FINANCE CHAPTER 10 - 10 1 CHAPTER 10 Project Cash Flow...

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10 - 1 CHAPTER 10 Project Cash Flow Estimation and Risk Analysis Cash flow estimation Financial risk basics Project risk assessment Project risk incorporation The capital budgeting process Copyright © 2013 by the Foundation of the American College of Healthcare Executives
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10 - 2 Introduction The four steps in a project financial analysis are: Estimate the project’s cash flows. Assess the project’s risk. Estimate the discount rate. Measure the financial impact. In the previous chapter, we focused on the fourth step. In this chapter, we focus on the first three. Copyright © 2013 by the Foundation of the American College of Healthcare Executives
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10 - 3 Key Concepts in Cash Flow Estimation Focus on incremental cash flows Cash flow timing Project life Watch out for: Sunk costs (do not include) Opportunity costs (include) For other resources For capital Impact on other business lines (include) Include inflation effects Include strategic value Copyright © 2013 by the Foundation of the American College of Healthcare Executives
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10 - 4 Cash Flow Estimation Example Consider Midtown Clinic’s proposal for a new X-ray machine. Midtown is a not-for-profit provider. Cost: $200,000 purchase price $40,000 shipping and installation Expected life = 4 years. Salvage value = $25,000 . Copyright © 2013 by the Foundation of the American College of Healthcare Executives
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10 - 5 Utilization = 5,000 scans/year. Net revenue = $80 per scan. Supplies costs = $40 per scan. Labor costs = $100,000 . Neutral inflation rate = 5% . Corporate cost of capital = 10% . Cash Flow Estimation Example (Cont.) Copyright © 2013 by the Foundation of the American College of Healthcare Executives
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10 - 6 Time Line Setup 0 1 2 3 4 OCF 1 OCF 2 OCF 3 OCF 4 Initial Costs (CF 0 ) + Terminal CF NCF 0 NCF 1 NCF 2 NCF 3 NCF 4 Copyright © 2013 by the Foundation of the American College of Healthcare Executives
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10 - 7 Equipment $200 Installation & Shipping 40 Net cash outlay $240 Investment at t = 0 (000s) Copyright © 2013 by the Foundation of the American College of Healthcare Executives
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10 - 8 Operating cash flows (000s) 1 2 3 4 Revenues $400 $420 $441 $463 Supplies costs 200 210 221 232 Net op. CF $100 $105 $110 $116 How were these values developed? Why haven’t we included depreciation ? Labor costs 100 105 110 116 Copyright © 2013 by the Foundation of the American College of Healthcare Executives
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10 - 9 Terminal cash flows at t = 4 (000s) Salvage value $25 Tax on SV 0 Net terminal CF $25 Copyright © 2013 by the Foundation of the American College of Healthcare Executives
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10 - 10 0 $100 1 $105 2 $110 3 $116 4 ($240) 25 $141 Net cash flows (000s) Note that these cash flows are estimates .
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