WAC formula Case Study
After the department heads have their lists for their departments ready, they submit these lists to fiscal affairs where the lists are consolidated to form a final master list. The master list is then reviewed and approved by the board of trustees. The aforementioned seems like a bureaucratic system, that in paper sounds reliable, but since we are humans, we are victims of some behavioral biases that in this case might affect the evaluation of what projects the board of trustees approves.
While, reading the case it is mentioned that the general practice of the board of trustees and of the previous SCOFF was to give high priority to medical equipment and tended to forget about the administrative service areas. Besides giving high priority to medical equipment, there were also hierarchy robbers as to which departments get this medical equipment, the departments that fill the most amount of beds, which are probably the largest ones, are more likely to get what they want, leaving the smallest departments with fewer chance to get their requests met.
Other interesting thing that happened is that some chiefs carry more “eight than others, so naturally these chiefs again are more likely to get what they Ant. Here we are seeing a big flaw, not all the projects are weighted equally against each other by benefits and costs only, but by asking, who ordered this? And how large s the department that is asking us for this. The board of trustees is probably sinning of indulgent with certain chiefs, because their works might depend on the relationships they have with them and also indulgent with the big departments.
The latter I do not think is that much of a problem, if a department fills more beds then it ought to be weighted different than a department then fills less beds, Just because by agreeing to the requests of the biggest department more patients are going to be benefited, which is a big concern for any medical center.
Now, since this is a center hat also engages in research with the local university there is a conflict of interest, some of the requests of the smaller departments might be beneficial for research that might yield some huge benefits for medicine in the future, rather than yielding immediate benefits for the patients.
We also have to deal with the administrative services, these are important for the organization of the medical center and for the operations it performs. It is mentioned that physicians should also be concerned about the administrative department doesn’t because there is a possible administrative service areas could deteriorate to the point that the hospital is unable to contain its costs, or that it is unable to maintain its quality, and it clearly affects everyone.
Even though the main function of the hospital is to serve its patients and for that you need good equipment, the board of trustees should also be concerned about the way things are ran outside the operations room. We have a complex situation here, if things continue the way they do the hospital and its workers may find themselves in a situation where they are unable to contain costs for them, or unable to maintain the quality. – a I-l think the right discount rate to use is 6.
4%. I got this number using the WAC formula which is a calculation of a firm’s cost of capital in which each category of capital is proportionately weighted. The WAC equation is the cost of each capital component multiplied by its proportional weight and then summing: WAC= (E/A)*Re Re= cost of equity; Rd= cost of debt; E= market value of the firm’s equity; D= market ‘alee of the firms debt A=Assets= E+D; T= Corporate tax rate.
More important, the numbers used where E= $17054(permanently restricted assets + unrestricted assets), $44160(from total assets), D= $27106(Total liabilities and net assets – equity), Rd= 4. 86, Re= 10, and O Most of this numbers came from exhibit 1 with exception of Rd, Inch was calculated by summing up the mortgage times its interest plus the bonds times its interests divided by D, Re which is found on the section of discount rate on the case study and taxes which Max Kavas said we could use O.
Using the aforementioned we get that the Pet Scanner Proposal discounted over 10 years has a $ 212 594.
75 and the Laundry proposal has a Neff$ 1 246607. 81. It-we Mould like to know how changing the discount rate would affect the NP of each project. For both projects we have that as the discount rate decreases each project increases in value, and when the discount rate increases both projects decrease in ‘alee. We can say that the relationship between the value of project and the discount rate is inversely proportional.
For a discount rate of 3% for the Pet Proposal we get a Neff$ 1 450 672.
41 and for a discount rate of we get a Neff-$ 577 177. 96. On the other hand for the Laundry proposal at 3% discount rate we get a Novo $ 1 23 669. 97 and for a discount rate of 10% we get a Novo $ 853 701. 64. B- For the AIR calculations we get that the PET scanner has an AIR of 7.
63% and the Laundry has an AIR of 23%. C- Once you change the reimbursement rate of the PET proposal to 60%, the project gets much more attractive the NP increases nine fold and the AIR increases.
On the other even though the NP of the laundry proposal plummeted by about half a million when we changed the savings from 15 years to 10 years it is still an attractive proposal. Once the changes are implemented the PET project seems eke a better option, it yields bigger positive cash flows than the laundry proposal, has NP that is about four times higher than the laundry NP and now that the changes are implemented the IRS are closer to each other. – The assumption that PET scans are going to be reimbursed at a rate of seems plausible in a future, but not now due to the fact that FIG is still waiting on the approval of the FDA and because at the time several of the large insurance companies were not covering part or all of the PET scan.
The process of approval for new drug that want to enter the market is about five, years. FIG is already being used in hospitals and TN under review so let’s say that at most the drug will be approved in in four years.
With the approval of the drug I would guess that more insurance companies would be Milling to give some money to cover up the PET scans of their patients, which is I think perfectly reasonable assumption, due to the fact that this service might be in high demand, because on the long run it not only saves money to the patients, but might also help patients know if they have any diseases more accurately than the current practices. What I see is that maybe not during the second or third year the imbruement rates would go up, but maybe from year five and on we might see an increase on these rates.
The assumption that the savings of the laundry would end after ten years is a little more difficult to accept, there is a possibility that this might happen, we do not receive any information in the text that suggests that it is a possibility.
What could happen in the future would be that the hospital might find in need of more staff to deal with the laundry machines or maybe the machines could break, but in the text says that the hospital is going to have maintenance and training or the staff for all the fifteen life years of the equipment.
I wouldn’t worry too much about the possibility that the equipment is only going to give savings for ten years, it does not seem plausible. 4- Assumption one everything stays the same) From a financial point of view the project that should be accepted is the laundry, it has a higher net present value, and it is an expense that sometime in the future you Nil have to make unless a laundry opens close to the hospital. Not from a financial standpoint the laundry might be the best for the Job security of the SCOFF. Lets describe these in more detail. The laundry has a NP of $ 1 246 607.
1, while the PET scanner has a NP of $212 594. 62. The laundry’s NP is about six times the PET scanner’s NP, but not only that, also the AIR for the laundry is 23% which bigger than the AIR of the PET scan at which is 7. 63%. The numbers don’t leave anything up for discussion it is clear that from a financial stand point the laundry is a better Investment. In the text it reads that “the laundry facilities had struggles to keep up Math the demand.
The current process was quite labor intensive due to relatively small capacity washer and dryer machines…..
Nevertheless, the department’s request for capital had been turned down in each of the two past years. ” The hospital eventually will have to somehow expand the capacity of their current equipment, or buy new equipment. Since the former is not possible, if not now sometime in the future they will have to buy the new laundry equipment. In addition think is relevant for the this point to think about the next, the PET scan will probably make the demand for the hospital ‘s services go up, that means about 2000 more clothes to wash. If the hospital is already struggling with the current demand, what
Nil happen with an increase on that demand? That is something to keep in mind. Also relevant is that if the laundry is not accepted in this year the PET scan will be accepted, but the problem with the PET scan is revenues it generates, the revenues are tied with the insurance companies and with the Fads approval of FIG.
Think for a second, FIG might be approved in a future, so why not wait to get the PET scan and give a chance to the laundry this year. Maybe if we wait for to buy the PET scan it Mould be better, once we know more about the future. Last but not least, we are helping the administrative department; Mrs..
Willis said “conditions in certain administrative service areas cool d deteriorate to the point that we re unable to contain costs for the hospital, or that we’re unable to maintain quality’, we don’t Ant to get to that point were the hospital can’t maintain quality.
Also, in this case the new SCOFF was hired by Mrs.. Willis this might create some agency conflicts, the SCOFF might be concerned about his Job security so that might make him push for the laundry option, and he might as well try to demonstrate that now that he is the new SCOFF some things will change around here.
Things like paying more attention to quests made by certain heads of the departments might end now that there is someone new in the house. I think the laundry proposal will be accepted it has good points to its favor, like higher NP and AIR.
The laundry is not tied with the approval of any drug. Mr.. Klein probably wants to demonstrate his boss that he is not like the former SCOFF and he is not going to necessarily give preference to the requests of the Hessians. For these reasons I would say, that even though some of the physicians and researchers from the university might not be happy with it, the laundry is going to be accepted.
