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Measuring Physician Contribution to the Healthcare Safety Net 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 Measuring Physician Contribution to the Healthcare Safety Net case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Measuring Physician Contribution to the Healthcare Safety Net case study is a Harvard Business School (HBR) case study written by Lawrence M. Metzger, Steven Andes, David N. Gans, James W. Margolis. The Measuring Physician Contribution to the Healthcare Safety Net (referred as “Charity Uncompensated” from here on) case study provides evaluation & decision scenario in field of Technology & Operations. It also touches upon business topics such as - Value proposition, .

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






Case Description of Measuring Physician Contribution to the Healthcare Safety Net Case Study


There are an estimated 46 million Americans without health insurance and an even larger number for whom health insurance does not cover all needed medical services. These individuals and families have to rely more and more on government programs and physicians' willingness to provide uncompensated services, most often described by providers as charity care. Previous studies have shown a downward trend in the percent of physicians willing or able to provide charity care. We extend this research by examining the results of the Medical Group Management Association's Cost Survey of Medical Group Practices for 2005, 2006, and 2007. It is important to examine the uncompensated care reported by medical groups because groups have policies that may govern how much, if any, charity care their physicians provide. This survey data shows that, overall, the number of medical practices providing charity care continues to decline. The results and analysis of the survey data indicate that uncompensated (charity) care is being offered by less than half of medical practices, and at less than 2% of total gross charges. We examined the results by potential explanatory variables: population density, practice size, physician practice specialty, practice ownership structure, payer mix, and practice financial performance. Results were consistent across all categories; charity care is declining. These results have major policy implications for both the federal government and all state governments, especially in light of the current recession and proposed healthcare reform legislation.


Case Authors : Lawrence M. Metzger, Steven Andes, David N. Gans, James W. Margolis

Topic : Technology & Operations

Related Areas :




Calculating Net Present Value (NPV) at 6% for Measuring Physician Contribution to the Healthcare Safety Net Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10007796) -10007796 - -
Year 1 3464366 -6543430 3464366 0.9434 3268270
Year 2 3959101 -2584329 7423467 0.89 3523586
Year 3 3937013 1352684 11360480 0.8396 3305592
Year 4 3247851 4600535 14608331 0.7921 2572602
TOTAL 14608331 12670050




The Net Present Value at 6% discount rate is 2662254

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.




Capital Budgeting Approaches

Methods of Capital Budgeting


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

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

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






Formula and Steps to Calculate Net Present Value (NPV) of Measuring Physician Contribution to the Healthcare Safety Net

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 Technology & Operations 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 Charity Uncompensated 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 Charity Uncompensated 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 (10007796) -10007796 - -
Year 1 3464366 -6543430 3464366 0.8696 3012492
Year 2 3959101 -2584329 7423467 0.7561 2993649
Year 3 3937013 1352684 11360480 0.6575 2588650
Year 4 3247851 4600535 14608331 0.5718 1856969
TOTAL 10451761


The Net NPV after 4 years is 443965

(10451761 - 10007796 )








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 (10007796) -10007796 - -
Year 1 3464366 -6543430 3464366 0.8333 2886972
Year 2 3959101 -2584329 7423467 0.6944 2749376
Year 3 3937013 1352684 11360480 0.5787 2278364
Year 4 3247851 4600535 14608331 0.4823 1566286
TOTAL 9480998


The Net NPV after 4 years is -526798

At 20% discount rate the NPV is negative (9480998 - 10007796 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Charity Uncompensated 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 Charity Uncompensated has a NPV value higher than Zero then finance managers at Charity Uncompensated 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 Charity Uncompensated, then the stock price of the Charity Uncompensated 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 Charity Uncompensated 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 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.

What can impact the cash flow of the project.

Understanding of risks involved in the project.

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

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

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.






Negotiation Strategy of Measuring Physician Contribution to the Healthcare Safety Net

References & Further Readings

Lawrence M. Metzger, Steven Andes, David N. Gans, James W. Margolis (2018), "Measuring Physician Contribution to the Healthcare Safety Net Harvard Business Review Case Study. Published by HBR Publications.


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