×




University Hospitals Cleveland Medical Center: Managing Capacity in Neurology 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 University Hospitals Cleveland Medical Center: Managing Capacity in Neurology case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. University Hospitals Cleveland Medical Center: Managing Capacity in Neurology case study is a Harvard Business School (HBR) case study written by Joel Goh, Robert S. Huckman, Nikhil Sahni. The University Hospitals Cleveland Medical Center: Managing Capacity in Neurology (referred as “Neurology Outpatient” from here on) case study provides evaluation & decision scenario in field of Technology & Operations. It also touches upon business topics such as - Value proposition, Human resource management, Manufacturing, Supply chain, Time 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






Case Description of University Hospitals Cleveland Medical Center: Managing Capacity in Neurology Case Study


In December 2014, Dr. Anthony Furlan, chair of the Department of Neurology at University Hospitals Cleveland Medical Center (UH), faced a mandate from the hospital's executive leadership team. Specifically, all UH departments were directed to take steps within six months to reduce the waiting time for outpatient appointments-measured as the time to first available outpatient appointment-to no more than 15 days. For Furlan and his colleagues in neurology, achieving this target was a significant challenge, as the department's current time to first available appointment was 93 days. The case considers several alternatives for reducing waiting time in outpatient neurology without increasing the total clinical staff. The case allows students to evaluate opportunities for expanding the effective capacity of a complex service operation and to understand the tradeoffs between customer service and labor utilization.


Case Authors : Joel Goh, Robert S. Huckman, Nikhil Sahni

Topic : Technology & Operations

Related Areas : Human resource management, Manufacturing, Supply chain, Time management




Calculating Net Present Value (NPV) at 6% for University Hospitals Cleveland Medical Center: Managing Capacity in Neurology Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10000138) -10000138 - -
Year 1 3472441 -6527697 3472441 0.9434 3275888
Year 2 3966009 -2561688 7438450 0.89 3529734
Year 3 3972432 1410744 11410882 0.8396 3335331
Year 4 3245409 4656153 14656291 0.7921 2570668
TOTAL 14656291 12711620




The Net Present Value at 6% discount rate is 2711482

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. Internal Rate of Return
2. Profitability Index
3. Payback Period
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. Timing of the expected cash flows – stockholders of Neurology Outpatient 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. Neurology Outpatient shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.






Formula and Steps to Calculate Net Present Value (NPV) of University Hospitals Cleveland Medical Center: Managing Capacity in Neurology

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 Neurology Outpatient 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 Neurology Outpatient 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 (10000138) -10000138 - -
Year 1 3472441 -6527697 3472441 0.8696 3019514
Year 2 3966009 -2561688 7438450 0.7561 2998873
Year 3 3972432 1410744 11410882 0.6575 2611939
Year 4 3245409 4656153 14656291 0.5718 1855573
TOTAL 10485898


The Net NPV after 4 years is 485760

(10485898 - 10000138 )








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 (10000138) -10000138 - -
Year 1 3472441 -6527697 3472441 0.8333 2893701
Year 2 3966009 -2561688 7438450 0.6944 2754173
Year 3 3972432 1410744 11410882 0.5787 2298861
Year 4 3245409 4656153 14656291 0.4823 1565109
TOTAL 9511843


The Net NPV after 4 years is -488295

At 20% discount rate the NPV is negative (9511843 - 10000138 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Neurology Outpatient 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 Neurology Outpatient has a NPV value higher than Zero then finance managers at Neurology Outpatient 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 Neurology Outpatient, then the stock price of the Neurology Outpatient 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 Neurology Outpatient 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 can impact the cash flow of 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.

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.






Negotiation Strategy of University Hospitals Cleveland Medical Center: Managing Capacity in Neurology

References & Further Readings

Joel Goh, Robert S. Huckman, Nikhil Sahni (2018), "University Hospitals Cleveland Medical Center: Managing Capacity in Neurology Harvard Business Review Case Study. Published by HBR Publications.


Totally SWOT Analysis / TOWS Matrix

Technology , Software & Programming


Kikukawa Enterprise SWOT Analysis / TOWS Matrix

Capital Goods , Constr. & Agric. Machinery


VisDynamics SWOT Analysis / TOWS Matrix

Technology , Semiconductors


Montagne et Neige SWOT Analysis / TOWS Matrix

Capital Goods , Construction Services


Aecom Technology SWOT Analysis / TOWS Matrix

Capital Goods , Construction Services


Allied Mind SWOT Analysis / TOWS Matrix

Financial , Misc. Financial Services


Standard Life UK Smaller SWOT Analysis / TOWS Matrix

Financial , Misc. Financial Services


Houlihan Lokey Inc SWOT Analysis / TOWS Matrix

Financial , Investment Services


Qibu SWOT Analysis / TOWS Matrix

Consumer Cyclical , Apparel/Accessories


Caregen SWOT Analysis / TOWS Matrix

Healthcare , Biotechnology & Drugs