Overview
Palms Hospital, established in 1946 by Rob Winslow, is presently one of the best hospitals in Islamorada, Florida. It has one of the best inpatient care facilities in the Key Islands. In recent years, favorable federal regulatory rules, advancement in surgical procedure techniques, and substantial increase in the number of outpatient surgery services have created a high potential for outpatient surgery market. Key Islands have seen a phenomenal growth in population in recent years, which has increased the demand for inpatient as well as outpatient care services. Currently, Islamorada has no hospital with a facility of outpatient surgical procedures, which gives Palms Hospital an opportunity to enter and provide service in this area. Outpatient surgery centers, also known as ambulatory surgery centers, are becoming popular among patients because of low cost service and affordability. Even insurance service providers often prefer ambulatory surgery procedures as they have to pay fewer amounts to the medical service providers, including doctors and hospitals. Palms Hospital intends to grab this untapped demand by investing in building an outpatient surgery care center. However, the board of directors of the hospital is not sure of the rate of returns of the investment needed to build the facility, and therefore, making a comprehensive financial analysis is required to identify all the risks and uncertainties around the investment and to understand the rate of return on each of the possible future scenarios.
Analysis
Palms Hospital already holds a piece of land close to its hospital facility, which it can sell to earn a net income of $200,000. It can also invest approximately $10 million to build an outpatient surgery center. However, there are several uncertainties associated with the investment. There are three variables deemed as highly uncertain, but potentially can impact the financial return of this project.
The number of procedures per day is a variable, which will influence the amount of revenues that will be generated after the investment. However, there is a huge uncertainty around the number of procedures per day as this will be the first time this kind of product will be offered to the people of Islamorada. The acceptance of outpatient surgery care can only be gauged crudely. Although it is estimated that the average number of cases will be twenty per day, in the case of non-acceptance or slow acceptance of people of Islamorada, the number can go as low as ten per day. In the event of favorable conditions, the number of patients can soar as high as 25 per day. However, it is difficult to determine the probability associated with each of those cases. Therefore, it is almost impossible to do a scenario analysis for each of those potential outcomes.
The average revenue per procedure is also a determinant of the total revenue. It is estimated that the average value per procedure will be $1000, but if people only come for very simple procedures in outpatient surgery care, then the average can go as low as $800. However, if more complicated cases are handled in the ambulatory care, then the cost may go as high as $1200. Although it is difficult to determine the type of services people will avail in the outpatient surgery care, the average revenue of $1000 can be taken for conducting a financial analysis with a fair amount of certainty.
Finally, the salvage value for buildings and equipments is another thing that creates more uncertainty around the financial analysis. Since there is no similar facility available in and around the area, it is almost impossible for Palms Hospital to estimate the salvage value of the building and equipments after 5 years (5 years is decided by the Financial Analysis team of the Palms Hospital for depreciation purpose of the assets). It is seen that, in many cases, buildings often depreciate fast, whereas, in other cases, the salvage value of buildings can appreciate if the demand situation goes up. Apart from these three possible uncertainties, there are several other factors that will impact the potential rate of returns of the project. These factors include the impact of the outpatient surgery care on the inpatient surgery cases and the chances of the establishment of another outpatient surgery care.
As many of these parameters cannot be determined with a probability associated with the investment, it will not be possible to conduct a complete scenario analysis. Therefore, in most of the cases, financial analysis on the investment is done on the basis of expected value for each of the parameters stated above. With those parameters, three cases will be simulated, including most likely, best and worst. Historically, Palms Hospital accepted investment if the NPV (Net Present Value) value of an investment is positive and the coefficient of variation is 2 or below. The most likely case is simulated at 10% cost of capital, the best case scenarios are simulated at 6% cost of capital, and the worst case scenarios are simulated at 14% cost of capital. These three scenarios were examined using a time value of money (NPV) method and the variations in each of those cases were determined using Monte Carlo simulation.
In case of the most likely scenario (10%), the NPV came to $724,923, and the coefficient of variations came out to be 5.9. Although the NPV is positive in this case, indicating a profitable outcome for the investment, the coefficient of variation is extremely high. The risk associated with this case is more than what Palms Hospital would like. Therefore, this option should only be pursued if Palms Hospital can come up with risk adjustment techniques through further evaluation of the parameters. In the worst case scenario with 14% cost of capital, the NPV comes out to be - $297,119, and the coefficient of variation is -12.4 (negative coefficient of variation does not make any sense statistically). As the NPV is negative in this case, Palms Hospital should not go ahead with the investment with a 14% cost of capital. In the best case scenario, the NPV for the investment came to be $83,461,484, and the coefficient of variation is 0.6. Of all the options, this seems to be the best option as the NPV is positive and the coefficient of variation is considerably low. However, to achieve this, Palms Hospital needs to secure a CCC (cost of capital) of 6% from the market for the project. If it is able to secure this CCC, then only it should go ahead with the investment for outpatient surgery centers.
Conclusion
Like many investments, investment in ambulatory surgery care for Palms Hospital is fraught with many uncertainties, such as patient per day, revenue per surgery procedure, and salvage value of building equipment. All these are very crucial for determining the viability of the project investment. In the absence of proper probabilities associated with each of the parameters, expected values are taken for scenario analysis. The financial analysis result shows that in the case of a 6% CCC, the investment will make a huge profit with low coefficient of variation, but most likely case seems to have a lot of coefficient of variations (uncertainties). Therefore, it is recommended that before investing in outpatient surgery care facilities, Palms Hospital does a further risk assessment of all the parameters and tries to determine them with more certainty so that a more deterministic financial investment analysis can be done before Palms Hospital goes ahead with the actual investment.
