The Capital Budgeting Process of Healthcare Organizations

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According to Wilkinson (2013), most medium size companies do not know how to handle capital budgeting decision because of the lack of exposure. Most of these companies treat capital budgeting like an operating budget. However, capital budgeting decisions should be treated as a long-term investment of the company because they have a direct impact on cash flows. They are many capital budgeting decisions every company has to make which include those of replacing assets such as machinery and long-term investment projects. It is critical for managers to know that functional needs identify capital budgeting decisions because of risk evaluations and strategic planning. These decisions include long-term decisions such as replacement of capital assets, reorganization of assets and investment in research and development expenditures.

Assignment 9.4

Poralis invested 2.12 million in a capital budgeting investment. The expected market returns from the investment is 10%. The expected duration of the project is 10 years. However, there is no cash flow given to calculate the present value. In order to determine the cash flow, the expected rate of return after ten years is dividend by the initial cash outlay. The cash flow can be established by forming an equation as follows:

	Cash flow	Discounting rate 10%	PV
1-10	2.12	0	(2.12)
	x	6.1446	6.144x

6.144x = 2.12 million

X= 2.12/6.144

Cash flow = $345,018.4

Therefore, the cash flow which must generated a market expected rate of return is 345, 018.4.

Calculating the expected rate of return from Poralis investment in capital assets

In order to determine the expected cash from investment in capital assets, it is essential to establish the purchases of plant and equipment from investment activities (Saxena, 2015). This figures can be obtained from the cash flow statement in the investment activities. The amount of investment in capital asset is $249, 485. The project has an expected rate of return of 10 percent and a useful life of 10 years. It is assumed that the plant and equipment have a useful life of ten years and an expected rate of return of 10%. The capital investment is treated as the initial capital outlay when determining the present value of the investment.

	Cash flow	Discounting rate 10%	PV
1-10	$249, 485	0	($249, 485)
	x	6.1446	6.144x

6.1446x= $249, 485

X= 249,485/6.144

X= 40, 6063

Therefore, the cash flow that will yield an internal rate of return of 10 percent is 40, 6063.

Although it is easy to identify the cash flow from investment in capital asset, it is important to consider the risk associated with each project. These risks can be evaluated using sensitive analysis or decision tree analysis. Sensitive analysis identifies what will happen if the expected rate of return changes (Marino & Matsusaka, 2005). For instance, if the expected rate of return changes from 10 percent to 12 percent, the present value will decrease. However, if the rate of return decreases, the present value of future cash flow will increase. Decision tree analysis involves plotting a graph of simple profitability analysis that identifies possible scenario and expected profitability (Mukherjee, Rahahleh, Lane & Dunn, 2016). When all possible outcomes are plotted on a graph, managers can be able to identify all possible scenarios, thus, allowing them to make decisions that are more informed. However, decision tree model requires more experience because it involves complex calculations.

In summary, it is critical for small companies to ensure they have adequate skills to help them calculate capital budgeting decision.

References

Marino, A. M., & Matsusaka, J. G. (2005). Decision Processes, Agency Problems, and Information: An Economic Analysis of Capital Budgeting Procedures. Review Of Financial Studies, 18(1), 301-325.

Mukherjee, T., Al Rahahleh, N., Lane, W., & Dunn, J. (2016). The Capital Budgeting Process of Healthcare Organizations: A Review of Surveys. Journal Of Healthcare Management, 61(1), 58-77.

Saxena, A. K. (2015). Capital budgeting principles: bridging theory and practice. Academy Of Accounting & Financial Studies Journal, 19(3), 283-293.

Wilkinson, J. (2013). Capital Budgeting Methods: The Strategic CFO. Web.

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The Capital Budgeting Process of Healthcare Organizations

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