Newcastle Business School

Financial Management and Decision-Making in

Healthcare

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Course

Instructor

Due date

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 Question 1 (10 marks)

Context

You are the CFO of a private healthcare service provider and have identified the

following two opportunities with a four-year life cycle. The opportunity is to

provide healthcare services to two different third-party healthcare service

providers for alternative therapies. The original contract period is four years

with an option to extend, however, given the inherent uncertainty, the option to

extend at this point in time is valued at zero. The two alternative therapies are

Acupuncture (AC) and Electromagnetic Therapy (ET). The two projects are

mutually exclusive, meaning you would only be able to choose one, due to limited

capital.

Required:

(a) Answer (3 marks)

Answer

Project Project
Year
AC ET

-
-
0 140,00
140,000
0

1 70,000 15,000

2 60,000 40,000

3 40,000 72,000

4 20,000 90,000

2
 IRR 16.70% 15.58%

Based on irr, I would choose project AC since it has higher rate of return.

(b) Answer

Project AC Project ET

15396.3651 20236.4468

NPV 3 4

Based on NPV, I would choose Project ET since it has a higher net present value. The

project ET NPV is greater than project AC by $4840. The results are different

between the NPV and IRR since the IRR method assumes that cash flows generated

by the project are reinvested at the IRR rate, which is not always a realistic

assumption. In contrast, the NPV method takes into account the actual required rate of

return for the project, which reflects the cost of capital and the risk associated with the

project.

(c) Answer (3 marks)

Answer

At a rate of 16%, I would choose project AC over ET, AND I WOULD ALSO

CHOOSe project ET over AC at a required rates of 10%.

I would be indifferent at a required rate of 13.5610625769454%.

(d) If the projects were of unequal lives, can you compare them? If so, how?

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 (1 mark)

Answer

Yes, I would compare projects with unequal lives by using a common metric such as

the Equivalent Annual Annuity (EAA). EAA represents the equal annual cash flow

that would be generated by a project over its life, assuming the same discount rate for

all projects.

Question 2 (15 marks)

Required

(a) Answer (5 marks)

Answer

Year Cash Inflow Cash Outflow Depreciation Taxable Income Taxes (30%)

Working capital After-tax Cash Flow Cash flow

0 1600000 0 0 0 40000 -1640000 -1640000

1 1600000 400000 320000 880000 264000 616000 936000

2 1600000 400000 320000 880000 264000 616000 936000

3 1600000 400000 320000 880000 264000 616000 936000

4 1600000 400000 320000 880000 264000 616000 936000

5 1600000 400000 320000 880000 264000 40000 616000 936000

The NPV of the project is $1,302,275.80

(b) Answer (7 marks)

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ANSWER

Sensitivity
analysis
  Normal case Best case Worst case
  Cashflow Cashflow Cashflow
0 -1640000 -1476000 -1804000
1 936000 936000 936000
2 936000 936000 936000
3 936000 936000 936000
4 936000 936000 936000
5 936000 936000 936000
Ksh1,302,275.8 Ksh1,444,884.5 Ksh1,159,667.1
NPV 0 0 1

Yes, I would still choose the project since it has a positive NPV under all the

scenarios.

(c) Answer

Answer

In profit-making enterprises, the cost of capital is crucial in determining the

profitability of investment projects (Sattar, 2015). The cost of capital represents the

minimum return that the company must earn on its investment to satisfy the

expectations of its investors. If the expected return on investment is less than the cost

of capital, the investment will not be profitable.

In the not-for-profit sector, the cost of capital is also an important

consideration. Non-profit organizations often rely on donations and grants to finance

their operations (Michalski, 2011). The cost of capital in this context refers to the

opportunity cost of investing funds in one project over another. For example, a non-

profit organization may have to decide whether to invest funds in a new program or

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expand an existing one. The cost of capital would be used to evaluate each project's

potential return on investment and determine which project is more financially viable.

Overall, the cost of capital is an essential concept in finance and relevant to profit-

making enterprises and the not-for-profit sector. It represents the minimum return

investors require on their investment and is used to evaluate the financial viability of

various investment projects.

References

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Michalski, G. (2011). Influence of the post-crisis situation on cost of capital and

intrinsic liquidity value in non-profit organizations. International journal of

management and social sciences (IJMSS), 1(1), 67-78.

Sattar, M. S. A. (2015). Cost of capital–the effect to the firm value and profitability;

empirical evidences in case of personal goods (textile) sector of KSE 100

index. Journal of Poverty, Investment and Development, 17, 24-28.