Read Case 20 (pages 127-132) from Gapenski’s Cases in Healthcare Finance – “Coral Bay Hospital.” SEE ATTACHMENT.
Create a presentation.
In your presentation, provide a response to the following questions from the case study:
One board member wants to make sure that a complete risk analysis, including sensitivity and scenario analyses, is performed before the proposal is sent to the board.Perform a sensitivity analysis.What management information is provided by the sensitivity analysis?Perform a scenario analysis.What management information is provided by the scenario analysis?Why is the expected NPV obtained in the scenario analysis different from the base case NPV?A board member is interested in the utilization breakeven of the Center.What are the breakeven values of the three input variables that are highly uncertain?What management information is provided by the breakeven analysis?
For some additional guidance on how to construct a professional presentation, please see the link below.
https://www.wiley.com/network/researchers/promoting-your-article/6-tips-for-giving-a-fabulous-academic-presentation
Copyright 2018. Health Administration Press.
All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted under U.S. or applicable copyright law.
C AS E
C O R A L B AY H O S P I TA L
TRADITIONAL PROJECT ANALYSIS
20
Coral Bay Hospital is a 250-bed, investor-owned hospital located in
Coral Bay, Florida, which is known as the “The Sport Fishing Capital of
the World.” The hospital was founded in 1946 by Dr. Rob Winslow, a
prominent Florida physician, on his return from service in World War II.
He relinquished control of Coral Bay in 1967 while it was still small and in
a relatively quiet setting. However, in recent years, south Florida has experienced a population explosion, which has fostered high economic growth
and the need for more healthcare services. Today, under a succession of
excellent CEOs, Coral Bay is recognized as one of the leading healthcare
providers in the area.
Coral Bay’s management is currently evaluating a proposed ambulatory
(outpatient) surgery center. (For more information on ambulatory surgery,
see the Ambulatory Surgery Center Association website at www.ascassociation.org.) More than 80 percent of all outpatient surgery is performed by
specialists in gastroenterology, gynecology, ophthalmology, otolaryngology,
orthopedics, plastic surgery, and urology. Ambulatory surgery requires an
average of about one-and-a-half hours to complete: Minor procedures take
about one hour or less, and major procedures typically take two or more
hours. About 60 percent of the procedures are performed under general
anesthesia, 30 percent under local anesthesia, and 10 percent under regional
or spinal anesthesia. In general, operating rooms are built in pairs so that
a patient can be prepped in one room while the surgeon is completing a
procedure in the other room.
The outpatient surgery market has experienced significant growth since
the first ambulatory surgery center opened in 1970. By 1990, about 2.5 million
© Fou nd at ion of ACHE, 2018. Repr oduc t i o n w i t h o u t p e r mi s s i o n i s p r o h i b i t e d .
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C ase s in Health care F in a n c e
procedures were being performed at stand-alone outpatient centers, and by
2017, the number had grown to more than 20 million. This growth has been
fueled primarily by three factors. First, rapid advancements in technology
have enabled many procedures that were historically performed in inpatient
surgical suites to be offered at outpatient settings. This shift was caused mainly
by advances in laser, laparoscopic, endoscopic, and arthroscopic technologies.
Second, Medicare has been aggressive in approving new minimally invasive
surgery techniques, so the number of Medicare patients using outpatient
surgery services has grown substantially. Third, patients prefer outpatient
surgeries because they are more convenient, and third-party payers prefer
them because they are less costly.
Because of these factors, the number of inpatient surgeries has remained
more or less flat over the past 20 years, whereas the number of outpatient
procedures has continuously grown more than 10 percent annually. Rapid
growth in the number of outpatient surgeries has been accompanied by a
corresponding growth in the number of outpatient facilities nationwide.
The number currently stands at about 5,300, so competition in many areas
has become intense. Somewhat surprisingly, no outpatient surgery center
exists in Coral Bay’s immediate service area, although rumors are that local
surgeons are exploring the feasibility of a physician-owned facility.
Coral Bay currently owns a parcel of land adjacent to its facility that is
a perfect location for the surgery center. The hospital bought the land five
years ago for $150,000 and spent (and expensed for tax purposes) $25,000
to clear the land and put in sewer and utility lines last year. If sold in today’s
market, the land would bring in $200,000, net of all fees, commissions, and
taxes. Land prices have been extremely volatile, so Coral Bay’s standard
procedure is to assume a salvage value equal to the current value of the land.
Of course, land is not depreciated for either book or tax purposes.
The surgery center building, which would house four operating suites,
would cost $5 million, and the equipment would cost an additional $5
million, for a total of $10 million. Assume that both the building and the
equipment fall into the MACRS (modified accelerated cost recovery system)
five-year class for tax-depreciation purposes. (In reality, the building would
have to be depreciated over a much longer period than the equipment.)
The project will probably have a long life, but Coral Bay typically assumes
a five-year life in its capital budgeting analyses and then approximates the
value of the cash flows beyond Year 5 by including a terminal, or salvage,
value in the analysis. To estimate the salvage value, Coral Bay typically uses
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C a s e 2 0 : C o ra l Bay Ho s p it a l
12 9
the market value of the building and equipment after five years, which for
this project is estimated to be $5 million before taxes, excluding the land
value. (Note that taxes must be paid on the difference between an asset’s
salvage value and its tax book value at termination. For example, if an asset
that cost $10,000 has been depreciated down to $5,000 and then sold for
$7,000, the firm owes taxes on the $2,000 excess in salvage value over tax
book value.)
The expected volume at the surgery center is 20 procedures a day. The
average charge per procedure is expected to be $1,500, but charity care, bad
debts, managed care plan discounts, and other allowances lower the net
patient revenue amount to $1,000. The surgery center would be open five
days a week, 50 weeks a year, for a total of 250 days a year. As detailed in
exhibit 20.1, labor costs to run the surgery center are estimated at $918,000
per year, including fringe benefits. Utilities, including hazardous waste disposal, would add another $50,000 in annual costs.
If the surgery center were built, the hospital’s cash overhead costs would
increase by $36,000 annually, primarily for housekeeping and buildings and
grounds maintenance. In addition, the center would be allocated $25,000
of Coral Bay’s current $2.8 million in administrative overhead costs. On
average, each procedure would require $200 in expendable medical supplies,
including anesthetics. Although Coral Bay’s inventories and receivables
would increase slightly if the center is constructed, its accruals and payables
would also increase. The overall change in net working capital is expected
to be small and hence not material to the analysis. Coral Bay’s marginal
federal-plus-state tax rate is 40 percent.
One of the most difficult factors to deal with in project analysis is inflation. Both input costs and charges in the healthcare industry have been
rising at about twice the rate of overall inflation. Furthermore, inflationary
pressures have been highly variable. Because of the difficulties involved in
forecasting inflation rates, Coral Bay begins each analysis by assuming that
both revenues and costs, except for depreciation, will increase at a constant
rate. Under current conditions, this rate is assumed to be 3 percent.
When the project was mentioned briefly at the last board of directors
meeting, several questions were raised. In particular, one director wanted to
make sure that a complete risk analysis, including sensitivity and scenario
analyses, was performed before the presentation of 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
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130
C ase s in Health care F in a n c e
loser. The board does not want a repeat of that occurrence. One of the directors stated that she thought Coral Bay 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 affect the services we currently offer.”
Another director, who is also Coral Bay’s chief of medicine, expressed
concern over the impact of the ambulatory surgery center on the current
volume of inpatient surgeries. This concern prompted an analysis by the head
of the surgery department, who reported that an outpatient surgery center
could siphon off up to $1 million in cash revenues annually. When pressed,
the department head estimated that such a reduction in volume could also
lead to a $500,000 reduction in annual cash expenses.
To develop the data needed for the risk analysis, Jules Bergman, Coral
Bay’s director of capital budgeting, met with the department heads of surgery, marketing, and facilities. After several sessions, they concluded that
three input variables are highly uncertain: number of procedures per day,
average revenue per procedure, and building and equipment salvage value.
If another entity enters the local ambulatory surgery market, the number of
procedures could be as low as ten per day. Conversely, if acceptance is strong
and no competing surgery centers are built, the number of procedures could
be as high as 25 per day, compared with the most likely value of 20 per day.
The expected average net patient revenue of $1,000 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 than anticipated were performed) and managed care penetration remained low, then the average revenue could be as high as $1,200.
Conversely, if the severity were lower than expected and managed care
penetration increases, the average revenue could be as low as $800. Finally,
if real estate and medical equipment values stay strong, the building and
equipment salvage value could be as high as $6 million, but if the market
weakens, the salvage value could be as low as $4 million, compared with an
expected value of $5 million.
Jules also discussed the probabilities of the various scenarios with the
medical and marketing staffs, but after considerable debate no consensus
could be reached. To add to the confusion, one member of the medical staff,
who had just returned from a University of Michigan executive program
on financial management, questioned why the scenario analysis had to be
confined to just three scenarios. “Why not five or seven?” he queried. In
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C a s e 2 0 : C o ra l Bay Ho s p it a l
13 1
addition, the current cost of capital includes an expected inflation estimate
of 2 percent that will be used to make a decision today, but future inflation
is uncertain and could affect cash flows in the future. Jules said that a good
way to assess the impact of uncertain, future inflation on project profitability
is to create a table such as the one shown in exhibit 20.2.
To help with the risk incorporation phase of the analysis, Jules consulted
with Mark Hauser, Coral Bay’s chief financial officer, about both the risk
inherent in the hospital’s average project and how the hospital typically
adjusts for risk. Mark told Jules that, on the basis of historical scenario
analysis data that use worst, most likely, and best case values, the average
project has a coefficient of variation of net present value in the range of
1.0 to 2.0 and that 4 percentage points are typically added or subtracted to
the 9 percent corporate cost of capital to adjust for differential project risk.
Coral Bay has hired you as a financial consultant. Your task is to conduct
a complete project analysis on the ambulatory surgery center and then present your findings and recommendations to the board of directors.
Position
Annual Salary
FTEs
Total Salary
Executive director
$60,000
1
$ 60,000
Director of nursing
50,000
1
50,000
Accounting clerk
35,000
1
35,000
Collections clerk
30,000
1
30,000
Scheduling clerk
25,000
1
25,000
Registered nurses
60,000
8
480,000
Nursing assistants
30,000
2
60,000
Transcriptionist
25,000
1
25,000
Total
EXHIBIT 20.1
Coral Bay Hospital:
Projected Surgery
Center Staffing
Requirements
$765,000
Plus 20 percent fringe-benefit allowance
153,000
Total salaries and benefits
$918,000
FTE: full-time equivalent
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132
EXHIBIT 20.2
Impact of Uncertain
Future Inflation on NPV
of Proposed Ambulatory
Surgery Center
C ase s in Health care F in a n c e
Level of Net Patient Revenue Inflation
0%
1%
2%
3%
4%
5%
6%
0%
NPV
NPV
NPV
NPV
NPV
NPV
NPV
Level of
1%
NPV
NPV
NPV
NPV
NPV
NPV
NPV
Cost
2%
NPV
NPV
NPV
NPV
NPV
NPV
NPV
Inflation
3%
NPV
NPV
NPV
NPV
NPV
NPV
NPV
4%
NPV
NPV
NPV
NPV
NPV
NPV
NPV
5%
NPV
NPV
NPV
NPV
NPV
NPV
NPV
6%
NPV
NPV
NPV
NPV
NPV
NPV
NPV
NPV: net present value
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