this method, liquidity of the undertaken project will be measured by using cash inflows pattern of the undertaken project. Payback period of project is the period within which initial investment of the project is recovered back. Therefore lower payback period is acceptable.
Calculation of payback period
|
Years |
1 |
2 |
3 |
4 |
5 |
|
Cash inflow |
$ 30,000 |
$ 30,000 |
$ 35,000 |
$ 35,000 |
$ 40,000 |
|
Cumulative inflows |
$ 30,000 |
$ 60,000 |
$ 95,000 |
$ 130,000 |
$ 170,000 |
(Leyman & Vanhoucke, 2017)
Payback period = 2 years
Internal rate of return
IRR is the capital budgeting method in which breakeven point in terms of rate of return from the undertaken capital project.
|
Years |
0 |
1 |
2 |
3 |
4 |
5 |
NPV |
Cash flows |
|
Cash inflow |
|
$ 30,000 |
$ 30,000 |
$ 35,000 |
$ 35,000 |
$ 40,000 |
|
|
|
Cash outflow |
($ 60,000) |
- |
- |
- |
- |
- |
|
|
|
Net cash flows |
($ 60,000) |
$ 30,000 |
$ 30,000 |
$ 35,000 |
$ 35,000 |
$ 40,000 |
|
|
|
P.V. Factor @ 8% |
1 |
0.909 |
0.826 |
0.751 |
0.683 |
0.621 |
|
|
|
Present value |
($ 60,000) |
$ 27,270 |
$ 24,780 |
$ 26,285 |
$ 23,905 |
$ 24,840 |
$ 67,080 |
$ 127,080 |
|
P.V. Factor @ 46% |
1 |
0.685 |
0.469 |
0.321 |
0.220 |
0.151 |
|
|
|
Present value |
($ 60,000) |
$ 20,550 |
$ 14,070 |
$ 11,235 |
$ 7,700 |
$ 6,040 |
($ 405) |
$ 59,595 |
(Masini & Menichetti, 2013)
Internal rate of return
IRR = Lower rate of return + (Net present value at lower rate / Net present value at lower rate - Net present value at higher rate) x Higher rate of return - Lower rate of return
Lower rate of return = 8 %
Higher rate of return = 46 %
Net present value at lower rate = $ 67,080
Net present value at higher rate = ($ 405)
Internal rate of return = 8 % + [$ 67,080 / $ 67,080 – ($ 405)] x (46 % - 8 %)
Internal rate of return = 8 % + [$ 67,080 / $ 67,485] x (38)
Internal rate of return = 8 % + [$ 0.99] x (38)
Internal rate of return = 8 % + 37.66
Internal rate of return = 45.66 %
(Mellichamp, 2017)
Non-Financial factors
Operational efficiency or increased capacity: If this option is selected then Health Matter Private Hospital will be having increased capacity benefit. As additional 2 private patient rooms will be made then hospital will able to increase its patient capacity and this will also increase profit of the Health Matter Private Hospital (Paul, 2008).
Competitive advantage: This option will also impact or increase competitive edge of Health Matter Private Hospital as they will be able to serve more customers and with improved facilities (Purves, Niblock & Sloan, 2015).
Conclusion
From the analysis of this report, it can be concluded that all three options has their own advantages and disadvantages. Therefore analysis of investment options has been undertaken and results of the same has been analysed. It can be concluded that management of Health Matter Private Hospital has to opt that investment option that should reap both financial and non-financial factors. Each investment options have their separate benefits from each other. Option 1 has non-financial factors and better customer relationship and customer engagement is most important factor that shall be taken into account. On the other hand, in option 2 both financial and non-financial factors has been analysed for decision making. It can be concluded that option2 has perfect blend of both financial benefits and non-financial benefits. In last option, capital budgeting methods is used to analyse financial benefits with the investment option.
Recommendations
On the basis of analysis made for all the three options, it is recommended to management to select investment option 2. Investment option 3 can also select but in option 2, financial and non-financial benefits are there. Following are some reasons for selecting investment option 2:
- Investment option 2 has highest profitability i.e. highest net present value
- Developing competitive advantage is the another factor that proves option 2 is best
- In option 2, there is defined amount or lease rental that will be received by hospital and there is no risk of loss, loss will be borne by shop operator.
References
Bennouna, K., Meredith, G.G. & Marchant, T., 2010. Improved capital budgeting decision making: evidence from Canada. Management Decision, 48(2), pp.225–247.
Borgers, A. et al., 2015. Do social factors influence investment behavior and performance? Evidence from mutual fund holdings. Journal of Banking & Finance, 60, p.112.
Brunzell, T., Liljeblom, E. & Vaihekoski, M., 2013. Determinants of capital budgeting methods and hurdle rates in Nordic firms. Accounting & Finance, 53(1), pp.85–110.
Calcerrada & García-Ruiz, 2015. Analysis of questioned documents: A review. Analytica Chimica Acta, 853, pp.143–166.
Favato et al., 2013. A Novel Method to Value Real Options in Health Care: The Case of a Multicohort Human Papillomavirus Vaccination Strategy. Clinical Therapeutics, 35(7), pp.904–914.
Gamsakhurdia, T. & Maisuradze, K., 2015. The theoretical and practical aspect of selecting the capital budgeting methods. European Scientific Journal, SE(2), p.47.
Ghiami, Y. & Beullens, P., 2016. Planning for shortages? Net Present Value analysis for a deteriorating item with partial backlogging. International Journal of Production Economics, 178, p.1.
Leyman & Vanhoucke, 2017. Capital- and resource-constrained project scheduling with net present value optimization. European Journal of Operational Research, 256(3), pp.757–776.
Masini & Menichetti, 2013. Investment decisions in the renewable energy sector: An analysis of non-financial drivers. Technological Forecasting & Social Change, 80(3), pp.510–524.
Mellichamp, D.A., 2017. Internal rate of return: Good and bad features, and a new way of interpreting the historic measure. Computers and Chemical Engineering, 106, pp.396–406.
Paul, S., 2008. The demand for credit from non-financial institutions: An empirical investigation. Credit Management, pp.22–26.
Purves, N., Niblock, S.J. & Sloan, K., 2015. On the relationship between financial and non-financial factors. Agricultural Finance Review, 75(2), pp.282–300.
Rigopoulos, G., 2015. A review on Real Options utilization in Capital Budgeting practice. International Journal of Information, Business and Management, 7(2), pp.1–16.
Rousos, E.-P. & Lee, B.S., 2012. Multicriteria analysis in shipping investment evaluation. Maritime Policy & Management, 39(4), pp.423–442.
Stretcher, R., Johnson, S. & Funck, M., 2013. Shareholder Wealth Maximization Unde Non-Constant Marginal Cost of Capital: Lifeway Science, Inc. Journal of Business Strategies, 30(1), pp.35–51.
Wiesemann, Kuhn & Rustem, 2010. Maximizing the net present value of a project under uncertainty. European Journal of Operational Research, 202(2), pp.356–367.
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