Analyzing Low Patient Satisfaction at Herzog Memorial 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 Analyzing Low Patient Satisfaction at Herzog Memorial Hospital case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Analyzing Low Patient Satisfaction at Herzog Memorial Hospital case study is a Harvard Business School (HBR) case study written by Jack Boepple. The Analyzing Low Patient Satisfaction at Herzog Memorial Hospital (referred as “Herzog Tinsley” 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, Customer service, Customers, Operations management, Product development.

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 Analyzing Low Patient Satisfaction at Herzog Memorial Hospital Case Study

In late 2012 Adeline Herzog Memorial Hospital in Castle Rock, Colorado, was facing a problem with patient satisfaction. The Press-Ganey scores for the third-floor nursing unit-the primary destination (70 percent) for patients admitted through the emergency department-were at the 15th percentile, and the key HCAHPS score for inpatients was well below the Colorado average. Over the past six months Jeri Tinsley, director of medical, surgical, and intensive care services, had made various changes to try to improve the patient satisfaction scores for her 32-bed unit, but the scores seemed stuck at an unacceptably low level. Tinsley worried that if improvements were not made soon, patients would start "voting with their feet" and take their business to competing hospitals. As a registered nurse, Tinsley's expertise was helping people heal; it was not analyzing data. In particular, she was overwhelmed by the patient comments included in the surveys; she had no idea how to analyze them and could not decide which issues to address first.

Case Authors : Jack Boepple

Topic : Leadership & Managing People

Related Areas : Customer service, Customers, Operations management, Product development

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Calculating Net Present Value (NPV) at 6% for Analyzing Low Patient Satisfaction at Herzog Memorial Hospital Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10016014)	-10016014	-	-
Year 1	3448797	-6567217	3448797	0.9434	3253582
Year 2	3981211	-2586006	7430008	0.89	3543264
Year 3	3937309	1351303	11367317	0.8396	3305841
Year 4	3225732	4577035	14593049	0.7921	2555082
TOTAL			14593049		12657768

The Net Present Value at 6% discount rate is 2641754

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. Internal Rate of Return
2. Payback Period
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. Herzog Tinsley 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 Herzog Tinsley 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 Analyzing Low Patient Satisfaction at Herzog Memorial 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 Herzog Tinsley 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 Herzog Tinsley 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	(10016014)	-10016014	-	-
Year 1	3448797	-6567217	3448797	0.8696	2998954
Year 2	3981211	-2586006	7430008	0.7561	3010367
Year 3	3937309	1351303	11367317	0.6575	2588845
Year 4	3225732	4577035	14593049	0.5718	1844323
TOTAL					10442489

The Net NPV after 4 years is 426475

(10442489 - 10016014 )

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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	(10016014)	-10016014	-	-
Year 1	3448797	-6567217	3448797	0.8333	2873998
Year 2	3981211	-2586006	7430008	0.6944	2764730
Year 3	3937309	1351303	11367317	0.5787	2278535
Year 4	3225732	4577035	14593049	0.4823	1555619
TOTAL					9472882

The Net NPV after 4 years is -543132

At 20% discount rate the NPV is negative (9472882 - 10016014 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Herzog Tinsley 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 Herzog Tinsley has a NPV value higher than Zero then finance managers at Herzog Tinsley 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 Herzog Tinsley, then the stock price of the Herzog Tinsley 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 Herzog Tinsley 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 will be a multi year spillover effect of various taxation regulations.

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.

Understanding of risks involved in 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 Analyzing Low Patient Satisfaction at Herzog Memorial Hospital

References & Further Readings

Jack Boepple (2018), "Analyzing Low Patient Satisfaction at Herzog Memorial Hospital Harvard Business Review Case Study. Published by HBR Publications.