Posted: June 16th, 2022

UVa Health System: The Long-Term Acute Care Hospital Project

wk3_assignment.xlsxwk4_assignment.xlsx

Case UVa Health System: The Long-Term Acute Care Hospital Project              Wk 3 is the first of two consecutive weeks on CAPITAL BUDGETING.                 You will learn the three steps in capital budgeting:       1 Identify relevant incremental cash flows      2 Calculate cost of capital (k-wacc) to use as the discount rate      3 Calculate the  metrics of capital budgeting: Net Present Value, Profitability Index,         Internal Rate of Return, and Payback Period.      Then, you will apply the metrics and information in the case study to make a recommendation         whether to accept or reject the LTAC project.      The essence of the capital budgeting process is to make sure, BEFORE an investment is made,       that its prospective rate of return is high enough to justify the investment.              Reading Cohen Finance Workbook chapter 4 is a review of Time Value of Money, which you covered in a previous course.       Review it as necessary, but defer the review until you look at the TVM applications in chapter 5 beginning on p 79.       You need to know TVM to understand the capital budgeting metrics of NPV, PI, and IRR. Make sure you       have that context in mind before reviewing the TVM chapter 4 (only if you need to).                Give the Uva Health Care System: The Long-Term Acute Care Hospital Project Case a quick read to understand what is going on – about        calculating k-wacc and the decision metrics for the project, to give it either a green light or a red light.                Wk 3 gives you practice on the basics. You won’t have a full understanding of what the LTAC Project case is about at       the end of Wk3. In Wk4, you will return to the case, analyze the project, and make a recommendation.             Look at the Wk 3 assignment questions in the Q1, Q2, Q3 tabs.               Read Cohen Finance Workbook chapter 5 selectively. Focus on:        See the FLOW DIAGRAM in GREEN depicting the CAPITAL BUDGETING template.       See the IS/BS Model in GREEN depicting the connection between PPE (BS) and operating expense (IS).       Read pps 61-65 as a general introduction to capital budgeting.       Read pps 70-76 on weighted average cost of capital to answer Q1.       Read bottom p 67 to 69 on Net Working Capital to answer Q2.       Read pps 79-85 on NPV, PI, IRR, PP to answer Q3.            Questions        See tabs for Q1, Q2, Q3       THESE QUESTIONS MUST BE ANSWERED USING EXCEL.       MAKING CALCULATIONS OUTSIDE THE SPREADSHEET AND ENTERING THE RESULTS IS NOT USING EXCEL.       YOU MUST USE EXCEL FORMULAS FOR MAKING CALCULATIONS!               Case UVa Health System: The LATC Hospital Project                 Wk 4 is the second of two weeks on CAPITAL BUDGETING              Study the Wk 3 Solutions Template before proceeding into Wk 4.                       Learning Objectives  (repeated from Wk3 Assignment Template)            You will learn the three steps in capital budgeting:     SEE THE FLOW DIAGRAM – YOU ARE NOW WORKING ON THE GREEN-COLORED ANALYSIS.        1 Identify relevant incremental cash flows            2 Calculate cost of capital (k-wacc) to use as the discount rate            3 Calculate the  metrics of capital budgeting: Net Present Value, Profitability Index,               Internal Rate of Return, and Payback Period.            Then, you will apply the metrics and information in the case study to make a recommendation               about which of the two projects to accept.            The essence of the capital budgeting process is to make sure, before an investment is made,             that its prospective rate of return is high enough to justify the investment,             i.e., that the project is CREATES value, not DESTROYS value.                          Directions  (some repeating from Wk3 Assignment Template)           1 Make a quick scan through the LTAC case and the exhibits.             2 Listen to the Intro Audio            3 Cohen Finance Workbook chapter 4 is a review of Time Value of Money, which you covered in a previous course.             Review it as necessary, but defer the review until you look at the TVM applications in chapter 5 beginning on p 79.             You need to know TVM to understand the capital budgeting metrics of NPV, PI, and IRR. Make sure you             have that context in mind before reviewing the TVM chapter 4 (only if you need to).            4 Read the case again, to grasp all the details, especially the Mulroney memo to her boss.            5 To understand how a capital budgeting template works, follow the step-by-step procedure in the book, pages 61-70            6 Scan pages 70-76 on weighted average cost of capital. No need to emphasize at this point because discount rates are given in the case.            7 Read pages 79-84 on NPV, PI, IRR, PP.            8 Pages 83-85 show a worked-out example of a capital budgeting decision.                         Questions               If you work with a group, write answers on your own, independently. Group answers violate academic integrity requirements.             1 See Q1 tab. Scroll down until you see the questions.    Capital Budgeting Template   The template calculates FREE CASH FLOW=[EBIT-TAX+DEPREC]+/-CHANGE NWC+/-CAPEX.    2 See Q2 tab. Scroll down until you see the questions.    K-wacc           The 1st term is income statement data; the 2nd & 3rd terms are balance sheet data.    3 See Q3 tab. Scroll down until you see the questions.    Sensitivity Analysis    LEARN THIS FORMULA (EQUATION) COLD!                                 Expect to revisit these calculations and decisions in Wk7.  

ATTACHED FILE(S)

READ THIS FIRST

1

2

3

. Make sure you

ase a quick read to understand what is going on – about

Case	UVa Health System: The Long-Term Acute Care Hospital Project
Wk 3 is the first of two consecutive weeks on CAPITAL BUDGETING.
You will learn the three steps in capital budgeting:
Identify relevant incremental cash flows
Calculate cost of capital (k-wacc) to use as the discount rate
Calculate the metrics of capital budgeting: Net Present Value, Profitability Index,
Internal Rate of Return, and Payback Period.
Then, you will apply the metrics and information in the case study to make a recommendation
whether to accept or reject the LTAC project.
The essence of the capital budgeting process is to make sure, BEFORE an investment is made,
that its prospective rate of return is high enough to justify the investment.
Reading	Cohen Finance Workbook chapter 4 is a review of Time Value of Money, which you covered in a previous course.
Review it as necessary, but defer the review until you look at the TVM applications in chapter 5 beginning on p 79.
You need to know TVM to understand the capital budgeting metrics of NPV, PI, and	IRR
have that context in mind before reviewing the TVM chapter 4 (only if you need to).
Give the Uva Health Care System: The Long-Term Acute Care Hospital	Project C
calculating k-wacc and the decision metrics for the project, to give it either a green light or a red light.
Wk 3 gives you practice on the basics. You won’t have a full understanding of what the LTAC Project case is about at
the end of Wk3. In Wk4, you will return to the case, analyze the project, and make a recommendation.
Look at the Wk 3 assignment questions in the Q1, Q2, Q3 tabs.
Read Cohen Finance Workbook chapter 5 selectively. Focus on:
See the FLOW DIAGRAM in GREEN depicting the CAPITAL BUDGETING template.
See the IS/BS Model in GREEN depicting the connection between PPE (BS) and operating expense (IS).
Read pps 61-65 as a general introduction to capital budgeting.
Read pps 70-76 on weighted average cost of capital to answer Q1.
Read bottom p 67 to 69 on Net Working Capital to answer Q2.
Read pps 79-85 on NPV, PI, IRR, PP to answer Q3.
Questions
See tabs for Q1, Q2, Q3
THESE QUESTIONS MUST BE ANSWERED USING EXCEL.
MAKING CALCULATIONS OUTSIDE THE SPREADSHEET AND ENTERING THE RESULTS IS NOT USING EXCEL.
YOU MUST USE EXCEL FORMULAS FOR MAKING CALCULATIONS!

Q1-COST of CAPITAL (K-wacc)

0

%

given

0%

0.00% given

0.00% given

0.00 given

0.00%

%

0.00%

.

COMPUTE WEIGHTED AVERAGE COST OF CAPITAL

enter data in blue-colored cells

BASIC:

Formula

Equation

COST OF DEBT:

Coupon Rate

0.0

given

Marginal Tax Rate

0.0%

Cost of Debt

0.00%

b5*(1-b6)

k-d = I x (1-t)

weight of debt

d ÷ d+e

COST OF EQUITY:

Risk-Free Rate

Risk Premium

R-m – R-f

Beta

Cost of Equity

b11+(b13*b12)

k-e = R-f + [ß x (R-m – R-f)]

weight of equity

100

1-b8

e ÷ d+e

Weighted-Average Cost of Capital

(b8*b7)+(b15*b14)

(k-d x wt-d)+(k-e x wt-e)

Above is the template explained in chapter 5 pps 70-76.

Use the template to answer Q1.

Q1:

Page 75 in Cohen Finance Workbook displays a K-wacc calculation for a company.

Suppose that the inputs to that k-wacc calculation have changed.

The company’s financial risk has increased, so its coupon rate is now 9%.

Its marginal tax rate increased to 30%.

To reduce financial risk, its ‘target’ weight of debt is reduced to 30%.

The risk-free rate on treasury bonds is now 2%.

The risk premium stays the same at 8%.

The beta, reflecting higher financial risk, rises to

1.5

Recalculate k-wacc, using the template at the top of this page.

Explain the significance of the change in k-wacc to the capital budgeting analysis and recommendation. Use the box below:

Q2-NWC

1000.0 1000.0 1000.0 1000.0

22.0 22.0 22.0

30

82.2 82.2 82.2 82.2

50

3.0 3.0 3.0 3.0

25 1.5 1.5 1.5 1.5 1.5

83.7 83.7 83.7 83.7

0.0

83.7 0.0 0.0 0.0 0.0

Change in Net Working Capital:

Revenue 1000.0

Cost of goods sold 22.0

Receivables (enter days in Column B) 30 82.2

Inventory (enter days in Column B) 50 3.0

4.2

Payables (enter days in Column B) 25 1.5

2.0

Net working capital needs 83.7

Liquidation of working capital 0.0
Investment in working capital 83.7

8.4 8.4 8.4

Change in Net Working Capital:
Revenue 1000.0 1100.0 1200.0 1300.0 1400.0
Cost of goods sold 22.0

26.4 28.6 30.8

Receivables (enter days in Column B) 60

Inventory (enter days in Column B) 100

7.2

8.4

Payables (enter days in Column B) 25 1.5 1.7 1.8 2.0 2.1

Net working capital needs

Liquidation of working capital 0.0

Investment in working capital 168.9

16.9 16.9 16.9

Go to the bottom of p 68 in the Cohen Finance Workbook.
There is no picture of a faucet – but – visualize a sink faucet turning on and off, controlling the flow of water.
Picture a receivables faucet, an inventory faucet, and a payables faucet.
The number of days can be lower (faucet turned low) or higher (faucet turned high).
This is how net working capital is controlled, by setting the number of days of each.
The investment in working capital is one of the entries in a forecast.
This question helps you learn how to forecast net working capital.
Q2a – Explain how the table below works, i.e., what are the inputs, what are the outputs, and how
are the inputs transformed into the outputs.
HINT: Examine the formulas in the cells.
		Change in Net Working Capital:
		Revenue							1000.0
		Cost of goods sold						2		2.0	22.0	$ signs in the formula ‘fix’ the cell so
		Receivables (enter days in Column B)						82.2	the formula can be copied to other cells
		Inventory (enter days in Column B)						3.0	without changing that cell, i.e.,
		Payables (enter days in Column B)	copying on a ‘fixed’ rather than a ‘relative’ basis
		Net working capital needs								83.7
		Liquidation of working capital	at the end of a project’s life, working capital is liquidated
		Investment in working capital
Answer Q2a in this box:
Q2b – Row 43 changes compared to row 14 in Q2a. Explain how the
investment in working capital changes (compared to the amount in Q2a) and why.
	1100.0		1200.0		1	300.0		1400.0
2	4.2		26.4		28.6		30.8
90.4	98.6	106.8	115.1
3.3	3.6	3.9
	1.7			1.8		2.1
92.1	100.4	108.8	11	7.2
				8.4
Answer Q2b in this box:
Q2c – B71 and B72 are changed from the number of days in Q2a and Q2b. Explain how the
investment in working capital changes (compared to the amount in Q2b) and why.
24.2
164.4	180.8	197.3	213.7	230.1
6.0	6.6	7.8
	168.9	185.8	202.7	219.6	236.5
			16.9
Answer Q2c in this box:

Q3-METRICS

calculations that were discussed in MBAD 6233 Financial Markets.

:

3.1

1.8

300.0 0.0 0.0 0.0 0.0 0.0

0.0

Free cash flow

-300.0

Internal Rate of Return (IRR)

Project C

25,000 200,000

25,000 200,000

25,000 25,000

25,000

IRR
PP

Recall the	Internal Rate of Return (IRR)
	Free cash flow
Operating cash flow	72.6	88.8	105.1	109.6	124.3
Minus: Invesment in net working capital	12.3		3.1	0.9
Minus: Investment in PPE (CapEx)
Plus: Salvage value
	-300.0	60.3	85.7	102.0	108.7	122.5	rounding error
Cumulative free cash flow	-239.7	-154.0	-52.0	56.7	179.2
Discount rate (K-wacc)	10.9%
Net Present Value (NPV)	43.7
Profitability Index (PI)	1.1
15.9%
Payback Period (PP)	inspection
The panel above is extracted from p 85 in Cohen Finance Workbook.
Examine the formulas that calculate NPV, PI, and IRR.
Estimate PP by inspection using row 9 cumulative free cash flow-the year when cumulative free cash flow becomes a positive number.
Q3a
Using the data below for the three projects, and the formulas you discerned in B12, B13, and B14,
calculate NPV, PI, and IRR for the three projects, using two different k-wacc discount rates, 8% and 11%.
The data for Projects A,B,C are arrayed vertically; they are the same as row 8 in the horizontal panel above.
Project A	Project B
Initial Outlay	-50,000	-100,000	-450,000
Cash Inflows: Yr 1	10,000						25,000			200,000
Yr 2	15,000
Yr 3	20,000
Yr 4
Yr 5	30,000
enter formulas in the cells in this box
NPV at 8%
NPV at 11%
PI at 8%
PI at 11%
Q3b
Interpret the meaning of the calculations you made in Q3a.
Hint: Do you recommend accepting or rejecting the projects?
Hint: What is the impact on the decision metrics when k-wacc changes from 8% to 11%?
Hint: Do all three decision metrics lead to the same recommendation?

READ THIS FIRST

1

2

3

1

2

3

, PI, and

. Make sure you

4

5

6

in the case.

7

8

1

2

Scroll down until you see the questions.

3

Scroll down until you see the questions.

Case	UVa Health System: The LATC Hospital Project
Wk 4 is the second of two weeks on CAPITAL BUDGETING
Study the Wk 3 Solutions Template before proceeding into Wk 4.
Learning Objectives	(repeated from Wk3 Assignment Template)
You will learn the three steps in capital budgeting:	SEE THE FLOW DIAGRAM – YOU ARE NOW WORKING ON THE GREEN-COLORED ANALYSIS.
Identify relevant incremental cash flows
Calculate cost of capital (k-wacc) to use as the discount rate
Calculate the metrics of capital budgeting: Net Present Value, Profitability Index,
Internal Rate of Return, and Payback Period.
Then, you will apply the metrics and information in the case study to make a recommendation
about which of the two projects to accept.
The essence of the capital budgeting process is to make sure, before an investment is made,
that its prospective rate of return is high enough to justify the investment,
i.e., that the project is CREATES value, not DESTROYS value.
Directions	(some repeating from Wk3 Assignment Template)
Make a quick scan through the LTAC case and the exhibits.
Listen to the Intro Audio
Cohen Finance Workbook chapter 4 is a review of Time Value of Money, which you covered in a previous course.
Review it as necessary, but defer the review until you look at the TVM applications in chapter 5 beginning on p 79.
You need to know TVM to understand the capital budgeting metrics of				NPV				IRR
have that context in mind before reviewing the TVM chapter 4 (only if you need to).
Read the case again, to grasp all the details, especially the Mulroney memo to her boss.
To understand how a capital budgeting template works, follow the step-by-step procedure in the book, pages 61-70
Scan pages 70-76 on weighted average cost of capital. No need to emphasize at this point because discount rates are					given
Read pages 79-84 on NPV, PI, IRR, PP.
Pages 83-85 show a worked-out example of a capital budgeting decision.
Questions
If you work with a group, write answers on your own, independently. Group answers violate academic integrity requirements.
See Q1 tab.			Scroll down until you see the questions.	Capital Budgeting Template	The template calculates FREE CASH FLOW=[EBIT-TAX+DEPREC]+/-CHANGE NWC+/-CAPEX.
See Q2 tab.			K-wacc	The 1st term is income statement data; the 2nd & 3rd terms are balance sheet data.
See Q3 tab.	Sensitivity Analysis	LEARN THIS FORMULA (EQUATION) COLD!
Expect to revisit these calculations and decisions in Wk7.

Q1 Capital Budgeting Template

50 NPV

NPV

1

IRR

IRR

ease in Utilization

4%

K-wacc

Year 1 2 3 4 5 6 7 8 9 10

18,250 18,250 18,250 18,250 18,250 18,250 18,250 18,250 18,250

Utilization 26% 60%

13 30 31 32 34 35 36 38 39 41

30 27 27 27 27 27 27 27 27 27

/Census

3.5 3.5 3.5 3.5 3.5 3.5 3.5 3.5

Full-Time Employees 62

57

158

46 118

138

38 97

105 109 114 118 123 128 133

9% 14 37 38 39 41 43 44 46 48 50

2% 3 8 8 9 9 9 10 10 11 11

158 406 422 439 456 474 493 513 534 555

Annual Incr

1.3%

$35,000 1.3%

1% 70

(000 omitted)

Annual Incr

3%

8%

NA

3% 200

232

246

500 500 500 500 500 500 500 500 500 500

(000 omitted)

Total Expenses 7,840 13,896 14,585 15,316 16,092 16,915 17,789 18,717 19,702 20,749

3,751

16.3%

487

548

617

30 days 93

253

Net Working Capital 666

666

67 70 72 75 78 81 85 88

Calculation

Operating Profit (804) 3,769 3,787 3,791 3,779 3,751 3,703 3,635 3,544 3,427

500 500 500 500 500 500 500 500 500 500

(7,500) 0 0 0 0 0 0 0 0 0

Free Cash Flows (000 omitted) (7,500)

4,220

4,176

$5,687 (000 ommited)

17.6%

Year 1 2 3 4 5 6 7 8 9 10

NWC Recovery 0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0

$10,425 (000 ommited) (7,500) (8,470) 3,263 4,220 4,221 4,207 4,176 4,125 4,054 3,959

21.2%

(000 ommited)

14.2%

	UNIVERSITY OF VIRGINIA MEDICAL CENTER
	Long Term Acute Care Hospital		Free Cash Flow Projections
	Revenue and Cost Assumptions	Results-No		NWC Recovery		Results-NWC Recovery
	Number of Beds				$5,687				$10,425								(000 ommited)
				Year		Utilization				26%				17.6%				21.2%
	Year 2 Utilization				60%
				Annual Incr
	Operating Expense (% of Revenue)		7.0%
10%
	VOLUME
	Patient Day Capacity																				18,250
	62%		65%		67%		70%		73%		76%		79%		82%
	Patient Days Used		4,745		10,950		11,388		11,844		12,317		12,810		13,322		13,855		14,409		14,986
	Average Patient Census per Day
	Average Length of Stay
	Number of Patients per Year						158				406				422				439				456				474				493				513				534				555
		Full-Time Employees		4.8																		3.5
			105				109				114						118				123				128				133				138		144
	INSURANCE PAYER		Patient Mix
	Medicare		36%		146		152		164		171		178		185		192				200
	Medicaid		29%		122		127		132		143		149		155		161
	Commercial Payers		24%		101
	Other
	Indigent
	Billing
	Medicare—bill per patient		$27,795			0.0%		1,583		4,058						4,220		4,389		4,565		4,747		4,937		5,135		5,340		5,554
	Medicaid—bill per patient				$35,000						1.3%		1,605		4,170		4,337		4,510		4,691		4,878		5,073		5,276	5,		487		5,707
	Commercial Payers—bill per day		$2,800		5.0%		3,189		7,726		8,035		8,357		8,691		9,039		9,400		9,776		10,167		10,574
	Other—bill per patient	$38,																																								500				548		1,424		1,480		1,540		1,601		1,665		1,732		1,801		1,873		1,948
	Indigent—bill per patient		111		288		299		311		323		336		350		364		378		394
	Total Revenue								(000 omitted)		7,035		17,665		18,372		19,107		19,871	20,				666		21,493		22,352	23,		246	2				4,176
	Less Uncollectable		177		184		191		199		207		215		224				232		242
	Total Net Revenue		6,965		17,489		18,188		18,916		19,672		20,459		21,278		22,129		23,014		23,935
	EXPENSES
	Salary, Wage, Benefits (based on $ per employee)		$60,250		3,760		6,516		6,980		7,477		8,009		8,580		9,190		9,845		10,546		11,297
	Supplies, Drugs, Food (% net revenue)				16.3%		1,135		2,851		2,965		3,083		3,207		3,335		3,468		3,607						3,751		3,901
	Management Fees (% net rev)		557		1,399		1,455		1,513		1,574		1,637		1,702		1,770		1,841		1,915
	Operating Expenses (fixed + 7 % net rev)		$1,200,000		1,688		2,424		2,473		2,524		2,577		2,632		2,689		2,749		2,811		2,875
	Land Lease per year		$200,000		206		212		219		225		239				253		261
	Depreciation (straight line 30yrs)		$15,000,000
			Total Expenses				7,840				13,896				14,585				15,316				16,092				16,915				17,789				18,717				19,702				20,749
			Operating Profit				(804)				3,769				3,787				3,791				3,779				3,703				3,635				3,544				3,427
	Operating Margin		-11.4%		21.3%		20.6%		19.8%		19.0%		18.1%		17.2%		15.2%				14.2%
			Net Working Capital		Notes:
	Accounts Receivable				30 days		572		1,437		1,495		1,555	1,		617		1,682		1,749		1,819		1,892		1,967
	Inventory Supplies, Drugs, Food		60 days		187		469		507		527		570		593		641
	Accounts Payable		234		244		264		274		285		296		308		321
	1,672		1,739		1,808		1,880		1,956		2,034		2,115		2,200		2,288
	Change in NWC		1,006
		Free Cash Flows
	Add Depreciation
	Less Capital Expenditures								(7,500)
	Less Increase in Net Working Capital		(666)		(1,006)		(67)		(70)		(72)		(75)		(78)		(81)		(85)		(88)
			(8,470)				3,263				4,221				4,207				4,125				4,054				3,959		3,839
	NPV (no recovery in year 10)
	IRR (no recovery in year 10)
	$2,288
	Sale of Facility at Book Value		$10,000
	NPV with Year 10 Recovery		16,127
	IRR with Year 10 Recovery
	Net Profit (Operating Profit – Interest)		(2,004)		2,569		2,587		2,591		2,579		2,551		2,503		2,435		2,344		2,227
	Net Profit/Net Revenue		-28.8%		14.7%		13.7%		13.1%		12.5%		11.8%		11.0%		10.2%		9.3%
Study the above analysis carefully, examining the inputs, outputs, and formulas used to do the calculations.
Q1a	Mulroney did not use working capital cash flows in her original analysis. The analysis above
includes incremental investment in working capital. Discuss why she was either correct or incorrect not to
include them.
Q1b	Compare the decision metrics NPV & IRR for the “no recovery of NWC” and “recovery of NWC” scenarios,
stating which scenario best captures reality. Based on your answer, give the project a green or red light.
Q1c	Examine the decision metric ‘profit margin’, and explain if it leads to a green or red light for this project.
Even though the board of directors uses this metric, it is defective. Explain why. HINT: FCF definition.
Q1d	Reconcile your answers to Q1b and Q1c.

Q2 K-wacc

%

given

0.0% given

4.72%

0%

0.00% given

0.00% given

0.00 given

0.00%

A+

A

0.00%

A-

+

BBB

BB

BB-

B+

B

A B BB B-

0.60

If LATC was a project in a for-profit hospital like HCA

COMPUTE WEIGHTED AVERAGE COST OF CAPITAL
BASIC:	Formula	Equation	Case Exhibit 4
COST OF DEBT:	U.S. Treasury Yields
Coupon Rate					0.00	1-year	4.77%
Marginal Tax Rate	5-year		4.72%
Cost of Debt		0.00%	b5*(1-b6)	k-d = I x (1- t)	10-year
weight of debt	d ÷ d+e	30-year	4.73%
Data source: http://federalreserve.gov/releases/h15/data.htm (accessed March 2006).
COST OF EQUITY:
Risk-Free Rate	Corporate Bond Yields
Risk Premium	R-m – R-f	AAA	5.31%
Beta	AA	5.38%
Cost of Equity	b11+(b13*b12)	k-e = R-f + [ß x (R-m – R-f)]
weight of equity	100%	1-b8	e ÷ d+e	5.41%
5.45%
Weighted-Average Cost of Capital	(b8*b7)+(b15*b14)	(k-d x wt-d)+(k-e x wt-e)	5.53%
	BBB	5.62%
5.88%
For-Profit Comparables	B	BB-	6.07%
HCA Inc	Community Health	Health Management Associates
Revenues (millions)	$24,475	$3,720	$3,580	BB+	6.40%
Assets (millions)	$5,222	$961	$997	6.79%
Total debt (millions)	$9,278	$1,810	$1,014	6.96%
Stock price ($/share)	$52.12	$39.73	$23.25
Shares outstanding (millions)	452.7	88.5	247.2	7.39%
Market cap (millions)	$23,593	$3,517	$5,747	7.57%
Bond rating	7.84%
Beta		0.60	0.70	Data source: Bloomberg, “Fair Market Curve Analysis,” 10-Year Corporate Bonds, March 2, 2006.
Q2a	Calculate the K-wacc for HCA using the template above. Enter the data that you
have in the case and the table above. If you need additional data, assume it using
your good judgment from what you have learned so far in the course.
In the answer box, cite your result, compare it to the K-wacc used in the Q1
analysis, and explain how your revised K-wacc would change the Q1 results.
Q2b		If LATC was a project in a for-profit hospital like HCA
above, would the NPV be higher or lower? Explain ‘analytically’ by examining
all relevant inputs to NPV.
Q2c
above, would the IRR be higher or lower? Explain.
HINT: To avoid getting trapped by this question, make sure your answer is
‘analytical’, i.e., examine all relevant inputs and output.
Q2d	Can a non-profit hospital accept projects that a for-profit hospital would reject?

Q3 Sensitivty Analysis

UNIVERSITY OF VIRGINIA MEDICAL CENTER
Long Term Acute Care Hospital Free Cash Flow Projections

Revenue and Cost Assumptions

Results-NWC Recovery
Number of Beds 50 NPV $5,687 NPV $10,425 (000 ommited)

26% IRR 17.6% IRR 21.2%
Year 2 Utilization 60%

4%
Operating Expense (% of Revenue) 7.0%

K-wacc

Year 1 2 3 4 5 6 7 8 9 10
VOLUME
Patient Day Capacity 18,250 18,250 18,250 18,250 18,250 18,250 18,250 18,250 18,250 18,250
Utilization 26% 60% 62% 65% 67% 70% 73% 76% 79% 82%
Patient Days Used 4,745 10,950 11,388 11,844 12,317 12,810 13,322 13,855 14,409 14,986
Average Patient Census per Day 13 30 31 32 34 35 36 38 39 41
Average Length of Stay 30 27 27 27 27 27 27 27 27 27
Number of Patients per Year 158 406 422 439 456 474 493 513 534 555

4.8 3.5 3.5 3.5 3.5 3.5 3.5 3.5 3.5 3.5
Full-Time Employees 62 105 109 114 118 123 128 133 138 144

INSURANCE PAYER Patient Mix
Medicare 36% 57 146 152 158 164 171 178 185 192 200
Medicaid 29% 46 118 122 127 132 138 143 149 155 161
Commercial Payers 24% 38 97 101 105 109 114 118 123 128 133
Other 9% 14 37 38 39 41 43 44 46 48 50
Indigent 2% 3 8 8 9 9 9 10 10 11 11
158 406 422 439 456 474 493 513 534 555

Billing Annual Incr
Medicare—bill per patient $27,795 0.0% 1,583 4,058 4,220 4,389 4,565 4,747 4,937 5,135 5,340 5,554
Medicaid—bill per patient $35,000 1.3% 1,605 4,170 4,337 4,510 4,691 4,878 5,073 5,276

5,707
Commercial Payers—bill per day $2,800 5.0% 3,189 7,726 8,035 8,357 8,691 9,039 9,400 9,776 10,167 10,574
Other—bill per patient

1.3% 548 1,424 1,480 1,540 1,601 1,665 1,732 1,801 1,873 1,948
Indigent—bill per patient $35,000 1.3% 111 288 299 311 323 336 350 364 378 394
Total Revenue (000 omitted) 7,035 17,665 18,372 19,107 19,871

21,493 22,352

Less Uncollectable 1% 70 177 184 191 199 207 215 224 232 242
Total Net Revenue (000 omitted) 6,965 17,489 18,188 18,916 19,672 20,459 21,278 22,129 23,014 23,935

EXPENSES Annual Incr
Salary, Wage, Benefits (based on $ per employee) $60,250 3% 3,760 6,516 6,980 7,477 8,009 8,580 9,190 9,845 10,546 11,297
Supplies, Drugs, Food (% net revenue) 16.3% 1,135 2,851 2,965 3,083 3,207 3,335 3,468 3,607 3,751 3,901
Management Fees (% net rev) 8% 557 1,399 1,455 1,513 1,574 1,637 1,702 1,770 1,841 1,915

Operating Expenses (fixed + 7 % net rev) $1,200,000 NA 1,688 2,424 2,473 2,524 2,577 2,632 2,689 2,749 2,811 2,875
Land Lease per year $200,000 3% 200 206 212 219 225 232 239 246 253 261
Depreciation (straight line 30yrs) $15,000,000 500 500 500 500 500 500 500 500 500 500
Total Expenses (000 omitted) 7,840 13,896 14,585 15,316 16,092 16,915 17,789 18,717 19,702 20,749

Total Expenses 7,840 13,896 14,585 15,316 16,092 16,915 17,789 18,717 19,702 20,749

Operating Profit (804) 3,769 3,787 3,791 3,779 3,751 3,703 3,635 3,544 3,427
Operating Margin -11.4% 21.3% 20.6% 19.8% 19.0% 18.1% 17.2% 16.3% 15.2% 14.2%

Net Working Capital Notes:
Accounts Receivable 30 days 572 1,437 1,495 1,555

1,682 1,749 1,819 1,892 1,967
Inventory Supplies, Drugs, Food 60 days 187 469 487 507 527 548 570 593 617 641
Accounts Payable 30 days 93 234 244 253 264 274 285 296 308 321
Net Working Capital 666 1,672 1,739 1,808 1,880 1,956 2,034 2,115 2,200 2,288
Change in NWC 666 1,006 67 70 72 75 78 81 85 88

Operating Profit (804) 3,769 3,787 3,791 3,779 3,751 3,703 3,635 3,544 3,427
Add Depreciation 500 500 500 500 500 500 500 500 500 500
Less Capital Expenditures (7,500) (7,500) 0 0 0 0 0 0 0 0 0
Less Increase in Net Working Capital (666) (1,006) (67) (70) (72) (75) (78) (81) (85) (88)
Free Cash Flows (000 omitted) (7,500) (8,470) 3,263 4,220 4,221 4,207 4,176 4,125 4,054 3,959 3,839

NPV (no recovery in year 10) $5,687 (000 ommited)
IRR (no recovery in year 10) 17.6%

Year 1 2 3 4 5 6 7 8 9 10
NWC Recovery 0 0 0 0 0 0 0 0 0 $2,288
Sale of Facility at Book Value 0 0 0 0 0 0 0 0 0 $10,000

NPV with Year 10 Recovery $10,425 (000 ommited) (7,500) (8,470) 3,263 4,220 4,221 4,207 4,176 4,125 4,054 3,959 16,127
IRR with Year 10 Recovery 21.2%

Net Profit (Operating Profit – Interest) (000 ommited) (2,004) 2,569 2,587 2,591 2,579 2,551 2,503 2,435 2,344 2,227
Net Profit/Net Revenue -28.8% 14.7% 14.2% 13.7% 13.1% 12.5% 11.8% 11.0% 10.2% 9.3%

1

2

3

Results-No NWC Recovery	Year 1 Utilization	Annual Increase in Utilization
10.0%
Full-Time Employees/Census	5,487	$38,500	20,666	23,246	24,176
1,617	Free Cash Flows Calculation
Q3a	The analysis above is identical to the one on the Q1 tab.
Do a sensitivity analysis by systematically changing certain assumptions in the spreadsheet above:
change the K-wacc to 8.3%
change year 2 utilization to 45%
change commercial payers to 30% of patient mix
Use the answer box to prepare a summary of the original (Q1) results
and the revised (Q3) results, i.e., a summary table.
Q3b	Revise the decision you made in Q1 based on the above sensitivity analysis, comparing Mulroney’s
assumptions and the sensitivity analysis assumptions to expectations stated in the case.
Be sure to consider both ‘hard quantitative data” from decision metrics and ‘soft qualitative information’
from the case.