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In order for a business or organization to grow there is need to invest wisely. For one to invest wisely the benefits to be realized from the investment should their point of focus. The challenge in this case is arriving at the suitable investment option in relation to the future goals of an organization. If the projects have equal risk the challenge may seem bigger if one does not utilize capital budgeting techniques to arrive at the best investment option. In order to arrive at the actual return to be realized from an investment, several measures. However, the best measure is the Net present Value (NPV) since it can be applied in various organizations. Additionally, NPV ensures that the actual benefit or loss to be realized from an investment is clearly brought out. With this in mind the decision arrived at by the investor will be the best decision.
Investment decisions that will have a huge impact on any organization should be based on financial analysis. Capital budgeting techniques should be applied in this case since the decision to build Neonatal Wing or Rehab Center is a very important decision. The following four measures should be applied in order to arrive at the best NPV, ROI, PI (Profitability Index) & product mix. In this research paper this concepts as well as their use/value in analyzing the validity of the 2 projects will be discussed.
The product mix being utilized in the analysis of a project is usually indicated by the Payer mix. Additionally, cash mix is being utilized in the analysis of a project, then payer mix can as well indicate it. The cash flow for a given project that are usually utilized during analysis are directly impacted by either product mix or cash mix. For example, in a scenario where the payer mix comprises of payers whose pays rates almost equaling retail rates, then payments will be made by the these payers in a timely manner thereby resulting in a cash flow which is strong. For instance, one bad measure of comparison in this case is if a bigger percentage of patients being admitted in the rehab end being patients with no insurance are measured against the number of patients who visit the Neonatal wing as well as the services the Neonatal wing offers. Cash generation is of essence in this case. This is so since with no cash flow operations in the business will be halted.
A hospital facing financial hardships will fail to offer services of right standard. This implies that hospitals should strive to generate cash flows which are sufficient for the hospital in order for them to have a policy which is effective in relation to fiscal as well as social aspects of the hospital (Gapenski & Pink, 2007). Additionally, payer mix should be utilized to arrive at the appropriate forecast of cash flow so that the hospital can aware of its future potential earnings as well as cash flows to be generated for each project.
All cash flow generated by each project should be against the initial investment. The requirement for ROI is that cash flows from a project should be more than the initial investment made on the project i.e. adequate cash should be generated by a project in order to cover the investment made initially investment made on the project. ROI is very crucial for every project since it helps the investors to weigh initial investment against the returns realized from the project. In so doing they will be in a position to make the right decision since if the returns are not attractive they will reject the project in order to avoid incurring losses. However if the returns are eye catching then they should accept the project. If 2 projects end up having a ROI which is attractive then the project having an ROI which higher than the other should be accepted. i.e. projects having ROI being higher than the hurdle rate (Gapenski & Pink, 2007).
PI shows the Profit to be realized from a project. Whenever a project has a PI value which is less than 1, then the project should be rejected, & when the value for PI of a project ends up being greater than 1 then the investor should invest into the project. This based on the fact that whenever PI value is >1 then it implies that the future cash flow’s present value will be greater initial amount invested into a project. To save on time, whenever NPV has been used to analyze a project it is not necessary to determine the PI of the project since in several cases they tend arrive at the same results.
Net present value (NPV):
In the NPV method, capital cost is used as the discounting rate from which future cash flows are discounted. This implies that in this method the time value of money is of essence. Whenever a project has been analyzed and the NPV of the project is found to >0, then the project should be accepted. On the other hand if the NPV of a project ends up being < 0 then the project should be rejected. In situations where the occurrence of cash flow is in different period it is usually difficult to select a project.
The hospital should utilize the NPV to evaluate the two projects. In order to determine future cash flows, the hospital should utilize the payers mix method. Thus, project with highest NPV should be accepted by the hospital. This is the case considering that the project are mutually exclusive (Ross, Westerfield, Jaffe, & Jordan, 2011, 210-215).
- Damodar, A. (n.d.). Measuring Return on Investments. Retrieved from people.stern.nyu.edu website:
- Dunham-Taylor, J., & Pinczuk, J. Z. (2006). Managing Resources/Budgeting in Ambulatory Care. In Health care financial management for nurse managers (pp. 383 – 384). Sudbury, Mass: Jones and Bartlett Publishers.
- Ross, S. A., Westerfield, R., Jaffe, J. F., & Jordan, B. D. (2011). Net Present Value and Other Investment Rules. In Corporate finance (3rd ed., p. 220). Boston, Mass: McGraw-Hill/Irwin.
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