ASSIGNMENT ON Healthcare Finances ** CHART
Healthcare Finances
(ASSIGNMENT ON Healthcare Finances ** CHART)
Student
Institution
Course
Instructor
Healthcare Finances
Capital investment decisions are the most fundamental decisions in a company, involving a current outlay in return for future benefits. All companies make investments to realize benefits or profits in the future. These investments take a substantial percentage of the company’s resources, and actions are irreversible, necessitating a comprehensive decision-making process to increase the chances of success. Capital investments are planned through capital budgeting, which involves evaluating potential big projects or investments, like installing a new system or building a new plant (Gapenski & Reiter, 2016). Capital budgeting entails evaluating the project’s cash inflows and outflows to compute potential returns to be generated to meet a particular benchmark (Gapenski & Reiter, 2016). There are various methods used to appraise capital investments, including the net present value (NPV), Internal Rate of Return (IRR), Modified Internal Rate of Return (MIRR), and the Payback method. (ASSIGNMENT ON Healthcare Finances ** CHART)
The net present value represents the difference between the current cash inflows value and the present cash outflows value over a period (Wang, 2021). The internal rate of return helps estimate the profitability of potential capital investments (Wang, 2021). An assumption of the modified internal rate of return is that the positive cash flows are reinvested into the company’s cost of capital, and the initial cash outlay is financed at the company’s financing cost (Qi et al., 2022). The payback method assesses the period it will take for an investment to pay back or recover the capital investment. (ASSIGNMENT ON Healthcare Finances ** CHART)
To compute the NPV, a company estimates a project’s future cash flows and uses a discount rate representing the project’s cost of capital and at risk to discount them into the present value amounts. Next, all the future positive cash flows of investment are reduced into the present value amount, and the NPV is obtained by subtracting the number from the initial project’s cash outlay (Wang, 2021). The IRR helps compute the rate of return an investment will potentially generate. The IRR is computed by first recalculating the NPV equation, with the NPV factor at zero, and solving for the unknown discount rate, which becomes the IRR (Wang, 2021). Calculating the MIRR also uses the NPV formula, but it assumes the positive cash flows are reinvested at the company’s cost of capital and the initial outlays are invested at the company’s financing cost (Qi et al., 2022). According to Konstantin et al. (2018), the payback period is obtained by dividing the investment amount by the annual cash flows. (ASSIGNMENT ON Healthcare Finances ** CHART)
The NPV is often preferred over the IRR, especially when cash flow shifts from positive to negative or from negative to positive over time and when multiple discount rates are used. The IRR is more suitable when a company is comparing across many investments or projects or in circumstances where it is challenging to compute an appropriate discount rate (Yan & Zhang, 2022). However, the IRR does not consider changing factors, including different discount rates. Because the MIRR assumes positive cash flows are financed at the capital cost and the initial outlay at the company’s financing cost, it tends to be more accurate in reflecting a project’s cost and profitability than the IRR (Qi et al., 2022). The MIRR can be used to rank investments of unproportioned sizes, addressing two major flaws associated with the IRR method. The MIRR offers a single solution for a particular project and a more valid and practical reinvestment rate of positive cash flows. Managers can also use the MIRR to change the reinvestment growth rate at different project stages (Qi et al., 2022). The MIRR has its limitations, including requiring the computation of a cost of capital estimate to make a decision, which can be subjective and vary per the assumptions made. MIRR information can sometimes lead to suboptimal decisions that do not increase value when considering several investment options at a go. Individuals lacking a financial background find MIRR computation difficult to understand because its theoretical basis is disputed across academics (Qi et al., 2022). The payback method helps managers determine the time length the initial investment will take to recover. It is suitable for managers more concerned regarding cash flows. Some limitations of the payback method include not considering the time value of money and only considering the cash inflows until the project’s cash outflows are recovered (Konstantin et al., 2018). The payback method does not take into account the cash inflows after investment recovery in the analysis. (ASSIGNMENT ON Healthcare Finances ** CHART)
All methods can help determine the desirability of an investment and have varying uses with capital budgeting. The NPV is the most preferable over the other capital budgeting methods because it offers more insights into capital investment and is more refined from mathematical and time-value-of-money perspectives (Wang, 2021). It is also the basis for calculating the IRR and the MIRR. The NPV is more dynamic because it can handle different discount rates or varying cash flow directions. The NPV has higher flexibility when appraising investments for individual periods. This method is more theoretically insightful in determining whether a capital investment like an acquisition will be valuable to a firm (Yan & Zhang, 2022). The interpretation is simple because a positive NPV shows inflows are greater than outflows, and the project would add value to the company, assuming no capacity constraints, and a project or investment should not be accepted when the NPV is negative.
Clinic Scenario
For this clinic scenario, the clinic is divided into three departments: the finance department, the human resource department, and the medical records department. Each department has projects categorized as high-risk, average-risk, or low-risk projects. The heads of the department are responsible for assigning the risk factor or rate for respective projects based on their risk categorization. The clinic has a cost of capital of 8%. Adopting similar adjustment amounts as in exhibit 15.8, high risk will be adjusted by 4 percentage and low risk by 2 percentage. Therefore, the clinic’s cost of capital is adjusted upward to 12 percent in the high-risk department and downward to 6% in the low-risk department. These adjustment amounts are also used in specific departments for individual projects. After adjustments, the system has results running from 16% for the high-risk project in the finance department, which is the installation of a new finance system, to 4 percent for the low-risk projects in the medical records department, which is connecting medical records to patient portals. (ASSIGNMENT ON Healthcare Finances ** CHART)
References
Gapenski, L. C., & Reiter, K. L. (2016). Healthcare finance: An introduction to accounting & financial management.
Konstantin, P., Konstantin, M., Konstantin, P., & Konstantin, M. (2018). Investment appraisal methods. Power and Energy Systems Engineering Economics: Best Practice Manual, 39-64. https://content.e-bookshelf.de/media/reading/L-10685619-9ba9df8716.pdf
Qi, J., Wang, Y., & Xu, Y. (2022, December). Research on Project Investment: Methods of NPV, IRR and MIRR. In 2022 International Conference on mathematical statistics and economic analysis (MSEA 2022) (pp. 710-715). Atlantis Press. https://www.atlantis-press.com/proceedings/msea-22/125982665
Wang, Y. (2021, December). The development and usage of NPV and IRR and their comparison. In 2021 3rd International Conference on Economic Management and Cultural Industry (ICEMCI 2021) (pp. 2044-2048). Atlantis Press. https://www.atlantis-press.com/proceedings/icemci-21/125966320
Yan, R., & Zhang, Y. (2022, March). The Introduction of NPV and IRR. In 2022 7th International Conference on Financial Innovation and Economic Development (ICFIED 2022) (pp. 1472-1476). Atlantis Press.
