Financial Memo

Case Study: Coral Bay Hospital

Date: August 10, 2022

To: Chief Financial Officer
Director, Coral Bay of Capital Budgeting Department
From: Financial Consultant
Subject: Financial Memorandum on Project Analysis on the Ambulatory Surgery Center
Problem Statement
Due to the rapid growth in the number of outpatient surgeries compared to the inpatient surgeries
in Coral Bay Hospital, it is an ongoing debate between directors of different departments of
Coral Bay Hospital, to build the outpatient surgery center as it siphons off $1 million cash
revenue annually. As a financial consultant, the complete project analysis is being performed that
includes the calculation of Net Present Value (NPV), Internal Rate of Return (IRR) along with
the sensitivity and scenario analysis. Also, the financial memorandum covers the recommended
solutions that provide valuable insights into the feasibility of the proposed plan for the
ambulatory surgery center.
Executive Summary
More than eighty percent of all outpatient surgery is performed by different specialists that
including ophthalmology, gynecology, otolaryngology, orthopedics, etc., and ambulatory surgery
requires about one and a half an hour to complete. It is estimated that by 1990, 2.5 million
surgeries are performed only in the outpatient centers due to the advancement in technology in
the outpatient centers, an increase in the number of Medicare patients, and the preference of
patients for outpatient surgeries due to better convenience and less cost. Besides the high demand
for Outpatient surgeries, there is no outpatient surgery center exists in the immediate service area
of Coral Bay Hospital. The data sets for the Ambulatory Surgery Center suggest that the project
implementation may lead to inflation as charges and input costs are rising in the healthcare
industry. Based on land initial cost, land opportunity costs, building costs, labor costs, inflation
rate, tax rate, and cost of capital, the values of NPV, IRR, MIRR, and Payback period are
calculated. Also, the cost of inflation for net patient revenue inflation is calculated. Sensitivity
Analysis is also performed with the cost of capital from 4.0 percent to 14 percent. The values of
the NPVs, IRR, MIRR, and payback period suggest that an ambulatory surgery center is highly
recommended to build as it is an hour of need, and the number of outpatient surgery patients is
increasing day by day in Coral Bay Hospital.
Background
The issues faced by the Coral Bay Hospital, regarding an outpatient center in the immediate
service area of the Hospital are because the number of outpatient surgeries is increasing due to
the increase in outpatient facilities nationwide. The competition is highly intense, and several
outpatient facilities nationwide are 5,300.
Proposed Solution
The proposed solution is to calculate the Net Present Value, Internal Rate of Return (IRR),
Modified internal rate of return (MIRR), and payback period based on the given values of the
land initial costs, building equipment costs, labor costs, utility costs, tax rate, inflation rate and
cost of capital of 10 percent. The values of the NPV and IRR are the widely used factors
commonly used in capital budgeting (Palmer 2021). Based on the given data sets, NPV is
calculated as $875,020, and IRR is 12.09 % with a payback period of 4.1 years. The net cash
flows for the years increased gradually for five years, and year 5 has net cash flows of
$5,545,562. The sensitivity analysis is performed with a cost of capital of 8.00 %, 12.00 %, and
10.00 % suggests that building an ambulatory surgery center is highly feasible. The internal rate
of return and payback period for all six values for the cost of capital gives the same value, which
is 0.13 and 4.1 years respectively. However, the Net present value (NPV), for the 4.00 percent,
cost of capital is comparatively higher than other capital costs. In the current scenario, the Cost
of capital is suggested to be 10 percent, which is feasible for the project implementation of the
ambulatory surgery center for outpatient surgeries.
Recommendations
Based on the calculated values of Net Present value (NPV), Internal Rate of Return (IRR), and
pay period with a given data set of land costs, capital costs, and inflation & tax rate, the
following recommendations are suggested for the ambulatory surgery center.
1. Scenario analysis data sets suggest that capital cost, per day procedure costs, and NPR
per day procedure costs along with the salvage value have a direct effect on the
calculated values of NPV, IRR, Payback period, and MIRR. For example, in scenario 1,
when the capital cost increased by 10%, per day procedure increased by 20, and NPR
per procedure has the value of $1,000 along with the salvage value of 5 Million Dollars,
then the value of NPV is $875,019.91 with a payback period of 4.1 years. However, in
Scenario 3, when the capital cost increased by 12%, per day procedure increased by 15,
and NPR per procedure has the value of $8000 along with the salvage value of 4 Million
Dollars, then the values of NPV becomes negative with a value of -$406, 763, 4.37,
which suggests that project is not feasible to proceed with the values of capital costs, and
per day procedure (Tuovila 2021). Similarly, in scenario 2, the payback period is reduced
to approximately half of scenario 1, which is 2.62. Therefore, it is highly recommended
to build the ambulatory surgery center with a capital cost of 10 percent with a salvage
value of 5 million dollars.
2. Also, the inflation table that shows the impact of future inflation on NPV of the proposed
Ambulatory Surgery Center suggests that when the cost of inflation is zero percent and
net patient revenue inflation is six percent, then the value of Net Present Value is
comparatively higher than any other NPV Values. Similarly, the value of NPV is lowest
when the cost of inflation is six percent and net patient revenue inflation is zero percent.
Therefore, it is recommended to build the ambulatory surgery center with zero percent
cost of inflation.
 Bibliography

Palmer, Barclay. 2021. “Should IRR or NPV Be Used in Capital Budgeting?” Investopedia.
https://www.investopedia.com/ask/answers/05/irrvsnpvcapitalbudgeting.asp#:~:text=IRR
%20and%20NPV%20have%20two,time%20or%20multiple%20discount%20rates.

Tuovila, Alicia. 2021. Net Present Value Rule. Investopedia.

https://www.investopedia.com/terms/n/npv-rule.asp#:~:text=If%20the%20calculated%20NPV
%20of,should%20not%20pursue%20the%20project.