WHAT IS THE PROJECT’S PAYBACK, NPV, AND IRR? INTERPRET EACH OF THESE MEASURES.Twin Falls’ management is currently evaluating a proposed ambulatory (outpatient) surgery center.
Twin Falls Community Hospital is a 250-bed, not-for-profit hospital located
in the city of Twin Falls, the largest city in Idaho’s Magic Valley region
and the seventh largest in the state. The hospital was founded in 1972 and
today is acknowledged to be one of the leading healthcare providers in the
Twin Falls’ management is currently evaluating a proposed ambulatory (outpatient) surgery center. Over 80 percent of all outpatient surgery is performed by specialists in gastroenterology, gynecology, ophthalmology, otolaryngology, orthopedics, plastic surgery, and urology. Ambulatory surgery requires an average of about one and one-half hours; minor procedures take about one hour or less, and major procedures take about two or more hours. About 60 percent of the procedures are performed under general anesthesia, 30 percent under local anesthesia, and 10 percent under regional or spinal anesthesia. In general, operating rooms are built in pairs so that a patient can be prepped in one room while the surgeon is completing a procedure in the other room.
The outpatient surgery market has experienced significant growth since the first ambulatory surgery center opened in 1970. This growth has been fueled by three factors. First, rapid advancements in technology have enabled many procedures that were historically performed in inpatient surgical suites to be switched to outpatient settings. This shift was caused mainly by advances in laser, laparoscopic, endoscopic, and arthroscopic technologies. Second, Medicare has been aggressive in approving new minimally invasive surgery techniques, so the number of Medicare patients utilizing outpatient surgery services has grown substantially. Finally, patients prefer outpatient surgeries because they are more convenient, and third-party payers prefer them because they are less costly.
These factors have led to a situation in which the number of inpatient
surgeries has grown little (if at all) in recent years while the number of
outpatient procedures has been growing at over 10 percent annually and now
totals about 22 million a year. Rapid growth in the number of outpatient
surgeries has been accompanied by a corresponding growth in the number of
outpatient surgical facilities. The number currently stands at about 5,000
nationwide, so competition in many areas has become intense. Somewhat
surprisingly, there is no outpatient surgery center in the Twin Falls area,
although there have been rumors that local physicians are exploring the
feasibility of a physician-owned facility.
The hospital currently owns a parcel of land that is a perfect location for
the surgery center. The land was purchased five years ago for $350,000, and
last year the hospital spent (and expensed for tax purposes) $25,000 to clear
the land and put in sewer and utility lines. If sold in today’s market, the
land would bring in $500,000, net of realtor commissions and fees. Land
prices have been extremely volatile, so the hospital’s standard procedure is
to assume a salvage value equal to the current value of the land.
The surgery center building, which will house four operating suites, would
cost $5 million and the equipment would cost an additional $5 million, for a
total of $10 million. The project will probably have a long life, but the
hospital typically assumes a five-year life in its capital budgeting analyses
and then approximates the value of the cash flows beyond Year 5 by including
a terminal, or salvage, value in the analysis. To estimate the terminal
value, the hospital typically uses the market value of the building and
equipment after five years, which for this project is estimated to be $5
million, excluding the land value.
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