Ch.14_Capital Budgeting_ST

Ch.14_Capital Budgeting_ST - CHAPTER 14 The Basics of...

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1 CHAPTER 14 The Basics of Capital Budgeting Definition and process Project classifications Role of financial analysis Cash flow estimation Breakeven and profitability measures
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2 Learning Objectives Explain project classifications and their effect on the capital budgeting process Estimate project cash flows Define payback, NPV, IRR and state their strengths and weaknesses Conduct payback, NPV, and IRR analyses and use them to make recommendations
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3 Capital Budgeting Basics Capital budgeting: Analysis of fixed asset acquisition decisions Characteristics of capital budgeting decisions
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4 The Process - simplified IDEA GENERATION PROJECT CLASSIFICATION FINANCIAL ANALYSIS QUALITATIVE ANALYSIS DECISION / INVESTMENT POST – AUDIT
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5 Process begins with ideas Project origination Senior management Unit / division leaders Physicians Other clinical staff
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6 Project Classifications Projects often classified by purpose / size Mandatory / discretionary replacement Expansion of existing services Expansion into new services / markets
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7 Capital allocation in practice 0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 Desired Actual Routine Strategic Source: Reiter, K, et al. (2000). Capital Investment Strategies in Health Care Systems. Journal of Health Care Finance. 26(4): 31-41.
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8 Role of Financial Analysis Investor-owned businesses Identify projects that contribute to shareholder wealth Not-for-profit businesses Identify projects’ expected effects on business’s financial condition
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9 Overview of Capital Budgeting Financial Analysis 1. Estimate capital outlay (investment cost) 2. Forecast cash flows Operating & terminal flows 3. Assess project’s riskiness 4. Estimate cost of capital 5. Measure financial impact
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10 Spreadsheet Setup Cash Revenues and Costs Time 0 1 2 Investment Cost ($40,000) Revenues $50,000 $55,000 Expenses 20,000 27,000 Terminal value 10,000 Net cash flow ($40,000) $30,000 $38,000
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11 Cash Flow Estimation KEY CONCEPTS AND CONSIDERATIONS Key to effective project analysis is the ability to forecast the cash flows !
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12 Investment Outlay Cost (price) of project + Shipping, installation, and related costs Total investment outlay
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13 Incremental Cash Flow Only incremental cash flows are relevant
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14 Incremental Cash Flow Example 1 A physician group practice plans to purchase a new bone density scanner for $75,000. The project is expected to increase net cash revenues from their current level of $50,000 per year to $150,000 per year starting in year 1.
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Ch.14_Capital Budgeting_ST - CHAPTER 14 The Basics of...

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