Cancer Treatment Centers of AmericaA? (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 Cancer Treatment Centers of AmericaA? (A) case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Cancer Treatment Centers of AmericaA? (A) case study is a Harvard Business School (HBR) case study written by Regina E. Herzlinger, Natalie Kindred. The Cancer Treatment Centers of AmericaA? (A) (referred as “Ctca Ctca's” from here on) case study provides evaluation & decision scenario in field of Leadership & Managing People. It also touches upon business topics such as - Value proposition, Corporate governance, Decision making, Entrepreneurship, Growth strategy, Innovation, Intellectual property, Marketing.

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 Cancer Treatment Centers of AmericaA? (A) Case Study

Cancer Treatment Centers of America (CTCA), a U.S. network of four privately owned oncology focused factory hospitals, was weighing options for growth. CTCA was entirely cancer focused and specialized in treating patients with complex and advanced-stage cancers, who were reached through advertising its integrative, team-based approach to care. CEO Stephen Bonner needed to decide whether to focus future expansion on building additional full-scale hospitals or pursuing a hub-and-spoke model, in which numerous oncology outpatient centers would be built in the region of each CTCA hospital. His decision would be made in the context of CTCA's unique business model and treatment philosophy and the public policy landscape, including certificate-of-need laws and the advent of Accountable Care Organizations (ACOs) and bundled payments. CTCA's for-profit status and direct-to-consumer advertising made it a target, he knew.

Case Authors : Regina E. Herzlinger, Natalie Kindred

Topic : Leadership & Managing People

Related Areas : Corporate governance, Decision making, Entrepreneurship, Growth strategy, Innovation, Intellectual property, Marketing

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Calculating Net Present Value (NPV) at 6% for Cancer Treatment Centers of AmericaA? (A) Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10008119)	-10008119	-	-
Year 1	3465232	-6542887	3465232	0.9434	3269087
Year 2	3980537	-2562350	7445769	0.89	3542664
Year 3	3944128	1381778	11389897	0.8396	3311566
Year 4	3232529	4614307	14622426	0.7921	2560466
TOTAL			14622426		12683782

The Net Present Value at 6% discount rate is 2675663

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

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 Ctca Ctca's 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. Ctca Ctca's 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 Cancer Treatment Centers of AmericaA? (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 Leadership & Managing People 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 Ctca Ctca's 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 Ctca Ctca's 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	(10008119)	-10008119	-	-
Year 1	3465232	-6542887	3465232	0.8696	3013245
Year 2	3980537	-2562350	7445769	0.7561	3009858
Year 3	3944128	1381778	11389897	0.6575	2593328
Year 4	3232529	4614307	14622426	0.5718	1848209
TOTAL					10464640

The Net NPV after 4 years is 456521

(10464640 - 10008119 )

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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	(10008119)	-10008119	-	-
Year 1	3465232	-6542887	3465232	0.8333	2887693
Year 2	3980537	-2562350	7445769	0.6944	2764262
Year 3	3944128	1381778	11389897	0.5787	2282481
Year 4	3232529	4614307	14622426	0.4823	1558897
TOTAL					9493334

The Net NPV after 4 years is -514785

At 20% discount rate the NPV is negative (9493334 - 10008119 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Ctca Ctca's 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 Ctca Ctca's has a NPV value higher than Zero then finance managers at Ctca Ctca's 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 Ctca Ctca's, then the stock price of the Ctca Ctca's 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 Ctca Ctca's 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.

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Negotiation Strategy of Cancer Treatment Centers of AmericaA? (A)

References & Further Readings

Regina E. Herzlinger, Natalie Kindred (2018), "Cancer Treatment Centers of AmericaA? (A) Harvard Business Review Case Study. Published by HBR Publications.