Surviving SAP Implementation in a Hospital 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 Surviving SAP Implementation in a Hospital case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Surviving SAP Implementation in a Hospital case study is a Harvard Business School (HBR) case study written by Juanita Cajiao, Enrique Ramirez. The Surviving SAP Implementation in a Hospital (referred as “Hospital Sap” 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, Knowledge management.

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 Surviving SAP Implementation in a Hospital Case Study

On January 1, 2011, the Valle del Lili Foundation, a university hospital in Cali, Colombia, went from using paper for medical records and all associated clinical and administrative processes to managing everything electronically. This was a significant deviation from the industry norm since it was unusual for a hospital to simultaneously implement electronic medical records, computerized physician order entry, and enterprise resource planning. If they are implemented at all, they are generally done so independently. Also, hospitals that rise to the challenge of adopting information technology face a high failure rate, mainly for staff-related reasons, especially when medical staff resist its use. VLF's management team knew it had to achieve the buy-in of doctors as well as of clinical and clerical staff if it was to successfully implement SAP, a system that would reformulate workflows throughout the hospital. This case documents how the hospital achieved this ambitious goal. In doing so, it illustrates how organizations can manage large-scale change processes.

Case Authors : Juanita Cajiao, Enrique Ramirez

Topic : Technology & Operations

Related Areas : IT, Knowledge management

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Calculating Net Present Value (NPV) at 6% for Surviving SAP Implementation in a Hospital Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10012085)	-10012085	-	-
Year 1	3472798	-6539287	3472798	0.9434	3276225
Year 2	3968244	-2571043	7441042	0.89	3531723
Year 3	3963456	1392413	11404498	0.8396	3327794
Year 4	3228939	4621352	14633437	0.7921	2557622
TOTAL			14633437		12693364

The Net Present Value at 6% discount rate is 2681279

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. Internal Rate of Return
3. Profitability Index
4. Net Present Value

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. Hospital Sap 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 Hospital Sap have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.

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Formula and Steps to Calculate Net Present Value (NPV) of Surviving SAP Implementation in a Hospital

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 Hospital Sap 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 Hospital Sap 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	(10012085)	-10012085	-	-
Year 1	3472798	-6539287	3472798	0.8696	3019824
Year 2	3968244	-2571043	7441042	0.7561	3000563
Year 3	3963456	1392413	11404498	0.6575	2606037
Year 4	3228939	4621352	14633437	0.5718	1846156
TOTAL					10472580

The Net NPV after 4 years is 460495

(10472580 - 10012085 )

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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	(10012085)	-10012085	-	-
Year 1	3472798	-6539287	3472798	0.8333	2893998
Year 2	3968244	-2571043	7441042	0.6944	2755725
Year 3	3963456	1392413	11404498	0.5787	2293667
Year 4	3228939	4621352	14633437	0.4823	1557166
TOTAL					9500556

The Net NPV after 4 years is -511529

At 20% discount rate the NPV is negative (9500556 - 10012085 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Hospital Sap 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 Hospital Sap has a NPV value higher than Zero then finance managers at Hospital Sap 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 Hospital Sap, then the stock price of the Hospital Sap 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 Hospital Sap 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 will be a multi year spillover effect of various taxation regulations.

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.

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 Surviving SAP Implementation in a Hospital

References & Further Readings

Juanita Cajiao, Enrique Ramirez (2018), "Surviving SAP Implementation in a Hospital Harvard Business Review Case Study. Published by HBR Publications.