Package Pricing at Mission 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 Package Pricing at Mission Hospital case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Package Pricing at Mission Hospital case study is a Harvard Business School (HBR) case study written by Sriram TK, Shailaja Grover, Satyabala Hariharan, Dinesh Kumar Unnikrishnan. The Package Pricing at Mission Hospital (referred as “Hospital Package” 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, Financial analysis, Pricing.

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 Package Pricing at Mission Hospital Case Study

Mission Hospital started its operations on April 02, 2008 with the aim of providing highest quality patient care facilities to all individuals at affordable rates. This super specialty hospital located in Durgapur, West Bengal, India, specializes in cardiac surgeries. Many of its patients are from nearby states and neighboring countries, and are covered under different health schemes. Among hospitals in India, flat rate for different treatments is becoming popular, mainly owing to healthcare tourism and government schemes. Dr. Satyajit Bose, chairman of Mission Hospital, was considering adoption of a package pricing (flat fee) strategy under which patients would be provided a fixed price for their treatment at the time of admission. This would imply that the package price should be calculated by the hospital on the basis of patient's clinical and non-clinical information available at the time of admission. Flat fee (or package pricing) can result in a loss to the hospitals if they do not accurately estimate the treatment cost for a patient. The hospital faces the challenge of identifying the key factors that drive the total cost of treatment so that it can quote an appropriate price to the patient.

Case Authors : Sriram TK, Shailaja Grover, Satyabala Hariharan, Dinesh Kumar Unnikrishnan

Topic : Leadership & Managing People

Related Areas : Financial analysis, Pricing

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Calculating Net Present Value (NPV) at 6% for Package Pricing at Mission Hospital Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10022112)	-10022112	-	-
Year 1	3470132	-6551980	3470132	0.9434	3273709
Year 2	3954976	-2597004	7425108	0.89	3519915
Year 3	3944459	1347455	11369567	0.8396	3311844
Year 4	3240919	4588374	14610486	0.7921	2567111
TOTAL			14610486		12672579

The Net Present Value at 6% discount rate is 2650467

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. Net Present Value
2. Profitability Index
3. Internal Rate of Return
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Hospital Package 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 Package 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 Package Pricing at Mission 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 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 Hospital Package 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 Package 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	(10022112)	-10022112	-	-
Year 1	3470132	-6551980	3470132	0.8696	3017506
Year 2	3954976	-2597004	7425108	0.7561	2990530
Year 3	3944459	1347455	11369567	0.6575	2593546
Year 4	3240919	4588374	14610486	0.5718	1853006
TOTAL					10454588

The Net NPV after 4 years is 432476

(10454588 - 10022112 )

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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	(10022112)	-10022112	-	-
Year 1	3470132	-6551980	3470132	0.8333	2891777
Year 2	3954976	-2597004	7425108	0.6944	2746511
Year 3	3944459	1347455	11369567	0.5787	2282673
Year 4	3240919	4588374	14610486	0.4823	1562943
TOTAL					9483904

The Net NPV after 4 years is -538208

At 20% discount rate the NPV is negative (9483904 - 10022112 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Hospital Package 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 Package has a NPV value higher than Zero then finance managers at Hospital Package 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 Package, then the stock price of the Hospital Package 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 Package 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 –

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 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.

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 Package Pricing at Mission Hospital

References & Further Readings

Sriram TK, Shailaja Grover, Satyabala Hariharan, Dinesh Kumar Unnikrishnan (2018), "Package Pricing at Mission Hospital Harvard Business Review Case Study. Published by HBR Publications.