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Capital Budgeting II Assignment https://www.homeworkmarket.com/files/uvaparaphraseq123-docx
Objectives
- Reinforce and extend understanding of the capital budgeting process using a realistic case
- Apply sensitivity analysis to the capital budgeting base case results as a risk analysis technique
- Step into the shoes of a financial analyst and/or her boss to know their roles and responsibilities
CASE: UVa Long Term Acute Care Hospital Project
Questions
1 See Q1 tab. Scroll down until you see the questions. Capital Budgeting Template
2 See Q2 tab. Scroll down until you see the questions. K-wacc
3 See Q3 tab. Scroll down until you see the questions. Sensitivity Analysis
Q1 HAS THE INPUT DATA FILLED IN FOR YOU TO INTERPRET.

IS-BS Model

INCOME STATEMENT BALANCE SHEET WORKING CAPITAL
Revenue ASSETS LIABILITIES AND EQUITY spontaneous change with revenue
Cost of sales Current assets Current liabilities ?what levels of ca, cl, s-t loans?
Gross profit Cash Trade payables CAPITAL BUDGETING
Other operating income Investments Other accruals ?what projects to accept?
Other operating expenses Trade receivables Tax liabilities FINANCING
Total cost and expenses Inventories Short-term loans, leases ?what is the debt capacity?
Operating profit (EBIT) Non-current assets Non-current liabilities
Interest, finance costs Property, plant & equipment Loans, debt, leases due after 1 year
Profit before tax Investment property Retirement benefit obligation COST OF DEBT
Income tax Goodwill Deferred tax liabilities
Net profit after tax Total non-current liabilities
Dividends K-WACC
Reinvested in the business Stockholder's equity (Net worth)
Preferred stock
OPERATING LEVERAGE Common stock COST OF EQUITY
Additional paid-in-capital
FINANCIAL LEVERAGE Retained earnings VALUATION
CASH FLOW
Total assets Total liabilities & equity COST OF CAPITAL

Flow Diagram

ANALYSIS STEPS: FINANCING DEBT EQUITY
1-HISTORICAL RATIOS DEBT
2-K-WACC HISTORICAL RATIOS I/S & B/S FORECAST EFN
3-CAPITAL BUDGETING
4-FORECAST & EFN LONG-FORM FORECAST I/S, B/S, & RATIOS EQUITY
5-EQUITY VALUATION EBIT CHART
6-FINANCING
income risk control mktblty flexblty timing
CAPITAL BUDGETING OP & CAP NATCF, NPV, IRR, PAYBACK
K-WACC
VALUATION ENTERPRISE VALUE USING FREE CASH FLOW
MARKET MULTIPLES: P/E, MV/BV, REV, EBIT

Q1

UNIVERSITY OF VIRGINIA MEDICAL CENTER QUESTIONS START AT ROW 88
Long Term Acute Care Hospital Free Cash Flow Projections
Revenue and Cost Assumptions Results-No NWC Recovery Results-NWC Recovery
Number of Beds 50 NPV $5,687 NPV $10,425 (000 ommited)
Year 1 Utilization 26% IRR 17.6% IRR 21.2%
Year 2 Utilization 60%
Annual Increase in Utilization 4%
Operating Expense (% of Revenue) 7.0%
K-wacc 10%
Year 1 2 3 4 5 6 7 8 9 10
VOLUME
Patient Day Capacity 18,250 18,250 18,250 18,250 18,250 18,250 18,250 18,250 18,250 18,250
Utilization 26% 60% 62% 65% 67% 70% 73% 76% 79% 82%
Patient Days Used 4,745 10,950 11,388 11,844 12,317 12,810 13,322 13,855 14,409 14,986
Average Patient Census per Day 13 30 31 32 34 35 36 38 39 41
Average Length of Stay 30 27 27 27 27 27 27 27 27 27
Number of Patients per Year 158 406 422 439 456 474 493 513 534 555
Full-Time Employees/Census 4.8 3.5 3.5 3.5 3.5 3.5 3.5 3.5 3.5 3.5
Full-Time Employees 62 105 109 114 118 123 128 133 138 144
INSURANCE PAYER Patient Mix
Medicare 36% 57 146 152 158 164 171 178 185 192 200
Medicaid 29% 46 118 122 127 132 138 143 149 155 161
Commercial Payers 24% 38 97 101 105 109 114 118 123 128 133
Other 9% 14 37 38 39 41 43 44 46 48 50
Indigent 2% 3 8 8 9 9 9 10 10 11 11
158 406 422 439 456 474 493 513 534 555
Billing Annual Incr
Medicare—bill per patient $27,795 0.0% 1,583 4,058 4,220 4,389 4,565 4,747 4,937 5,135 5,340 5,554
Medicaid—bill per patient $35,000 1.3% 1,605 4,170 4,337 4,510 4,691 4,878 5,073 5,276 5,487 5,707
Commercial Payers—bill per day $2,800 5.0% 3,189 7,726 8,035 8,357 8,691 9,039 9,400 9,776 10,167 10,574
Other—bill per patient $38,500 1.3% 548 1,424 1,480 1,540 1,601 1,665 1,732 1,801 1,873 1,948
Indigent—bill per patient $35,000 1.3% 111 288 299 311 323 336 350 364 378 394
Total Revenue (000 omitted) 7,035 17,665 18,372 19,107 19,871 20,666 21,493 22,352 23,246 24,176
Less Uncollectable 1% 70 177 184 191 199 207 215 224 232 242
Total Net Revenue (000 omitted) 6,965 17,489 18,188 18,916 19,672 20,459 21,278 22,129 23,014 23,935
EXPENSES Annual Incr
Salary, Wage, Benefits (based on $ per employee) $60,250 3% 3,760 6,516 6,980 7,477 8,009 8,580 9,190 9,845 10,546 11,297
Supplies, Drugs, Food (% net revenue) 16.3% 1,135 2,851 2,965 3,083 3,207 3,335 3,468 3,607 3,751 3,901
Management Fees (% net rev) 8% 557 1,399 1,455 1,513 1,574 1,637 1,702 1,770 1,841 1,915
Operating Expenses (fixed + 7 % net rev) $1,200,000 NA 1,688 2,424 2,473 2,524 2,577 2,632 2,689 2,749 2,811 2,875
Land Lease per year $200,000 3% 200 206 212 219 225 232 239 246 253 261
Depreciation (straight line 30yrs) $15,000,000 500 500 500 500 500 500 500 500 500 500
Total Expenses (000 omitted) 7,840 13,896 14,585 15,316 16,092 16,915 17,789 18,717 19,702 20,749
Total Expenses 7,840 13,896 14,585 15,316 16,092 16,915 17,789 18,717 19,702 20,749
Operating Profit (804) 3,769 3,787 3,791 3,779 3,751 3,703 3,635 3,544 3,427
Operating Margin -11.4% 21.3% 20.6% 19.8% 19.0% 18.1% 17.2% 16.3% 15.2% 14.2%
Net Working Capital Notes:
Accounts Receivable 30 days 572 1,437 1,495 1,555 1,617 1,682 1,749 1,819 1,892 1,967
Inventory Supplies, Drugs, Food 60 days 187 469 487 507 527 548 570 593 617 641
Accounts Payable 30 days 93 234 244 253 264 274 285 296 308 321
Net Working Capital 666 1,672 1,739 1,808 1,880 1,956 2,034 2,115 2,200 2,288
Change in NWC 666 1,006 67 70 72 75 78 81 85 88
Free Cash Flows Calculation
Operating Profit (804) 3,769 3,787 3,791 3,779 3,751 3,703 3,635 3,544 3,427
Add Depreciation 500 500 500 500 500 500 500 500 500 500
Less Capital Expenditures (7,500) (7,500) 0 0 0 0 0 0 0 0 0
Less Increase in Net Working Capital (666) (1,006) (67) (70) (72) (75) (78) (81) (85) (88)
Free Cash Flows (000 omitted) (7,500) (8,470) 3,263 4,220 4,221 4,207 4,176 4,125 4,054 3,959 3,839
NPV (no recovery in year 10) $5,687 (000 ommited)
IRR (no recovery in year 10) 17.6%
Year 1 2 3 4 5 6 7 8 9 10
NWC Recovery 0 0 0 0 0 0 0 0 0 $2,288
Sale of Facility at Book Value 0 0 0 0 0 0 0 0 0 $10,000
NPV with Year 10 Recovery $10,425 (000 ommited) (7,500) (8,470) 3,263 4,220 4,221 4,207 4,176 4,125 4,054 3,959 16,127
IRR with Year 10 Recovery 21.2%
Net Profit (Operating Profit - Interest) (000 ommited) (2,004) 2,569 2,587 2,591 2,579 2,551 2,503 2,435 2,344 2,227
Net Profit/Net Revenue -28.8% 14.7% 14.2% 13.7% 13.1% 12.5% 11.8% 11.0% 10.2% 9.3%
Study the above analysis carefully, examining the inputs, outputs, and formulas used to do the calculations.
Q1a Mulroney did not use working capital cash flows in her original analysis. The analysis above includes incremental investment in working capital. Discuss why she was either correct or incorrect not to include them.
Mulroney did not use working capital cash flows in order to show the unlevered cash flow or cashflow without financing. She omitted
the interest expense without net working capital Mulroney cannot correctly estimate the net working capital. The net working capital rises with
a new project such as acute care hosptal since increased volume of business will lead to increase in revenues. Thus increase in
revenue will increase net working capital. as the NPV is $5,687 since does not include net working capital, it is much less than NPV with net working capital which is
$10,425. Thus the incremental increase in NPV is important in estimating the net present value of the business. Similarly IPV
must also use NWC otherwise the rate of return is underestimated i.e. 17.6% vs 21.2% .
Q1b Compare the decision metrics NPV & IRR for the "no recovery of NWC" and "recovery of NWC" scenarios, stating which scenario best captures reality. Based on your answer, give the project a green or red light.
Q1c Examine the decision metric 'profit margin', and explain if it leads to a green or red light for this project. Even though the board of directors uses this metric, it is defective. Explain why. HINT: FCF definition.
Q1d Reconcile your answers to Q1b and Q1c.

Q2

COMPUTE WEIGHTED AVERAGE COST OF CAPITAL QUESTIONS START AT ROW 32
BASIC: Formula Equation Case Exhibit 4
COST OF DEBT: U.S. Treasury Yields
Coupon Rate 0.00% given 1-year 4.77%
Marginal Tax Rate 0.0% given 5-year 4.72%
Cost of Debt 0.00% b5*(1-b6) k-d = I x (1- t) 10-year 4.72%
weight of debt 0% d ÷ d+e 30-year 4.73%
Data source: http://federalreserve.gov/releases/h15/data.htm (accessed March 2006).
COST OF EQUITY:
Risk-Free Rate 0.00% given Corporate Bond Yields
Risk Premium 0.00% given R-m - R-f AAA 5.31%
Beta 0.00 given AA 5.38%
Cost of Equity 0.00% b11+(b13*b12) k-e = R-f + [ß x (R-m - R-f)]
weight of equity 100% 1-b8 e ÷ d+e A+ 5.41%
A 5.45%
Weighted-Average Cost of Capital 0.00% (b8*b7)+(b15*b14) (k-d x wt-d)+(k-e x wt-e) A- 5.53%
BBB+ 5.62%
BBB 5.88%
For-Profit Comparables BBB- 6.07%
HCA Inc Community Health Health Management Associates
Revenues (millions) $24,475 $3,720 $3,580 BB+ 6.40%
Assets (millions) $5,222 $961 $997 BB 6.79%
Total debt (millions) $9,278 $1,810 $1,014 BB- 6.96%
Stock price ($/share) $52.12 $39.73 $23.25
Shares outstanding (millions) 452.7 88.5 247.2 B+ 7.39%
Market cap (millions) $23,593 $3,517 $5,747 B 7.57%
Bond rating A B BB B- 7.84%
Beta 0.60 0.60 0.70 Data source: Bloomberg, “Fair Market Curve Analysis,” 10-Year Corporate Bonds, March 2, 2006.
Q2a Calculate the k-wacc for HCA using the template above. Enter the data that you
have in the case and the table above. If you need additional data, assume it using
your good judgment from what you have learned so far in the course.
In the answer box, cite your result, compare it to the k-wacc used in the Q1 Weighted Average Cost of Capital = Wd * Rd * (1-T) + We * Re 0% $0.07
analysis, and explain what makes it either higher or lower. 35% $0.07
Wd= Weight of Debt Wd= Debt/(Debt+Market Capitalization) $0.28
Rd= Cost of Debt 10-year 0.0472 A 0.054543 0.0025724
We= Weight of Equity We= 1-Wd $0.72
Capital Asset Pricing Model Re= Cost of Equity Re= Rf+Beta*Rm 0.0905 Rm= 6%
T= Tax rate T= 0% , 35% Beta= 0.60
Rf=5.45%
Q2b If LTAC was a project in a for-profit hospital like HCA above, would its NPV be higher or lower ? Explain 'analytically' by examining all relevant inputs to the NPV calculation.
Q2c If LTAC was a project in a for-profit hospital like HCA above, would the IRR be higher or lower? Explain.
HINT: To avoid getting trapped by this question, make sure your answer is 'analytical', i.e., examine all relevant inputs and output to the IRR calculation.
&C&A
&CPage &P

Q3

UNIVERSITY OF VIRGINIA MEDICAL CENTER QUESTIONS START AT ROW 88
Long Term Acute Care Hospital Free Cash Flow Projections
Revenue and Cost Assumptions Results-No NWC Recovery Results-NWC Recovery
Number of Beds 50 NPV $5,687 NPV $10,425 (000 ommited)
Year 1 Utilization 26% IRR 17.6% IRR 21.2%
Year 2 Utilization 60%
Annual Increase in Utilization 4%
Operating Expense (% of Revenue) 7.0%
K-wacc 10.0%
Year 1 2 3 4 5 6 7 8 9 10
VOLUME
Patient Day Capacity 18,250 18,250 18,250 18,250 18,250 18,250 18,250 18,250 18,250 18,250
Utilization 26% 60% 62% 65% 67% 70% 73% 76% 79% 82%
Patient Days Used 4,745 10,950 11,388 11,844 12,317 12,810 13,322 13,855 14,409 14,986
Average Patient Census per Day 13 30 31 32 34 35 36 38 39 41
Average Length of Stay 30 27 27 27 27 27 27 27 27 27
Number of Patients per Year 158 406 422 439 456 474 493 513 534 555
Full-Time Employees/Census 4.8 3.5 3.5 3.5 3.5 3.5 3.5 3.5 3.5 3.5
Full-Time Employees 62 105 109 114 118 123 128 133 138 144
INSURANCE PAYER Patient Mix
Medicare 36% 57 146 152 158 164 171 178 185 192 200
Medicaid 29% 46 118 122 127 132 138 143 149 155 161
Commercial Payers 24% 38 97 101 105 109 114 118 123 128 133
Other 9% 14 37 38 39 41 43 44 46 48 50
Indigent 2% 3 8 8 9 9 9 10 10 11 11
158 406 422 439 456 474 493 513 534 555
Billing Annual Incr
Medicare—bill per patient $27,795 0.0% 1,583 4,058 4,220 4,389 4,565 4,747 4,937 5,135 5,340 5,554
Medicaid—bill per patient $35,000 1.3% 1,605 4,170 4,337 4,510 4,691 4,878 5,073 5,276 5,487 5,707
Commercial Payers—bill per day $2,800 5.0% 3,189 7,726 8,035 8,357 8,691 9,039 9,400 9,776 10,167 10,574
Other—bill per patient $38,500 1.3% 548 1,424 1,480 1,540 1,601 1,665 1,732 1,801 1,873 1,948
Indigent—bill per patient $35,000 1.3% 111 288 299 311 323 336 350 364 378 394
Total Revenue (000 omitted) 7,035 17,665 18,372 19,107 19,871 20,666 21,493 22,352 23,246 24,176
Less Uncollectable 1% 70 177 184 191 199 207 215 224 232 242
Total Net Revenue (000 omitted) 6,965 17,489 18,188 18,916 19,672 20,459 21,278 22,129 23,014 23,935
EXPENSES Annual Incr
Salary, Wage, Benefits (based on $ per employee) $60,250 3% 3,760 6,516 6,980 7,477 8,009 8,580 9,190 9,845 10,546 11,297
Supplies, Drugs, Food (% net revenue) 16.3% 1,135 2,851 2,965 3,083 3,207 3,335 3,468 3,607 3,751 3,901
Management Fees (% net rev) 8% 557 1,399 1,455 1,513 1,574 1,637 1,702 1,770 1,841 1,915
Operating Expenses (fixed + 7 % net rev) $1,200,000 NA 1,688 2,424 2,473 2,524 2,577 2,632 2,689 2,749 2,811 2,875
Land Lease per year $200,000 3% 200 206 212 219 225 232 239 246 253 261
Depreciation (straight line 30yrs) $15,000,000 500 500 500 500 500 500 500 500 500 500
Total Expenses (000 omitted) 7,840 13,896 14,585 15,316 16,092 16,915 17,789 18,717 19,702 20,749
Total Expenses 7,840 13,896 14,585 15,316 16,092 16,915 17,789 18,717 19,702 20,749
Operating Profit (804) 3,769 3,787 3,791 3,779 3,751 3,703 3,635 3,544 3,427
Operating Margin -11.4% 21.3% 20.6% 19.8% 19.0% 18.1% 17.2% 16.3% 15.2% 14.2%
Net Working Capital Notes:
Accounts Receivable 30 days 572 1,437 1,495 1,555 1,617 1,682 1,749 1,819 1,892 1,967
Inventory Supplies, Drugs, Food 60 days 187 469 487 507 527 548 570 593 617 641
Accounts Payable 30 days 93 234 244 253 264 274 285 296 308 321
Net Working Capital 666 1,672 1,739 1,808 1,880 1,956 2,034 2,115 2,200 2,288
Change in NWC 666 1,006 67 70 72 75 78 81 85 88
Free Cash Flows Calculation
Operating Profit (804) 3,769 3,787 3,791 3,779 3,751 3,703 3,635 3,544 3,427
Add Depreciation 500 500 500 500 500 500 500 500 500 500
Less Capital Expenditures (7,500) (7,500) 0 0 0 0 0 0 0 0 0
Less Increase in Net Working Capital (666) (1,006) (67) (70) (72) (75) (78) (81) (85) (88)
Free Cash Flows (000 omitted) (7,500) (8,470) 3,263 4,220 4,221 4,207 4,176 4,125 4,054 3,959 3,839
NPV (no recovery in year 10) $5,687 (000 ommited)
IRR (no recovery in year 10) 17.6%
Year 1 2 3 4 5 6 7 8 9 10
NWC Recovery 0 0 0 0 0 0 0 0 0 $2,288
Sale of Facility at Book Value 0 0 0 0 0 0 0 0 0 $10,000
NPV with Year 10 Recovery $10,425 (000 ommited) (7,500) (8,470) 3,263 4,220 4,221 4,207 4,176 4,125 4,054 3,959 16,127
IRR with Year 10 Recovery 21.2%
Net Profit (Operating Profit - Interest) (000 ommited) (2,004) 2,569 2,587 2,591 2,579 2,551 2,503 2,435 2,344 2,227
Net Profit/Net Revenue -28.8% 14.7% 14.2% 13.7% 13.1% 12.5% 11.8% 11.0% 10.2% 9.3%
Q3a The data above is identical to the data in the Q1 tab.
Do a sensitivity analysis (risk analysis) by systematically changing certain assumptions in the spreadsheet above:
1 change the K-wacc to 8.3%
2 change year 2 utilization to 45%
3 change commercial payers to 30% of patient mix
Use the answer box to prepare a summary of the base case (Q1) results
and the revised (Q3a) results, i.e., a summary table.
Q3b Revise the decision you made in Q1 based on the sensitivity analysis in Q3a.