FINANCIAL ADMINISTRATION

Case 28: University of Virginia Health System: The LongTerm Acute Care Hospital Project

Team 1
Minh Bui

Table of Content
Problem Identification
Possible Solution.
Analysis of Solution
Conclusion/Summary..
Final Recommendation
Specific Plan of Implementation..

I. Problem Identification
Larry Fitzgerald, the vice president for business development and finance, proposed a
new long-term acute care (LTAC) hospital to the board of director of the University of Virginia
Health System, a non-profit organization. LTAC hospital is designed to service patients who
required hospital stays of 25 days or more and at least some acute care during that time. Since
1999, The UV Health system maintained a profit margin of 4.9%, while the board of director
considered 3% as a minimum to sustain the system. However, in developing a new project, the
board wanted 5% profit margin as a minimum for the investing consideration. The board also
wanted to reinvest any profit that is beyond the 5% level in developing teaching and research
purposes.
The board wanted to maintain the AA bond rating for the hospital to keep the borrowing
cost low and allow the hospital to effectively compete for debt dollars in the future. The total
investment for the LTAC project was $15 million, which Fitzgerald believed that the loan would
not jeopardize the AA rating. The Fitzgeralds proposal to the board would be more convincing
and effective if a detail performance and profit forecast was presented. In detail, the projected
cash flows (DCF), net present value (NPV), internal rate of return (IRR), and payback period
(PB) would be helpful indicators to support the boards decisions.
II. Possible Solution
From the information about capacity, payer mix, fees, expenses projected by Karen
Mulroney, the Fitzgeralds financial analyst, I constructed the 10-year forecasted income
statement of the project to come up with the free cash flow (FCF) model. Then, NPV, IRR, and
PB period would be drawn based on FCF. Since the UV Health System was not a publicly traded
firm, the cost of equity was not applicable. As a result, the corporate bond yield would be used as
the discounted rate.
III.Analysis of Solution
1. Constructing The 10-Year Projected Income Statement
The detail income statement is presented in Appendix 1 located at the last page.
a. Revenue
The LTACs revenue was constructed by five different segments: Medicare (36%),
Medicaid (29%), Commercial Payers (24%), Others (9%), and Indigent (2%). Table 1 shows the
Medicaids revenue calculation, a part of the total revenue calculation. The same calculation
method was applied to other revenue segments and in further years.
Year 1
Year 2
Year 3
Number of Patients
46
118
126
Billing rate (per case)
$35,000
$35,455
$35,916
Segment Revenue
$1,063,700
$4,174,472
$4,509,961
Table 1. Medicaid Revenue
The number of Medicaid patients was projected to be 46, 118, and 126 in year 1, 2, and 3.
Besides, the Medicaid billing rate was expected to increase 1.3% annually. As a result, the

revenue of the segment was the multiplication of the number of patients with the billing rate per
case.
The total revenue each year was the sum of all revenue segments.
b. Expense
Supplies, Drugs, and Food (SDF), management fees, and variable operating expenses
acquired 16.3%, 8%, and 7% of the revenue, respectively. Besides, Salary, Wage, and Benefits
and land leasing increased by 3% annually. Moreover, fix operating expenses was $1.2 million
per year.
Financing
The total expense each year was the sum of all expenses described above.
c. Earnings Before Interest And Tax (EBIT)
2. Calculating Capital Budgeting Indicators
IV. Conclusion/Summary
V. Final Recommendation

VI. Specific Implementation