HLTH 8430 Week 7 Capital Investment Proposal Paper Example

Capital Proposal: Consolidating Two Hospital Laboratories Into One Core Laboratory, With the Conditions for Saying No

Student Name

Walden University

HLTH 8430: Healthcare Financial Management

Instructor Name

Month Day, Year

Capital Proposal: Consolidating Two Hospital Laboratories Into One Core Laboratory, With the Conditions for Saying No

Decision Box

Request: $16 million, illustrative, to consolidate routine laboratory testing for Harmon Valley Health's two hospitals into one automated core laboratory at the flagship hospital, with a rapid-response laboratory retained at the smaller hospital.

Criteria for approval: The committee should approve only if all three of the following hold. First, net present value stays positive at the system's 7% cost of capital under conservative volume assumptions. Second, debt service coverage stays above its 1.25 bond minimum, with a cushion, after financing. Third, turnaround for urgent tests at the smaller hospital can be protected at its current standard. If any criterion fails, the committee should decline or ask for a revised proposal. The body below tests each in turn.

Background

Each hospital now runs a full laboratory, with its own analyzers, reagent contracts and staff on every shift. Many routine tests, such as chemistry panels and blood counts for inpatients and outpatients, could be run on a single automated line at higher volume and lower unit cost. Some specialized tests are now sent to a commercial reference laboratory because neither hospital has the volume to run them. Consolidation would bring several of those tests in-house. The smaller hospital would keep a rapid-response laboratory for tests needed urgently by its emergency department and inpatient units.

Criterion One: Investment Value

Only cash flows the project itself creates or removes enter the analysis. Existing laboratory revenue is not counted, since the hospitals earn it with or without consolidation.

Table 1

Incremental Cash Flows (Illustrative, $ Millions a Year Unless Noted)

Net Present Value

Over a ten-year life, at the system's stated 7% cost of capital, the base case has a net present value of about $7.9 million. Under conservative volume, with lower reagent savings and less reference work brought in-house, the net present value falls to about $0.9 million. The project meets the first criterion, but only narrowly under conservative assumptions: a further shortfall of about $130,000 a year in savings would make it negative. The ten-year horizon is itself conservative for the renovation, which will last longer, but appropriate for the analyzers, which will need replacing. Capital budgeting texts recommend exactly this kind of scenario analysis when cash flow estimates are uncertain (Gapenski & Reiter, 2016).

Criterion Two: Financing

The investment decision and the financing decision are separate. The net present value above does not depend on how the project is paid for; low borrowing costs cannot make a weak project worth doing. The financing question is only which source does less harm to the system's balance sheet.

Paying cash. Funding $16 million from board-designated reserves would reduce days cash on hand by about five days, from 212 to about 207, still well above the 100-day covenant and above the peer median. Board-designated funds are without donor restrictions and can be redirected by the board (Financial Accounting Standards Board, 2016).

Borrowing. A $16 million, 20-year fixed-rate loan at about 5.5% would add about $1.3 million a year in debt service. Debt service coverage would fall from about 1.9 to about 1.86 times before counting the project's savings, still above the 1.25 minimum and above the 1.5 cushion the board has used informally. The project meets the second criterion under either source. Because coverage is the system's binding constraint and liquidity is not, paying cash does less harm, and a healthcare finance text's advice to match funding sources to the constraint that matters most points the same way (Cleverley & Cleverley, 2018).

Criterion Three: Turnaround at the Smaller Hospital

The smaller hospital's emergency department depends on fast results for tests such as troponin, basic chemistry, blood counts, coagulation studies and blood gases. The rapid-response laboratory would keep these tests on site around the clock, staffed on every shift, with the same analyzers it uses today. Routine and non-urgent tests would travel to the core laboratory by scheduled courier, with results expected within the same shift for morning draws. The current standard, results for urgent tests within 60 minutes of receipt for at least 90% of tests, would be measured monthly at the smaller hospital from the first day of consolidation. The project meets the third criterion by design, but this criterion is the one most dependent on execution, and the committee should expect to see it reported.

Risks the Criteria Do Not Capture

Three risks sit outside the criteria. Outreach testing: physician offices near the smaller hospital send some outpatient work to its laboratory today, and some may move that work to a commercial laboratory once routine testing leaves the campus. That revenue is not in the cash flows above, because the base case assumes it stays, and it is the risk the committee should watch most closely. Concentration: a single core laboratory is a single point of failure; a power outage, analyzer failure or flood at the flagship would affect both hospitals at once. A backup agreement with a reference laboratory would be needed. Transport: courier delays in bad weather could stretch turnaround for routine tests, and some specimens have stability limits that constrain how long they can travel. Each of these risks will be priced in a later brief that builds the strongest case against consolidation, so that the committee can see whether the recommendation survives them.

None of these risks changes the recommendation on its own, but together they explain why the conservative case matters more than the base case. A committee that approves the project should do so expecting the conservative outcome and treating the base case as an upside rather than a plan.

Recommendation

The project meets all three criteria, the first only narrowly under conservative volume. I recommend approval funded from board-designated reserves, on the condition that turnaround at the smaller hospital is reported monthly and that the committee reviews the volume of reference work brought in-house after the first year, since that line drives most of the difference between the base and conservative cases. If either falls short, the committee will have the evidence it needs to revisit the decision.

References

Cleverley, W. O., & Cleverley, J. O. (2018). Essentials of health care finance (8th ed.). Jones & Bartlett Learning.

Financial Accounting Standards Board. (2016). Accounting Standards Update No. 2016-14: Not-for-profit entities (Topic 958): Presentation of financial statements of not-for-profit entities. Financial Accounting Standards Board.

Gapenski, L. C., & Reiter, K. L. (2016). Healthcare finance: An introduction to accounting and financial management (6th ed.). Health Administration Press.