Scenario 1: ABC Hospital
ABC Hospital is a rural facility in Medford, Oregon that competes with
two other hospitals in delivering quality patient care in the Rogue Valley. One
of the competing hospitals provides cancer treatment services similar to ABC
Hospital and has been gaining a larger market share in the last 12 months
because of its television and billboard ads.
Recently, the local news station covered a story about a report
published by an independent research company stating that in the last five
years, the Rogue Valley has experienced a steady increase of residents with pancreatic
and testicular cancer. In response to this report and because of the shrinking
market share, the chief executive officer (CEO) of the hospital has tasked the chief
strategy officer (CSO) and the chief financial officer (CFO) with exploring
whether it should make additional investments in cancer treatment services that
will allow the organization to increase its capacity to serve more patients and
gain a larger sector of the market.
Based on their analysis, the CSO and CFO have presented you with the
following two options to review prior to the meeting with the CEO:
Option 1: ABC Hospital invests $11,995,000 in the development of a new state-of-the-art
cancer treatment center. Based on their estimates, the first year cash flow
will be $2,000,000, the second year cash flow will be $4,000,000, the third
year cash flow will be $5,000,000, and the fourth year cash flow will be
$8,000,000. The expected return of 8.9% is used as the discount rate.
Option 2: ABC Hospital invests $5,095,000 in a joint venture with a reputable
oncology group and the hospital agrees to a 55% interest in the joint venture. Based
on the estimates, the first year cash flow will be $1,500,000, the second year
cash flow will be $3,000,000, the third year cash flow will be $4,500,000, and
the fourth year cash flow will be $6,500,000. The expected return of 8.9% is
used as the discount rate.
Explain which of the two options you would recommend to the CEO. You may
only select one option. Support your position and show your calculations. It is
essential that you use at least two different financial ratio calculations.
Scenario 3: Montgomery Home and Community-Based Services
Montgomery Home and Community-Based Services is considering a major
expansion that will enable it to attract a different clientele to its
organization. Currently, they serve only 34% of the frail elderly seniors and
persons with disabilities in a three county area, with the majority of the
residents working for the federal and state government. Montgomery relies 100%
on local government funding to provide in home support and homemaker service to
their clients. Their new chief executive officer (CEO) would like the
organization to expand its revenue stream by investing in a senior multipurpose
center serving healthy seniors by offering them arts and crafts and health and
wellness programs. The center will also contain an Internet cafÃ© offering
nutritious breakfast and lunch options.
The CEO has commissioned a needs assessment, and the studyâ€™s results
reveal that there are only 15 retired seniors who would be willing to pay the
monthly fees to access the center. Further results reveal that there are approximately
120 seniors who will be retiring from the government in three years who would
be willing to become members at the center.
The proposed costs to operate this new facility are as follows:
Monthly Fixed Costs
Equipment Maintenance Contract: $200
Membership Fee: $105
Lunch Cost: $25
Breakfast Cost: $15
Based on the information above, the initial investment to establish the
center is $317,880. The organization anticipates that it will generate $25,700
of revenues in the first year, $40,000 in the second year, $78,000 in the third
year, $225,000 in the fourth year, and $310,000 in the fifth year.
The CEO has presented her proposal and financial information to the board
of directors, and they have advised her that they are in full support of her
strategy if the program is a benefit to the community and if the organization
can recoup its investment in three years. Based on the information presented in
the scenario, calculate the two analyses below and explain their implications.
1. Perform the break-even analysis to determine
how many seniors would need to have full monthly membership and pay for
breakfast and lunch for Montgomery Home and Community-Based Services to cover
its monthly expenses.
Break-even volume = Total fixed costs / (Average charge per client â€“ Average
variable cost per client)
2. Calculate the payback period to determine
how long it will take for the organization to recover its initial investment of
establishing the senior multipurpose center.
Payback period = A + (B/C)