Introduction
This paper, as indicated in the abstract discusses the financial viability appraisal methods that were used to advice the management of Jim-care medical centre on which of the two capital investment options to make. The hospital is a medium, but growing health centre that has a strategic plan to expand to attain a level of a fully fledged 24 hour service hospital with over 300 bed capacity. Currently, the institution has only 25 beds and the future looks as bright as it can be.
While the ultimate goal of the hospital is to provide high quality medical care to the community, thus enhancing the social welfare of the people, the hospital has financial goals as well as it aims to make profits (Antony & Robert, 2011). This will go a long way in helping it finance its current and future expansion plans.
The challenge at hand is therefore the insufficient funds to undertake many projects at the same time. This has made the hospital carry out several financial appraisal activities in the past so as to establish the ones that deserve the priority over others. This paper discusses one such financial appraisal activity that was commissioned by the management to identify which of the two capital expenditure projects that are in their strategic plan ought to be undertaken first.
The main concern by the management of the hospital at the time was the cash flows since the cash generated by the services was not sufficient to meet all their operational and investment needs. The method used to carry out the appraisal was therefore the discounted cash flow method Net present value (NPV).
Net present value is a financial appraisal method that takes in to consideration the time value of money and given the present value of the future cash flows (Wolf & Sylvester, 2009). This once obtained is compared with the initial cash outlay and a decision is made to adopt the project that has a higher NPV where there are two or more mutually exclusive projects. If the method is used to appraise just one project an NPV above zero indicates that the project is viable and should be undertaken.
The Hospital financial history and their strategic plan
Jim-care medical center has been in operation for the last ten years. As such, it has recorded some considerable growth and it aims to have an increased growth in the next ten years. This is due to its strategic planning that takes a ten year span. The Year 2011 marked its first decade in operation and also marked a period where the hospital’s achievement of the set targets was to be evaluated. The institution had achieved virtually all the set goals and this served as an underlying stratum for the next ten year strategic planning (Barney, 1991).
The hospital has however had difficulties with finances as sometimes they have been forced to borrow so as to boost their liquidity in order to meet their operational as well as recurrent expenditures. One of the objectives of the institution in the next ten years is to acquire improve in their financial position through increasing their liquidity as well as their cash flows.
The Two projects
The first project intends to construct a recreational facility for the hospitals’ staff who include the doctors, nurses, and the other medical staff. The aim of the project is to reduce the stress levels of the employees so as to enhance their service delivery.
It was noted with concern that some doctors are experiencing fatigue during work and this resulted in some negligence while performing their duties. The project therefore aims to build a facility where the employees can go after work and have some relaxation and which would ensure that they have good rest.
Some of the activities that to be carried in the facility is aerobics, in-door games such as table tennis, massage, and several other services. These activities are mean to provide a warm-down to the staff more so after work. The facility’s budget is $1,500,000.00 and is expected to pay back in the ten months. This is because its expected life is two years and before then it needs to have generated enough cash flows to enable the hospital’s management to carry out the other intended capital investments.
The second project entailed building a cancer care center for the post admission therapy for the cancer patients. This was established as a need by the community since the hospital has a cancer treatment program that majorly includes chemo therapy. However, after carrying out the chemo-therapy the patients are referred to other medical centers since the institution has not yet built a cancer-care facility.
The facility had a budget of $1,000,000.00 and was expected to generate the cash flows to pay back the investment in 8 months after which normal routine maintenance would be undertaken. Some of the activities intended for the facility were the post-chemo therapy care, rehabilitation as well as counseling.
The hospital’s management had to choose between the two projects because the amount of cash they had then was not sufficient to undertake the two projects concurrently. By the end of the ten years strategic period, the hospital however intends to have built the two facilities.
In this scenario, the limiting factor was the availability of the finances to fund the projects and as such the appraisal method that was used to come up with the investment advice was a financial quantitative method; Net present value as well as the Payback period (Milner, 2003). Other qualitative methods were considered as well but they did not prevail over the quantitative ones (Wild, Supranyam, & Hasley, 2007).
The link between the strategic plan and the financial decision
As indicated earlier, Jim-care health center has a ten year strategic period in which it evaluates the achievements of the past ten years set goals, re-adjusts where the need arises as well as sets new strategic targets for the next one decade. One such target is to improve the liquidity so as to fully fund their cash needs through proceeds from the hospital operations rather than engaging in borrowings (Barney, 1991).
The hospital therefore intends to increase their revenue base through introducing other revenue streams so as to improve the cash-flows. The two projects had were considered since they were expected to generate adequate cash flows to pay back the outlay in a period of less than 16 months. Once these projects had paid back in the set time period, any further cash in-flow is considered to be profits from the investment.
The increased cash flow would offer the institution with additional cash flows to carry out further future investment decisions as well as meeting their recurrent expenditure and operational cash needs as they fall due (Frederick, 2001). An attainment of this goal would therefore be a milestone in achieving the hospital’s ten year strategic goal. The results of the projects appraisal were therefore necessary in establishing the most viable of the two projects.
The finance team
The hospital commissioned a team of five financial professional where I held the position of the chair of the committee. The time period for the whole process was one month where all the available financial literature, data collection, analysis, and presentation of the report were required. The experienced was tremendous since most of the environment provided a practical view of what had been learnt in class as theory. It enabled the whole team apply the financial appraisal methods theoretical framework in real life financial scenarios.
The results were however encouraging as the financial and economic knowledge that was learn in class was put into practice. The methods that were used in appraising the two projects were the pay-back period and the Net Present value (NPV).
This is because of the specific needs of the management. the hospital required to engage in a project that would generate cash flows which would pay back the cash the soonest. This necessitated the need for payback period as a quantitative method. The hospital also wanted to establish the project that would have higher cash flows in the soonest time and this necessitated the use of the Net Present Value.
The Findings from the appraisal methods
Using the payback period, the first project which entailed construction of a recreational facility for the staff had the following data.
The payback period was 4.73 months
The second project had the following data available
The payback period for the cancer care center was 4.84 months
Analysis using the Net Present value (NPV)
Using the net present value to evaluate the projects, the following data were obtained.
The data for the cancer care center was as follows
The analysis of the findings
The first method that was used to evaluate the project was the payback period. Payback period is the time that elapses before the project generates cash in-flows to offset the initial outlay (Wild, Supranyam, & Hasley, 2007). Projects with shorter payback periods are preferred over the ones with longer ones. This is because of the risk that is associated with unforeseen future circumstances more so in the macro-economic environment.
When appraising one project, the management sets the required payback period and if the project does not beat the set deadline by the management the project is rejected. Using this appraisal method, the recreational facility construction is the preferred one sine it has a shorter payback period of 4.73 years as compared to the cancer care center payback period of 4.84 years.
The Net present value
The Net Present Value is the most desired capital appraisal technique since it considers the time value of money. It is defined as the difference between the initial cash outlay and the present value of the future cash in-flows that a project generates (Wendy & Mayer, 2003). It also considers other financial measures such as the cost of capital and as such, the management is able to make informed decisions on the market conditions.
When using this method to appraise mutually exclusive projects, the project with the highest net present value is chosen over the one that has a lower one. When appraising a single project’s viability, a project is considered acceptable if it has a net present value above zero. this means that the present value of the future cash flows is more than the present value of the cash outlay.
Using this method to appraise Jim-care health center, the project that was preferred was the construction of the recreation facility for the staffs. This is because the study showed that the facility had a net present value of $513,775.00 as compared to the cancer care center that had a net present value of $208,420.00
The qualitative non-financial factors
When carrying out financial appraisals, several non-financial factors are considered. These include such factors as the social welfare of the stakeholders, the environment conservation, and the motivational levels of employees which may not be captured in the quantitatively (Chrystal & Lipsey, 1997). The non financial factors that were considered in this study were the welfare of the cancer patients and the motivational level of the staffs.
Building the cancer care center would be very beneficial to the cancer patients in the community. This is because though it generated less cash flow projection than the recreational facility, the cancer care center would be of great qualitative need to the organization. This was however not the priority as at then as the hospital had cash flow difficulties and needed projects that would increase their cash flow requirements.
The other non-financial qualitative consideration considered was the motivation of employees at the hospital. The hospital management highly regarded this is an urgent need among the organization staff and as such, the choosing of the project highly regarded this need. The recreation center was chosen since it positively impacted n the motivation of the employees who saw that their welfare was being put into consideration by the management. This was an addition reason as to why the team advised the management undertake this project.
The outcome of the project
The management as was advised went on to undertake the construction of the recreational facility. This resulted in a more than the expected returns since the amount of money invested was recovered in the first 5 months after the completion of the project. This means that the financial techniques used were highly effective and the hospital has been able to improve its liquidity as well as the cash flows.
The consideration of the non-financial factors in the appraisal of the project was a also effective since the motivational levels of the employees has gone up considerable. The hospital is now in the process of undertaking the other project of building the cancer care center which promises to be a huge success as well.
References
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