The project manager must first determine the incremental cash flow of the project to determine its overall prospects. Financial flows such as the MRI’s initial cost, cash flows generated by the project’s operation, and cash flows connected to the project’s completion are all included. Determining the incremental cash flows when the project is at its start might be very difficult, as unpredictable factors and sunk costs emerge. These costs must be accounted for in the analysis by leaving room for variation in expected expenses. The expenditures required to analyze the project and decide whether or not to acquire the machine are known as sunk costs and are not recoupable (Investopedia, 2021). These costs will not affect the overall result of the analysis and can be reasonably discounted.
Opportunity costs are the costs incurred if the hospital decides not to acquire the gadget, as well as the cash outflows that will not be earned (Investopedia, 2021). In addition, the elements such as strategic value and inflation consequences must be considered in the study. Inflation happens when such costs change, such as labor costs rising due to wage inflation and inventory costs rising due to supply inflation. According to the cash flow analysis supplied by the hospital administration, the cost of this system is $2,000,000, with an additional $500,000 for installation and setup. As a result, the project’s starting cost will be $2,500,000 with variations thereupon depending on the circumstances.
The operation of the MRI system is depicted in this analysis as representative of a five-year period. The physicians and managers estimated the number of procedures, expected reimbursement amounts for each scan, MRI expenses, and any other financial flows resulting from the system’s functioning. After adding up the initial costs and fees, net revenue, labor and maintenance costs, and supplies, they calculated the net operating income for each of the five years. The total amount they were required to pay was, once again, equal to $2,500,000.
Year 1’s $510,000 is an estimate of net cash inflow from the open MRI’s first year of operation, considering both projected operational income and costs. They earned $535,500 in the second year, $562,275 in the third, $590,389 in the fourth, and $1,369,908 in the fifth. The cash flow projected from the sale of the MRI at the end of the project’s five-year life cycle is included in Year 5 net cash flow. The MRI project’s $2,500,000 cost is shown to have entirely recovered at the end of Year 5. If the cash flow forecast is right, the project will achieve breakeven by the end of year 4, with the rest of the cash flow constituting the profits obtained. Finally, due to the use of an 11.1 discount rate, the project’s net present value lies at $82.493.
The MRI project’s $2,500,000 cost is shown to have entirely recovered at the end of Year 5. If the cash flow forecast is correct, the project will achieve breakeven by the end of year 4, and the remaining cash flow will be profit. The project’s net present value is $82.493 since they used an 11.1 discount rate. Finally, financial analysis can show how much of an investment a business can manage and whether or not they are genuinely ready for capital investment. When businesses take in more money than they can handle or when their cash flow is underestimated, they go bankrupt. The opposite is true: by correctly calculating the expected cash flows and capital costs while conducting a timely financial evaluation, a firm can secure its financial security.
Reference
Investopedia. Incremental Cash Flows. (2021). Web.