Consider The Project In Problem 147, Chapter 14a

Consider The Project Contained In Problem 147 In Chapter 14a Perfor

Consider the project contained in Problem 14.7 in Chapter 14. a. Perform a sensitivity analysis to see how NPV is affected by changes in the number of procedures per day, average collection amount, and salvage value. b. Conduct a scenario analysis. Suppose that the hospital’s staff concluded that the three most uncertain variables were number of procedures per day, average collection amount, and the equipment’s salvage value. Furthermore, the following data were developed: Scenario Probability, Number of Procedures, Average Collection, Equipment Salvage Value. Worst, 0.25, 60, 100,000. Most likely, 0.50, 80, 150,000. Best, 0.25, 100, 100,000. c. Finally, assume that California Health Center’s average project has a coefficient of variation of NPV in the range of 1.0-2.0. (Hint: The coefficient of variation is defined as the standard deviation of NPV divided by the expected NPV.) The hospital adjusts for risk by adding or subtracting 3 percentage points to its 10 percent corporate cost of capital. After adjusting a differential risk, is the project still profitable? d. What type of risk was measured and accounted for in parts b and c? Should this be of concern to the hospital’s managers?

Paper For Above instruction

The evaluation of projects within healthcare organizations requires a nuanced understanding of both quantitative financial analysis and qualitative risk assessment. This paper explores the sensitivity and scenario analyses of a hospital project, alongside the implications of risk measurement and management, using the framework outlined in the provided problem. Specifically, it investigates the effects of key variables on net present value (NPV), assesses how uncertainties influence project viability, and discusses the applicability of risk adjustments in the decision-making process.

Sensitivity Analysis of Project Variables

Sensitivity analysis involves systematically varying individual project parameters to determine their impact on the project's NPV. For the hospital project in question, three variables are critical: the number of procedures performed per day, the average collection amount, and the salvage value of equipment. By adjusting each variable independently while holding others constant, we can measure the relative effect on NPV and identify which assumptions most influence project profitability.

For example, increasing the number of procedures per day enhances revenue, thereby likely increasing NPV. Conversely, a decrease in procedures reduces income and potentially turns a profitable project into a loss. Similarly, fluctuations in collection amounts directly affect cash flows—higher collections improve the NPV, while lower amounts diminish it. Salvage value impacts the terminal cash flow at project end; a higher salvage increases NPV, whereas a lower salvage decreases it.

Quantitatively, sensitivity analysis can be performed by calculating NPV at various levels of each variable, plotting these NPV values to visualize the sensitivity. This approach highlights which variables the project is most sensitive to, guiding managers on where to focus risk mitigation efforts.

Scenario Analysis and Uncertainty Consideration

Scenario analysis extends sensitivity analysis by evaluating the combined effect of multiple uncertain variables simultaneously. In this case, three key variables—number of procedures, collection amount, and salvage value—are assigned probabilities based on different scenarios: worst, most likely, and best. The specified probabilities are 0.25 for both worst and best, and 0.50 for the most likely scenario.

Calculating expected NPV involves weighting the NPVs under each scenario by their respective probabilities. This provides a probabilistic expectation of project outcome, integrating uncertainty across variables. The analysis reveals how favorable or adverse combinations of variables impact the project’s viability, informing risk management strategies.

For instance, the worst scenario with low procedures, low collection, and minimal salvage output might produce a negative NPV, flagging the project as high risk. Conversely, the best scenario with high procedures and collections, and a high salvage value, could yield a significantly positive NPV. The expected NPV resulting from these weighted outcomes offers a balanced view of possible project performance amidst uncertainty.

Risk Adjustments and Coefficient of Variation

The coefficient of variation (CV) characterizes the project’s relative risk by comparing the standard deviation of NPV to its expected value. With a CV range of 1.0 to 2.0, the project exhibits significant risk relative to its mean payoff. To account for this, the hospital adjusts the discount rate—originally 10 percent—by adding or subtracting 3 percentage points, depending on perceived risk level.

This adjustment modifies the discount rate to approximately 7-13 percent, reflecting the project’s risk profile. The decision to accept or reject the project hinges on whether the expected NPV, discounted at this adjusted rate, remains positive. If it remains profitable after the risk compensation, the project is considered financially viable despite uncertainties.

Types of Risks and Management Concerns

In parts b and c, the risks addressed primarily relate to market and operational uncertainties—namely, volume variation (number of procedures), revenue fluctuation (collection amounts), and salvage value. These are classified as market or demand risk and operational risk.

The hospital managers should consider whether these risks are acceptable and manageable. For example, strategies like contracting or contractual performance guarantees could mitigate procedure volume risks, while improved collection processes can reduce revenue variability. Regarding salvage value, warranty or maintenance agreements could provide some assurance of equipment residual value.

Additionally, the broader issue of risk management involves evaluating whether the remaining risks—such as technological obsolescence or policy changes—may further impact project viability. Proper risk assessment ensures that decision-makers are aware of potential downside and can develop contingency plans, aligning the project’s risk profile with the hospital’s strategic objectives and risk appetite.

Conclusion

Analyzing the financial sensitivity and scenario outcomes provides valuable insights into the project’s robustness amidst uncertainty. Adjusting for risk via discount rate modifications helps align expected returns with organizational risk tolerance. Moreover, understanding the nature of the risks—market demand, operational, and residual value—guides effective management strategies. Overall, thorough risk assessment supports informed, resilient investment decisions that optimize resource allocation within healthcare settings.

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