# Identify relevant incremental cash flows

Case UVa Health System: The Long-Term Acute Care Hospital Project

Wk 3 is the first of two consecutive weeks on CAPITAL BUDGETING.

You will learn the three steps in capital budgeting:

1 Identify relevant incremental cash flows

2 Calculate cost of capital (k-wacc) to use as the discount rate

3 Calculate the metrics of capital budgeting: Net Present Value, Profitability Index,

Internal Rate of Return, and Payback Period.

Then, you will apply the metrics and information in the case study to make a recommendation

whether to accept or reject the LTAC project.

The essence of the capital budgeting process is to make sure, BEFORE an investment is made,

that its prospective rate of return is high enough to justify the investment.

Reading Cohen Finance Workbook chapter 4 is a review of Time Value of Money, which you covered in a previous course.

Review it as necessary, but defer the review until you look at the TVM applications in chapter 5 beginning on p 79.

You need to know TVM to understand the capital budgeting metrics of NPV, PI, and IRR. Make sure you

have that context in mind before reviewing the TVM chapter 4 (only if you need to).

Give the Uva Health Care System: The Long-Term Acute Care Hospital Project Case a quick read to understand what is going on – about

calculating k-wacc and the decision metrics for the project, to give it either a green light or a red light.

Wk 3 gives you practice on the basics. You won’t have a full understanding of what the LTAC Project case is about at

the end of Wk3. In Wk4, you will return to the case, analyze the project, and make a recommendation.

Look at the Wk 3 assignment questions in the Q1, Q2, Q3 tabs.

Read Cohen Finance Workbook chapter 5 selectively. Focus on:

See the FLOW DIAGRAM in GREEN depicting the CAPITAL BUDGETING template.

See the IS/BS Model in GREEN depicting the connection between PPE (BS) and operating expense (IS).

Read pps 61-65 as a general introduction to capital budgeting.

Read pps 70-76 on weighted average cost of capital to answer Q1.

Read bottom p 67 to 69 on Net Working Capital to answer Q2.

Read pps 79-85 on NPV, PI, IRR, PP to answer Q3.

Questions

See tabs for Q1, Q2, Q3

THESE QUESTIONS MUST BE ANSWERED USING EXCEL.

MAKING CALCULATIONS OUTSIDE THE SPREADSHEET AND ENTERING THE RESULTS IS NOT USING EXCEL.

YOU MUST USE EXCEL FORMULAS FOR MAKING CALCULATIONS!

Case UVa Health System: The LATC Hospital Project

Wk 4 is the second of two weeks on CAPITAL BUDGETING

Study the Wk 3 Solutions Template before proceeding into Wk 4.

Learning Objectives (repeated from Wk3 Assignment Template)

You will learn the three steps in capital budgeting: SEE THE FLOW DIAGRAM – YOU ARE NOW WORKING ON THE GREEN-COLORED ANALYSIS.

1 Identify relevant incremental cash flows

2 Calculate cost of capital (k-wacc) to use as the discount rate

3 Calculate the metrics of capital budgeting: Net Present Value, Profitability Index,

Internal Rate of Return, and Payback Period.

Then, you will apply the metrics and information in the case study to make a recommendation

about which of the two projects to accept.

The essence of the capital budgeting process is to make sure, before an investment is made,

that its prospective rate of return is high enough to justify the investment,

i.e., that the project is CREATES value, not DESTROYS value.

Directions (some repeating from Wk3 Assignment Template)

1 Make a quick scan through the LTAC case and the exhibits.

2 Listen to the Intro Audio

3 Cohen Finance Workbook chapter 4 is a review of Time Value of Money, which you covered in a previous course.

Review it as necessary, but defer the review until you look at the TVM applications in chapter 5 beginning on p 79.

You need to know TVM to understand the capital budgeting metrics of NPV, PI, and IRR. Make sure you

have that context in mind before reviewing the TVM chapter 4 (only if you need to).

4 Read the case again, to grasp all the details, especially the Mulroney memo to her boss.

5 To understand how a capital budgeting template works, follow the step-by-step procedure in the book, pages 61-70

6 Scan pages 70-76 on weighted average cost of capital. No need to emphasize at this point because discount rates are given in the case.

7 Read pages 79-84 on NPV, PI, IRR, PP.

8 Pages 83-85 show a worked-out example of a capital budgeting decision.

Questions

If you work with a group, write answers on your own, independently. Group answers violate academic integrity requirements.

1 See Q1 tab. Scroll down until you see the questions. Capital Budgeting Template The template calculates FREE CASH FLOW=[EBIT-TAX+DEPREC]+/-CHANGE NWC+/-CAPEX.

2 See Q2 tab. Scroll down until you see the questions. K-wacc The 1st term is income statement data; the 2nd & 3rd terms are balance sheet data.

3 See Q3 tab. Scroll down until you see the questions. Sensitivity Analysis LEARN THIS FORMULA (EQUATION) COLD!

Expect to revisit these calculations and decisions in Wk7.