Question

Consider a not-for-profit hospital faced with a familiar choice: to open or not to open an emergency center in a new suburban hospital shopping mall. The mall’s developers claim that referrals alone will make the center a financial winner of the hospital. Cautious analysis in the comptroller’s office argue that the startup costs of the center, and its annual cash outflows (including insurance), will be a major drain on the hospital’s overall cash flow. Initial cash outflows for the center are projected as follows: $500,000 for equipment, furniture, and fixtures; and $175,000 for new working capital (inventory, accounts receivable, cash on hand). Analysts in the planning department estimate that the center will generate 7 visits per day, 7 days per week, 50 weeks per year, with average cash inflow per visit of $55. The planning analysts also estimate $120,000 per year in net cash flows from increased admissions to the hospital. Annual operating expenses of the center will be $250,000. The hospital’s average cost of capital is 6 percent. As a not-for-profit provider, the hospital has zero income tax rate. The center has an expected life of 10 years and the expected salvage value of the clinic after 10 years will be $40,000. Is the emergency center a wise use of the hospital’s limited funds? You may use the following framework to set up the problem.

Year	Cash Outflow	Direct Cash Inflow	Indirect Inflow	Net Cash Flow	Discounted Cash Flow
0
1
2
3
4
5
6
7
8
9

Please show your work.

Answer 1

Initial investment
Equipment	$     500,000
Furniture	$     175,000
Total	$     675,000
Annual cash inflow-direct
No of visits per day	7
Days in week	7
Weeks per year	50
Average cash inflow per visit	$              55
Annual cash inflow	7*7*50*55
Annual cash inflow	$     134,750
Calculation of NPV						6%
Year	Capital cost	Direct cash inflow	Indirect cash inflow	Cash outflow	Total cashflow	PV factor, 1/(1+r)^t	PV-Board game
0	$    (675,000)	$          -			$(675,000.00)	1.0000	$(675,000.00)
1		$134,750	$     120,000	$     (250,000)	$      4,750.00	0.9434	$      4,481.13
2		$134,750	$     120,000	$     (250,000)	$      4,750.00	0.8900	$      4,227.48
3		$134,750	$     120,000	$     (250,000)	$      4,750.00	0.8396	$      3,988.19
4		$134,750	$     120,000	$     (250,000)	$      4,750.00	0.7921	$      3,762.44
5		$134,750	$     120,000	$     (250,000)	$      4,750.00	0.7473	$      3,549.48
6		$134,750	$     120,000	$     (250,000)	$      4,750.00	0.7050	$      3,348.56
7		$134,750	$     120,000	$     (250,000)	$      4,750.00	0.6651	$      3,159.02
8		$134,750	$     120,000	$     (250,000)	$      4,750.00	0.6274	$      2,980.21
9		$134,750	$     120,000	$     (250,000)	$      4,750.00	0.5919	$      2,811.52
10	$       40,000	$134,750	$     120,000	$     (250,000)	$    44,750.00	0.5584	$    24,988.17
						NPV	$(617,703.80)
Since NPV is negative, it is not suggested to set up the ward.