Nanjing Gulou Hospital: Honoring the Heritage and Building the Future 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 Nanjing Gulou Hospital: Honoring the Heritage and Building the Future case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Nanjing Gulou Hospital: Honoring the Heritage and Building the Future case study is a Harvard Business School (HBR) case study written by Ning Jia, Weiqi Liu, Shanshan Cao. The Nanjing Gulou Hospital: Honoring the Heritage and Building the Future (referred as “Gulou Hospital” from here on) case study provides evaluation & decision scenario in field of Technology & Operations. It also touches upon business topics such as - Value proposition, IT.

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 Nanjing Gulou Hospital: Honoring the Heritage and Building the Future Case Study

Founded in 1892, Nanjing Gulou Hospital, is one of the earliest western medical hospitals in China. It was founded by Dr. William Edward Macklin, M.D., Disciples (Canada) Mission to China, with the assistance of Prof. Frank Eugene Meigs, the Curch of Christ (USA), and the local Nanjing community. At its early stage of establishment, the hospital took "Love, Kindness and Public Service" as its philosophy and "No prejudice to patients as the first priority", proposed by Macklin, as an aspiration. However, due to the uneven distribution of medical resources, neglect of humanities in China's medical education, among other reasons, Chinese public hospitals showed a lack of human concern over a long period of time. In 2004, the president of Gulou Hospital, Ding Yitao, took humanism as a breakthrough point, and first proposed the missing of honoring the hospital's heritage of humanism and building the best humanistic hospital. At a high level, the strategic transformation is implemented along three dimensions: building a memorial hall to honor the heritage of humanistic spirit of Gulou Hospital, launching an expansion project for the hospital that improves availability and quality of health care, as well as transforming hospital management, operation and performance evaluation that stimulate the cultural consciousness of all employees and create a humanistic hospital. Since Gulou Hospital embarked on the journal to build the best humanistic hospital in China, it has generated positive results in terms of patient attraction and satisfaction level. Gulou Hospital has become an exemplar of modern, humanistic hospital in China and received many awards. However, going forward, the hospital faces mounting challenges. How to further deepening the reform and engage all employees? Will Gulou Hospital's core competency sustain into the future and continues to enable the hospital to gain a strong foothold in the increasingly crowded healthcare market?

Case Authors : Ning Jia, Weiqi Liu, Shanshan Cao

Topic : Technology & Operations

Related Areas : IT

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Calculating Net Present Value (NPV) at 6% for Nanjing Gulou Hospital: Honoring the Heritage and Building the Future Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10020827)	-10020827	-	-
Year 1	3452985	-6567842	3452985	0.9434	3257533
Year 2	3963176	-2604666	7416161	0.89	3527213
Year 3	3941199	1336533	11357360	0.8396	3309107
Year 4	3223549	4560082	14580909	0.7921	2553353
TOTAL			14580909		12647205

The Net Present Value at 6% discount rate is 2626378

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. Payback Period
2. Net Present Value
3. Profitability Index
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. Timing of the expected cash flows – stockholders of Gulou Hospital 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. Gulou Hospital 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 Nanjing Gulou Hospital: Honoring the Heritage and Building the Future

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 Gulou Hospital 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 Gulou Hospital 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	(10020827)	-10020827	-	-
Year 1	3452985	-6567842	3452985	0.8696	3002596
Year 2	3963176	-2604666	7416161	0.7561	2996730
Year 3	3941199	1336533	11357360	0.6575	2591402
Year 4	3223549	4560082	14580909	0.5718	1843075
TOTAL					10433803

The Net NPV after 4 years is 412976

(10433803 - 10020827 )

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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	(10020827)	-10020827	-	-
Year 1	3452985	-6567842	3452985	0.8333	2877488
Year 2	3963176	-2604666	7416161	0.6944	2752206
Year 3	3941199	1336533	11357360	0.5787	2280786
Year 4	3223549	4560082	14580909	0.4823	1554566
TOTAL					9465046

The Net NPV after 4 years is -555781

At 20% discount rate the NPV is negative (9465046 - 10020827 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Gulou Hospital 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 Gulou Hospital has a NPV value higher than Zero then finance managers at Gulou Hospital 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 Gulou Hospital, then the stock price of the Gulou Hospital 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 Gulou Hospital 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 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 will be a multi year spillover effect of various taxation regulations.

What can impact the cash flow of the project.

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 Nanjing Gulou Hospital: Honoring the Heritage and Building the Future

References & Further Readings

Ning Jia, Weiqi Liu, Shanshan Cao (2018), "Nanjing Gulou Hospital: Honoring the Heritage and Building the Future Harvard Business Review Case Study. Published by HBR Publications.