Budgeting and Timeline Tools Paper
Budgeting and Timeline Tools Paper
My proposed change is beginning a flex pool system which will accommodate the staffing shortages throughout the hospital. This paper will outline the financial resources for this proposed changed, describe the budgeting tools used and challenges encountered throughout the budgeting process, and outline a timeline for the implementation of the proposed change.
The flex pool is expected to increase production by 30%, and which subsequently will increase the hospital’s income. The hospital needs 50 employees in the flex pool. The salary that will be paid to the employees annually is an approximate total of $420,000. Despite this, other allowances will amount to $180,000. The employees will have a contract of two years with a theoretical salvation value of $60,000. In the calculations, a discount rate of 10% will be used in the course of negotiations with the employees.
Budgeting Tools Used
There are various tools that will be utilized in the budgeting process. Net Present Value (NPV), Internal Rate of Return (IRR), Discounted Payback Period (DPP), and Profitability Index (PI).
NPV pursues the goal of financial management, which is to add value to the stockholders’ wealth, and displays the difference between the market value of the project and its costs (Parrino, Kidwell, & Bates, 2012). NPV is the present value of future cash flows minus initial investment and takes into consideration time value of money. It is consistent with the goal of financial management – to maximize the wealth of the company’s owners (Parrino et al., 2012). To calculate NPV, it is necessary to first estimate the expected future cash flows, afterwards compute the required return for projects of the appropriate risk level, and finally to identify the present value of the cash flows and deduct the sum of the initial investment. If NPV is greater than zero, it means that the expected cash flows of the project will exceed the project’s costs, which subsequently adds value to the firm. Contrarily, negative NPV will cut down the stockholders’ wealth. Applying NPV formula, we can calculate that the net present value of the project is $141,483.06.
Knowing that, where Ct = net cash inflow during the period t; Co = total initial investment costs; r = discount rate, and t = number of time periods (Investopedia, 2016).
We can calculate the project’s NPV, which is -$420,000 + $100,000/1.10 + $100,000/ (1.10)2 + $100,000/ (1.10)3 + $100,000/ (1.10)4 + $100,000/ (1.10)5 + $100,000/ (1.10)6 + $100,000/ (1.10)7 + $160,000/ (1.10)8 = $141,483.06.
This is a positive NPV, which means the project must be accepted, since it maximizes the value of the firm.
A popular alternative to NPV is internal rate of return (IRR), which is closely related to the NPV, since both methods take into consideration time value of money and both assume that the project will add value to the company. If the IRR is higher than the project’s discount rate, the project must be accepted. It is difficult to calculate IRR without using a financial calculator or Excel spreadsheet functions. For better understanding, IRR is the discount rate when NPV equals zero, representing the project’s growth for this investment (Parrino et al., 2012). IRR can give correct decisions for independent projects and is based on discounted cash flows. Taking the numbers of the example above, we can calculate the IRR of this project, which equals to 18.27%. This is 8.27% higher than the cost of capital, which means that the project must be accepted.
Another evaluation technique is discounted payback period (DPB), which in contrast to the traditional payback period, takes into consideration time value of money, i.e. future cash flows are discounted by the cost of capital (Hawawini, & Vialett, 2010). The DPB identifies the number of years necessary to recover the project’s initial investment. Hence, the shorter the payback period, the more attractive is the project. Unlike the other methods discussed above, DPB is based on profitability rather than liquidity. It is easy to compute and understand since it provides the cutoff point, usually in years, beyond which a project generates economic profit. On the other hand, DPB does not consider cash flows past this breakeven point and is not in favor of long-term projects. The DPB for our problem is 5.72 years.
DPB = (A – 1) + [Cost – Cumulative Present Value of Cash Flow (A – 1)]/ Present Value of Cash Flow A, where:
A is the year when the cumulative present value of cash flows from investment exceeded the initial investment;
A – 1 is the year prior to the year A;
Present Value of Cash Flow A is cumulative present value of the cash flows from investment at the end of year A – 1;
Cost is the initial cost of the investment (Simplified Accounting, 2016).
We can find that the payback period of the investment mentioned above is 5.72 years.
The last evaluation method discussed in this paper is profitability index (PI), which is very closely related to NPV as well, and represents present value of cash flows divided by the initial investments (Graham, Smart, & Megginson, 2010). PI compares the costs of the project to its benefits, i.e. it is the ratio of a project’s benefits to its cost. If the PI is greater than 1, the project must be accepted, subsequently, if the profitability index is lower than 1, the project must be rejected. The PI for our problem is 1.337, which means the project is expected to add value to the firm and therefore must be accepted.
The PI can be completed as follows: PI = 1 + NPV/Net Investment. In our case, the PI equals to 1 + $141,483.06/$420,000.00 = 1.337.
The greatest challenge I encountered was calculating the net present value (NPV). NPV is difficult to use and understand without financial or accounting background, since the discount rate and projected returns are problematic to calculate (Parrino et al., 2012). Also, NPV may not give accurate decision if the initial investments of the mutually exclusive projects are not equal and if the projects’ life spans differ.
Keeping in mind that the number of applicants expected will be huge, the following will be the expected flow of events:
- A) Advertisement of the jobs: 3 months, $1,000
- B) Receiving and reviewing the applications: 4 months, $0
- C) Interviewing the applicants: 3 months, $1,500
- D) Orientation to the all departments as they commence work: 1 month, $ 500
- E) Employees working under moderate supervision in all departments: 3 months, $0
- F) Employees working under minimal supervision: $3 months, $0
As such, the project will take an estimated 17 months and $3,000 in the initial phase.
*** Some variation however can be made by reducing the time allocated. Like the time for A can be added it to where it is much needed, like to C.
Graham, J. R., Smart, S. B., & Megginson, W. L. (2010). Corporate finance. Linking theory to what companies do. Third edition. South-Western Cengage Learning, Mason, p. 257-259
Hawawini, G., & Vialett, C. (2010). Finance for executives. Managing for Value Creation, 4th Ed. South-Western Cengage Learning, Mason, p. 222-230
Investopedia. (2016). Net Present Value – NPV. Retrieved from: http://www.investopedia.com/terms/n/npv.asp
Parrino, R., Kidwell, D. S., & Bates, T. W. (2012). Fundamentals of corporate finance. Second Edition. John Wiley & Sons, Inc., p. 306
Simplified Accounting. (2016). Discounted payback period. Retrieved from: http://accounting-simplified.com/management/investment-appraisal/discounted-payback-period.html#formula