Integrating Private Practice and Hospital-Based Breast Services at Baystate Health (Part A) Net Present Value (NPV) / MBA Resources

Introduction to Net Present Value (NPV) - What is Net Present Value (NPV) ? How it impacts financial decisions regarding project management?

NPV solution for Integrating Private Practice and Hospital-Based Breast Services at Baystate Health (Part A) case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Integrating Private Practice and Hospital-Based Breast Services at Baystate Health (Part A) case study is a Harvard Business School (HBR) case study written by Deborah Milstein, Susan Madden, Linda MacCracken. The Integrating Private Practice and Hospital-Based Breast Services at Baystate Health (Part A) (referred as “Baystate Breast” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, Organizational culture, Project management, Strategic planning.

The net present value (NPV) of an investment proposal is the present value of the proposal’s net cash flows less the proposal’s initial cash outflow. If a project’s NPV is greater than or equal to zero, the project should be accepted.

NPV = Present Value of Future Cash Flows LESS Project’s Initial Investment

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Case Description of Integrating Private Practice and Hospital-Based Breast Services at Baystate Health (Part A) Case Study

Dr. Laurie Gianturco ("Dr. G."), Chief of Radiology at Baystate Health and President of the private imaging practice Radiology & Imaging, Inc. ("R&I"), and her partner for this project, Suzanne Hendery, VP of Marketing & Communications at Baystate Health, considered their new assignment. With Baystate leadership's full executive sponsorship and support, but no additional budget, they were tasked with consolidating two competing practices-one operated by R&I, the other by Baystate Medical Center-to form a new breast services center under the Baystate umbrella. The consolidation would simplify redundant Baystate-affiliated breast services offerings, making the system less confusing for patients and providers while giving Baystate the opportunity to offer more patient-centered services as well as reducing its operating costs and boosting revenues. They knew it would be a complicated project, involving two competing physician practice cultures, three clinical specialty orientations, the potential disruption of existing referral networks, and the merger of imaging services for healthy women along with treatment for women with breast cancer. Despite these challenges, they banded together to define a patient-driven culture, create an integrated program, and build a strong brand anchored by the new facility. Their goal was to gain a competitive advantage by developing a relationship-based approach that would exceed customer (patients and referring physicians) expectations for service. "The financial argument was the easy part," Dr. G reflected. "How to actually design a model of care is where we came to an impasse."

Case Authors : Deborah Milstein, Susan Madden, Linda MacCracken

Topic : Strategy & Execution

Related Areas : Organizational culture, Project management, Strategic planning

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Calculating Net Present Value (NPV) at 6% for Integrating Private Practice and Hospital-Based Breast Services at Baystate Health (Part A) Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10017652)	-10017652	-	-
Year 1	3456169	-6561483	3456169	0.9434	3260537
Year 2	3962492	-2598991	7418661	0.89	3526604
Year 3	3970946	1371955	11389607	0.8396	3334083
Year 4	3247483	4619438	14637090	0.7921	2572311
TOTAL			14637090		12693534

The Net Present Value at 6% discount rate is 2675882

In isolation the NPV number doesn't mean much but put in right context then it is one of the best method to evaluate project returns. In this article we will cover -

Different methods of capital budgeting

What is NPV & Formula of NPV,
How it is calculated,
How to use NPV number for project evaluation, and
Scenario Planning given risks and management priorities.

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Capital Budgeting Approaches

Methods of Capital Budgeting

There are four types of capital budgeting techniques that are widely used in the corporate world –

1. Internal Rate of Return
2. Payback Period
3. Net Present Value
4. Profitability Index

Apart from the Payback period method which is an additive method, rest of the methods are based on Discounted Cash Flow technique. Even though cash flow can be calculated based on the nature of the project, for the simplicity of the article we are assuming that all the expected cash flows are realized at the end of the year.

Discounted Cash Flow approaches provide a more objective basis for evaluating and selecting investment projects. They take into consideration both –

1. Timing of the expected cash flows – stockholders of Baystate Breast have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.
2. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Baystate Breast shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.

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Formula and Steps to Calculate Net Present Value (NPV) of Integrating Private Practice and Hospital-Based Breast Services at Baystate Health (Part A)

NPV = Net Cash In Flowt1 / (1+r)t1 + Net Cash In Flowt2 / (1+r)t2 + … Net Cash In Flowtn / (1+r)tn
Less Net Cash Out Flowt0 / (1+r)t0

Where t = time period, in this case year 1, year 2 and so on.
r = discount rate or return that could be earned using other safe proposition such as fixed deposit or treasury bond rate. Net Cash In Flow – What the firm will get each year.
Net Cash Out Flow – What the firm needs to invest initially in the project.

Step 1 – Understand the nature of the project and calculate cash flow for each year.
Step 2 – Discount those cash flow based on the discount rate.
Step 3 – Add all the discounted cash flow.
Step 4 – Selection of the project

Why Strategy & Execution Managers need to know Financial Tools such as Net Present Value (NPV)?

In our daily workplace we often come across people and colleagues who are just focused on their core competency and targets they have to deliver. For example marketing managers at Baystate Breast often design programs whose objective is to drive brand awareness and customer reach. But how that 30 point increase in brand awareness or 10 point increase in customer touch points will result into shareholders’ value is not specified.

To overcome such scenarios managers at Baystate Breast needs to not only know the financial aspect of project management but also needs to have tools to integrate them into part of the project development and monitoring plan.

Calculating Net Present Value (NPV) at 15%

After working through various assumptions we reached a conclusion that risk is far higher than 6%. In a reasonably stable industry with weak competition - 15% discount rate can be a good benchmark.

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 15 %	Discounted Cash Flows
Year 0	(10017652)	-10017652	-	-
Year 1	3456169	-6561483	3456169	0.8696	3005364
Year 2	3962492	-2598991	7418661	0.7561	2996213
Year 3	3970946	1371955	11389607	0.6575	2610961
Year 4	3247483	4619438	14637090	0.5718	1856759
TOTAL					10469298

The Net NPV after 4 years is 451646

(10469298 - 10017652 )

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Calculating Net Present Value (NPV) at 20%

If the risk component is high in the industry then we should go for a higher hurdle rate / discount rate of 20%.

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 20 %	Discounted Cash Flows
Year 0	(10017652)	-10017652	-	-
Year 1	3456169	-6561483	3456169	0.8333	2880141
Year 2	3962492	-2598991	7418661	0.6944	2751731
Year 3	3970946	1371955	11389607	0.5787	2298001
Year 4	3247483	4619438	14637090	0.4823	1566109
TOTAL					9495981

The Net NPV after 4 years is -521671

At 20% discount rate the NPV is negative (9495981 - 10017652 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Baystate Breast to discount cash flow at lower discount rates such as 15%.

Acceptance Criteria of a Project based on NPV

Simplest Approach – If the investment project of Baystate Breast has a NPV value higher than Zero then finance managers at Baystate Breast can ACCEPT the project, otherwise they can reject the project. This means that project will deliver higher returns over the period of time than any alternate investment strategy.

In theory if the required rate of return or discount rate is chosen correctly by finance managers at Baystate Breast, then the stock price of the Baystate Breast should change by same amount of the NPV. In real world we know that share price also reflects various other factors that can be related to both macro and micro environment.

In the same vein – accepting the project with zero NPV should result in stagnant share price. Finance managers use discount rates as a measure of risk components in the project execution process.

Sensitivity Analysis

Project selection is often a far more complex decision than just choosing it based on the NPV number. Finance managers at Baystate Breast should conduct a sensitivity analysis to better understand not only the inherent risk of the projects but also how those risks can be either factored in or mitigated during the project execution. Sensitivity analysis helps in –

What can impact the cash flow of the project.

What will be a multi year spillover effect of various taxation regulations.

What are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

Understanding of risks involved in the project.

What are the uncertainties surrounding the project Initial Cash Outlay (ICO’s). ICO’s often have several different components such as land, machinery, building, and other equipment.

Some of the assumptions while using the Discounted Cash Flow Methods –

Projects are assumed to be Mutually Exclusive – This is seldom the came in modern day giant organizations where projects are often inter-related and rejecting a project solely based on NPV can result in sunk cost from a related project.

Independent projects have independent cash flows – As explained in the marketing project – though the project may look independent but in reality it is not as the brand awareness project can be closely associated with the spending on sales promotions and product specific advertising.

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Negotiation Strategy of Integrating Private Practice and Hospital-Based Breast Services at Baystate Health (Part A)

References & Further Readings

Deborah Milstein, Susan Madden, Linda MacCracken (2018), "Integrating Private Practice and Hospital-Based Breast Services at Baystate Health (Part A) Harvard Business Review Case Study. Published by HBR Publications.