Financial Management HPI4007 –Case 2 Lecture +
Learning Goals
1. What is meant by ‘investment’ and by ‘capital’ investment?
Capital investment: major monetary investments that are expected to achieve long-term benefits
and are undertaken with the aim to assure financial survival of an organization.
If an investment does not correspond to these features, it is not a capital investment
Two types of capital investments: material and financial investments
Financial investments: purchase of financial assets (e.g. shares, bonds, options etc).
Material investments: purchase of material assets (e.g. medical equipment, introduction of
management information system etc). We will focus on this type in this unit only.
Investments in land (e.g. purchasing, maintaining the land)
Investments in buildings (e.g. building, purchasing and maintaining the building)
Fixed equipment (e.g. purchasing and maintaining equipment fixed to the building)
Moveable equipment (e.g. purchasing and maintaining moveable equipment)
Multiple reasons for capital investment
1. Achieving organization objectives (e.g. improved access, quality etc)
2. Achieving financial objectives (e.g. cost recovery, profit size etc)
3. Attracting new financial resources (e.g. from investors, state etc)
Three types of decisions in capital investments (Zellman, chapter 7):
-Strategic decisions: capital investment decisions designed to increase a health care organization’s
strategic (long-term) position (e.g. purchasing physician practices to increase horizontal integration)
-Expansion decisions: capital investment decisions designed to increase the operational capability of
a healthcare organization (e.g. increasing examination space in a group practice to accommodate
increased volume)
-Replacement decisions: capital investment decisions designed to replace older assets with newer,
cost-saving ones (e.g. replacing a hospital’s existing cost-accounting system with a newer one)
2. What is investment analysis and what are its steps? What is time-value?
Capital investments are the subjects in investment analysis.
Investment analysis: systematic approach to evaluation to alternative investment options and
selection of the investment option that is most beneficial to the organization
There are several steps in an investment analysis (6)
1. Identification of need of investments (depend on organization objectives)
2. Identification of possible alternative investment (do nothing also option)
3. Value of the alternative investments (features of alternative)
-Financial features: numerical parameters -overview of parameters and valuation
o Initial investment
o Net annual cash flows
o Liquidation/rest/terminal value
o Lifetime of the investment project
o Discount rate
-Non-financial features: depend on nature of investment
o Increased output
1
, o Improved quality and production
o Higher access
4. Comparison of alternative investments (compare all values in evaluation technique)
5. Selection of an investment alternative (based on investment evaluation) -perform it
6. Methods of investment funding (identifies possible sources of funding)
Types of cash flows (4):
1. Operating: directly associated with investment (e.g. with regard to regular maintenance of
investment)
2. Spill-over: not directly associated with investment (e.g. as a result of investment, high
administrative burden)
3. Non-regular: do not appear periodically (e.g. extension of asset)
4. Unforeseeable: cannot be accounted for when investment is being analysed
Lifetime of the investment project: number of years for which the analysis of a specific investment is
performed. Can be different from economic lifetime (=refers to the number of years when the asset
can be used. For example: for an investment in land, the lifetime of the investment project can be
shorter than the actual economic lifetime (since it can be used longer after project as well)
-It is unfeasible to make long time predictions about expected net cash flows of the investment
-For investment with a shorter economic life time like equipment, the economic lifetime can be equal
to the investment project lifetime
Liquidation/rest/terminal value: indicates how much material asset will be worth at the end of the
project investment life time (can be indicated by expected value of a certain asset in the market at a
given moment in the future). However, if the economic life time is short, you can look how much you
can sell it for (recycling) and then this value will be indicated by these revenues.
Discount rate (opportunity rate): indicates required rate of return of an investment that is necessary
to compensate the temporary loss of funds that they use to pay for the investment and to
compensate for expected financial risk of the investment (due to several internal and external risk
factors). This can be determined intuitively based on discount rates associated with other
investments in the organization. However, it can also be based on the Capital Asset Pricing Model
which offers to systematically account for the unique company and market risks (not key topic)
3/4. How to select an investment option? Methods to be considered: payback (PB) period, net-present
value (NPV), internal rate of return (IRR), return on investment (ROI). What are the possible pros and
cons of these methods?
Several methods exists to do select an investment option (4):
1. Payback (PB) period
2. Net-present value (NPV)
3. Internal rate of return (IRR)
4. Return on investment (ROI)
Payback (PB) method: technique to attach value to investment option. It determines the payback
period (= the time period necessary to recoup the investment). The method will choose the project
with the shortest PB period. This is the preferred project.
=To calculate the PB period: you take the initial investment (as negative number = -500.000) and add
the nett annual cash flow per year (+150.000) until the number is
not negative anymore. When it is positive, it means that you have
paid back the initial investment with your annual cash flows. When
it is positive in the fourth year, the payback period is four years
after initial investment. In the lecture example, both alternatives
2
Learning Goals
1. What is meant by ‘investment’ and by ‘capital’ investment?
Capital investment: major monetary investments that are expected to achieve long-term benefits
and are undertaken with the aim to assure financial survival of an organization.
If an investment does not correspond to these features, it is not a capital investment
Two types of capital investments: material and financial investments
Financial investments: purchase of financial assets (e.g. shares, bonds, options etc).
Material investments: purchase of material assets (e.g. medical equipment, introduction of
management information system etc). We will focus on this type in this unit only.
Investments in land (e.g. purchasing, maintaining the land)
Investments in buildings (e.g. building, purchasing and maintaining the building)
Fixed equipment (e.g. purchasing and maintaining equipment fixed to the building)
Moveable equipment (e.g. purchasing and maintaining moveable equipment)
Multiple reasons for capital investment
1. Achieving organization objectives (e.g. improved access, quality etc)
2. Achieving financial objectives (e.g. cost recovery, profit size etc)
3. Attracting new financial resources (e.g. from investors, state etc)
Three types of decisions in capital investments (Zellman, chapter 7):
-Strategic decisions: capital investment decisions designed to increase a health care organization’s
strategic (long-term) position (e.g. purchasing physician practices to increase horizontal integration)
-Expansion decisions: capital investment decisions designed to increase the operational capability of
a healthcare organization (e.g. increasing examination space in a group practice to accommodate
increased volume)
-Replacement decisions: capital investment decisions designed to replace older assets with newer,
cost-saving ones (e.g. replacing a hospital’s existing cost-accounting system with a newer one)
2. What is investment analysis and what are its steps? What is time-value?
Capital investments are the subjects in investment analysis.
Investment analysis: systematic approach to evaluation to alternative investment options and
selection of the investment option that is most beneficial to the organization
There are several steps in an investment analysis (6)
1. Identification of need of investments (depend on organization objectives)
2. Identification of possible alternative investment (do nothing also option)
3. Value of the alternative investments (features of alternative)
-Financial features: numerical parameters -overview of parameters and valuation
o Initial investment
o Net annual cash flows
o Liquidation/rest/terminal value
o Lifetime of the investment project
o Discount rate
-Non-financial features: depend on nature of investment
o Increased output
1
, o Improved quality and production
o Higher access
4. Comparison of alternative investments (compare all values in evaluation technique)
5. Selection of an investment alternative (based on investment evaluation) -perform it
6. Methods of investment funding (identifies possible sources of funding)
Types of cash flows (4):
1. Operating: directly associated with investment (e.g. with regard to regular maintenance of
investment)
2. Spill-over: not directly associated with investment (e.g. as a result of investment, high
administrative burden)
3. Non-regular: do not appear periodically (e.g. extension of asset)
4. Unforeseeable: cannot be accounted for when investment is being analysed
Lifetime of the investment project: number of years for which the analysis of a specific investment is
performed. Can be different from economic lifetime (=refers to the number of years when the asset
can be used. For example: for an investment in land, the lifetime of the investment project can be
shorter than the actual economic lifetime (since it can be used longer after project as well)
-It is unfeasible to make long time predictions about expected net cash flows of the investment
-For investment with a shorter economic life time like equipment, the economic lifetime can be equal
to the investment project lifetime
Liquidation/rest/terminal value: indicates how much material asset will be worth at the end of the
project investment life time (can be indicated by expected value of a certain asset in the market at a
given moment in the future). However, if the economic life time is short, you can look how much you
can sell it for (recycling) and then this value will be indicated by these revenues.
Discount rate (opportunity rate): indicates required rate of return of an investment that is necessary
to compensate the temporary loss of funds that they use to pay for the investment and to
compensate for expected financial risk of the investment (due to several internal and external risk
factors). This can be determined intuitively based on discount rates associated with other
investments in the organization. However, it can also be based on the Capital Asset Pricing Model
which offers to systematically account for the unique company and market risks (not key topic)
3/4. How to select an investment option? Methods to be considered: payback (PB) period, net-present
value (NPV), internal rate of return (IRR), return on investment (ROI). What are the possible pros and
cons of these methods?
Several methods exists to do select an investment option (4):
1. Payback (PB) period
2. Net-present value (NPV)
3. Internal rate of return (IRR)
4. Return on investment (ROI)
Payback (PB) method: technique to attach value to investment option. It determines the payback
period (= the time period necessary to recoup the investment). The method will choose the project
with the shortest PB period. This is the preferred project.
=To calculate the PB period: you take the initial investment (as negative number = -500.000) and add
the nett annual cash flow per year (+150.000) until the number is
not negative anymore. When it is positive, it means that you have
paid back the initial investment with your annual cash flows. When
it is positive in the fourth year, the payback period is four years
after initial investment. In the lecture example, both alternatives
2
