IHP 630 Module 8 Milestone Three Example

Milestone Three: Should Stonebridge Invest in an Ambulatory Surgery Center?

[Student Name]

Southern New Hampshire University

IHP 630: Healthcare Finance and Reimbursement

Module Eight Milestone Three

[Instructor Name]

[Date]

The organization, setting and figures below are a composite written as a model document. No real employer, client, colleague or patient is described.

Milestone Three: Should Stonebridge Invest in an Ambulatory Surgery Center?

Stonebridge Regional Medical Center has lost outpatient surgical volume to two independent surgery centers in the past three years. Its orthopedic and general surgeons have proposed a joint venture ambulatory surgery center, with Stonebridge owning 51%. The hospital's thin cash reserves make any large investment a serious decision. This milestone evaluates the proposal using discounted cash flow analysis.

Why Surgery Centers

Munnich and Parente (2014) compared procedures performed in ambulatory surgery centers and hospital outpatient departments and found that procedures took substantially less time in surgery centers, without evidence of worse outcomes, which lowers costs and allows more cases per day. Hair et al. (2012) similarly found shorter perioperative times in freestanding centers than in hospitals for common outpatient procedures. Medicare and most commercial insurers also pay surgery centers less than hospital departments for the same procedure, which makes centers attractive to payers and employers.

The Proposal

The center would have four operating rooms and two procedure rooms, built at a total cost of $14 million, with Stonebridge contributing $7.1 million and surgeons the balance. It would open in eighteen months and reach about 5,800 cases a year by its third year, mainly orthopedic, general surgery and pain procedures.

Physician Ownership

Joint ventures with physicians align incentives but raise concerns. Hollingsworth et al. (2010) found that physicians who acquired ownership in surgery centers increased their surgical volume more than similar non-owners, raising the possibility that ownership encourages more procedures. The venture's governance will include an appropriateness review for high-volume procedures, and the arrangement must satisfy federal anti-kickback and physician self-referral safe harbors, which counsel will review.

Incremental Cash Flows

The relevant cash flows are incremental: the difference between Stonebridge's cash flows with and without the center. Stonebridge's 51% share of the center's projected cash flow is offset by cannibalization, since some cases would move from the hospital's own outpatient department, where they earn a contribution margin. But without the center, surgeons would likely take more cases to the competing centers, so part of that volume is lost either way. After netting these effects, incremental cash flow to Stonebridge is projected at $0.3 million in year one, $0.9 million in year two, $1.2 million in year three and $1.3 million a year thereafter, with an estimated terminal value of $4 million for its share at year ten.

Choosing a Discount Rate

Future cash is worth less than cash today, so projected flows are discounted. Stonebridge's cost of capital, reflecting its tax-exempt borrowing rate and the return it expects on invested reserves, is estimated at about 7%. Because a surgery center carries more risk than the hospital's core business, sensitivity tests at 5% and 9% bracket the estimate.

Net Present Value

Discounting each year's cash flow at 7% and summing gives a present value of about $9.8 million. Subtracting the $7.1 million investment yields a net present value of about $2.7 million. Because the figure is positive, the center should return more than Stonebridge pays for its capital.

Table 1. Incremental Cash Flows and Present Values at 7%

Note. Composite projections; figures rounded.

Internal Rate of Return and Payback

Solving for the rate that would make the project's NPV exactly zero gives an internal rate of return of about 12.6%, comfortably above the 7% cost of capital. Adding up cash flows without discounting, Stonebridge would recover its $7.1 million during year seven. Payback ignores the time value of money and later cash flows, so it is used here only as a measure of liquidity risk for a cash-constrained hospital.

Sensitivity Analysis

At a 5% discount rate, net present value rises to about $4.0 million; at 9%, it falls to about $1.6 million. The most important assumption is cannibalization. If none of the displaced volume would have gone to competitors, incremental cash flow falls by about $0.4 million a year, and net present value drops to roughly zero. Case volume is the second key driver: a 15% shortfall in cases would cut net present value by about half.

Table 2. Sensitivity of Net Present Value

Note. Composite estimates.

Can Stonebridge Afford It?

Kim and McCue (2008) examined nonprofit hospitals' capital investment and found that it was associated with financial factors such as cash flow and profitability as well as market conditions, suggesting that financially weak hospitals tend to invest less, which can widen gaps over time. Stonebridge faces exactly this dilemma. Paying $7.1 million from reserves would cut days cash on hand from about 62 to about 53, below its bond covenant's 60-day threshold. Financing the share with debt instead would push its debt load higher still.

Strategic Considerations

Beyond the numbers, the center would help retain surgeons, recapture volume lost to competitors and position Stonebridge for bundled and site-neutral payment. Not investing risks further erosion of outpatient surgery, regardless of the analysis.

Recommendation

The project has a positive net present value under most assumptions, but its value depends heavily on retaining volume that would otherwise go to competitors, and its cost would breach the cash covenant if paid from reserves. Stonebridge should proceed only if the release of about $9.7 million from revenue cycle improvements is achieved first, or if a partner such as a regional system or management company takes a larger share, reducing Stonebridge's contribution to about $4 million. Either path lets the hospital capture most of the center's value while keeping its cash cushion above the covenant.

Conclusion

Discounted cash flow analysis shows the surgery center would likely create value for Stonebridge, with a net present value near $2.7 million and a return well above the cost of capital. The decision turns on cannibalization and cash, and sequencing it after the revenue cycle gains protects the hospital's liquidity.

References

Hair, B., Hussey, P., & Wynn, B. (2012). A comparison of ambulatory perioperative times in hospitals and freestanding centers. The American Journal of Surgery, 204(1), 23-27. https://doi.org/10.1016/j.amjsurg.2011.07.023

Hollingsworth, J. M., Ye, Z., Strope, S. A., Krein, S. L., Hollenbeck, A. T., & Hollenbeck, B. K. (2010). Physician-ownership of ambulatory surgery centers linked to higher volume of surgeries. Health Affairs, 29(4), 683-689. https://doi.org/10.1377/hlthaff.2008.0567

Kim, T. H., & McCue, M. J. (2008). Association of market, operational, and financial factors with nonprofit hospitals' capital investment. Inquiry, 45(2), 215-231. https://doi.org/10.5034/inquiryjrnl_45.02.215

Munnich, E. L., & Parente, S. T. (2014). Procedures take less time at ambulatory surgery centers, keeping costs down and ability to meet demand up. Health Affairs, 33(5), 764-769. https://doi.org/10.1377/hlthaff.2013.1281