Palms Hospital Analysis
| Palms Hospital |
Memo
To:
From:
CC:
Date: [ 7/30/2010 ]
Re: Ambulatory Surgical Center
Executive Summary
The Palms Hospital is considering an expansion project that would utilize land previously purchased. By expanding into ambulatory surgical services, the hospital has the opportunity to increase revenues and capture market share in this area. Investigation in the NPV of the project and a scenario analysis reveal that the project would be profitable.
Debt Financing
This project will most likely involve debt financing. This means that interest expense would occur and should be taken into account in the analysis of the project. Interest expense is a cash expense and is automatically included when the net cash flows are adjusted for the time value of money. If you added interest expense into the cash flows outlays, it would get counted twice. Interest expense affects the amount of income taxes; it must be used in calculating income tax expense before subtracting it from cash flow outlay. Thus, interest expense would be accounted for by the cost of capital since the interest expense would be a cost associated with borrowing money for the project. The 10% cost of capital includes the cost of debt financing.
What to do with the Land
The $150,000 that the hospital paid for the land five years ago should be considered a sunk cost because it is a cash outlay that already occurred. Since it has been irrevocably committed, it is an outlay that is unaffected by the current decision to accept or reject the proposed ambulatory surgery center. It is a non-incremental cash flow that is not relevant to the analysis.
However, now that the land is valued by the market at $200,000, it is an opportunity cost of accepting this project. If the hospital uses the land for the project, it cannot sell the land and therefore $200,000 is foregone. Additionally, if the hospital uses the land for the surgical center, it cannot be used for another project. The
Memo
To:
From:
CC:
Date: [ 7/30/2010 ]
Re: Ambulatory Surgical Center
Executive Summary
The Palms Hospital is considering an expansion project that would utilize land previously purchased. By expanding into ambulatory surgical services, the hospital has the opportunity to increase revenues and capture market share in this area. Investigation in the NPV of the project and a scenario analysis reveal that the project would be profitable.
Debt Financing
This project will most likely involve debt financing. This means that interest expense would occur and should be taken into account in the analysis of the project. Interest expense is a cash expense and is automatically included when the net cash flows are adjusted for the time value of money. If you added interest expense into the cash flows outlays, it would get counted twice. Interest expense affects the amount of income taxes; it must be used in calculating income tax expense before subtracting it from cash flow outlay. Thus, interest expense would be accounted for by the cost of capital since the interest expense would be a cost associated with borrowing money for the project. The 10% cost of capital includes the cost of debt financing.
What to do with the Land
The $150,000 that the hospital paid for the land five years ago should be considered a sunk cost because it is a cash outlay that already occurred. Since it has been irrevocably committed, it is an outlay that is unaffected by the current decision to accept or reject the proposed ambulatory surgery center. It is a non-incremental cash flow that is not relevant to the analysis.
However, now that the land is valued by the market at $200,000, it is an opportunity cost of accepting this project. If the hospital uses the land for the project, it cannot sell the land and therefore $200,000 is foregone. Additionally, if the hospital uses the land for the surgical center, it cannot be used for another project. The