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University of Virginia Health System: The Long-Term Acute Care Hospital Project

1. Background

As a non-profit organization, University of Virginia Health System’s CFO, Larry Fitzgerald wants to convince the board of directors to adopt the project of building a new long-term acute care (LTAC) hospital. LTAC is financially attractive and can increase the capacity of the organization. Moreover, LTAC is beneficial for patients with a longer stay in the hospital. As a non-profit organization, the University of Virginia Health System should strike a balance between various goals, including benefits, social responsibility, sustainability, etc. This report will focus on the analysis of the free cash flow of the projects and try to provide valid evidence that can be used to convince the board of directors.

2. Issues

The key issue is whether to adopt the project or not. In other words, do the new projects meet the strategic goals of the University of Virginia Health System?

3. Discussion

First of all, we need to compute the WACC for the project, which will be used to discount the free cash flow for the project.

Rf = 4.72%, Rm = 5%, (rm – rf) = 0.28%, Beta = 0.65（average for health）

Results: Rs = 4.902%, Rd = 5.38% (Rating: AA).

Then we need to find the proportion of liability and equity funds. Since we can’t find the relevant data from this case, we use the average weight from other six companies. Thus, total debt is known, total equity is market cap. So, the Wd is total debt / (total debt + market cap)

Wd(average) = ( 28.23% + 33.98% + 15.00% + 21.61% + 32.63% + 16.58%)/6=24.67%

We(average) = 1-Wd = 75.33%

Tc = 0 (School is non-tax rate)

WACC = (E/V*rs)+(D/V*rd*(1-tc))

=(75.33%*4.902%)+(24.67%*5.38%*(1-0))

=5.02%

Above all, we find the WACC for the project to be 5.02%. The relationship between hospitals and universities will affect WACC. The tax rate of university hospitals is 0, which will greatly affect the calculated value of WACC. If the tax rate is adjusted to 30%, WACC will be reduced from 5.02% to 4.69%.

Before the calculation of FCF for each year, related costs and benefits need to be identified, which is shown in the following table.

According to the information provided in the memo from Karen Mulroney, the estimation of revenue increases from the addition of the new hospital are shown in the following table. The increased revenue equals patient day capacity*utilization*commercial payers per day (see excel for details).

The FCFs for the LTAC project are shown in the following table (see excel for details).

Above all, the payback period for the project is nearly 1 year. The IRR for the project is 69.34% and the NPV is $139,504,538.81. Therefore, the project is financially feasible with a positive net present value and short payback period.

If the number of beds increases to 40, the payback period for the project is 2.26 years, the IRR is 56.84%, and the NPV is $150,338,447. Therefore, as the assumption changes, the project is still financially feasible and still worth proposing.

4. Conclusion and Recommendation

Above all, the project of building a new long-term acute care (LTAC) hospital in the Health System should be accepted. On the one hand, it can provide financial benefits to the Health System with a rate of return of over 5%. According to the theory of net present value, all the projects with positive NPV can be accepted. Moreover, by getting the bank loan of 15 million, the bond rating of the Health System will not be influenced negatively, which means the bank loan will not increase the costs for the organization to get additional funds. On the other hand, the implementation of LTAC can improve the performance of the Health System by providing patients with better medical service. The ultimate goal of the Health System, as a not-for-profit organization is to improve the well-being of people. The LTAC project is beneficial to realize the strategic goal.