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Case Study 2 Essay

Community General Hospital started in 1914 as Whittaker Memorial Hospital. A man by the name of Dr. Noland Wright was appointed as a manager at that time to review the hospital’s financial records. It turns out that Dr. Wright was trained only in the medical field not business. Unfortunately, he was the main cause for poor financial management at Community General Hospital. By 1970, the hospital had suffered in major losses and debts with a $402,000 budget deficit at the end of 1983.

The hospital took drastic steps to alleviate the dire financial situation by laying off employees, refusing non-paying patients and tightening admission criteria. By 1990, the debt was in excess of $20 million. The most important subject of the Community General Hospital study case is related to the mismanagement of the institution, its executive reorganization, and the financial agony it undergoes. Community General Hospital has undergone three decades of difficult financial situations that had not been overcome. Overall, Community General Hospital needs to assess its risk for bankruptcy by calculating its z-score.

From an investment standpoint, it needs to assess how risky the company is viewed as a whole and if any illegal activities are being condoned. II. METHODOLOGY 1. Ratios 2. Z-Score 3. CAPM 4. Net Present Value 1. RATIOS A. Current Ratio = Current Assets / Current Liabilities B. Acid-Test Ratio = (Cash + Accounts Receivable + Short Term Investments) / Current Liabilities = (Current Assets – Inventory) / Current Liabilities C. Fixed Asset Turnover = Sales / Total Fixed Assets D. Total Asset Turnover = Sales / Total Assets E. Debt Ratio = Total Debt / Total Assets = (Short Term Notes + Long Term Debt) / Total Assets

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F. Times Interest Earned = EBIT / Interest Expense G. Net Profit Margin = Net Profit / Revenue = Net Income / Sales Net Profit: Revenue – COGS – Operating Expense – Interest and Taxes H. Return on Total Assets = EBIT / Total Net Assets = EBIT / Total Assets I. Return on Net Worth = Net Income / Net Worth = Net Income / (Common Stock + Capital Surplus) Net Worth: Owner’s Equity: Assets – Liabilities: Common Stock + Capital Surplus 2. Z-SCORE = 1. 2X1 + 1. 4X2 + 3. 3X3 + . 6X4 + 1. 0X5 Z-Score: overall index of corporate health X1: working capital divided by total assets: (current assets – current iabilities) / ta X2: retained earnings divided by total assets: (beginning RE + Net Income – Dividends) / ta X3: EBIT divided by total assets: net income before interest and taxes / ta X4: market value of preferred and common equity divided by total liabilities: (p+c equity) / lia X5: sales divided by total assets 3. CAPM (K) Risk Free + Beta (Expected Market Return – Risk Free Rate) Risk free = 5% based on Gov Bonds which are risk free Beta = . 97 (assumed) Expected Market return= 10 -15% (assumed) 4. Net Present Value Rn (1 + R)m – Cost Rn (1994) = $597,986; Rn (1995) = $503,203

R= assume its 5% m = number of years which is 2 years (1994 & 1995) III. SOLUTION 1. RATIOS A. Current Ratio 1994 = 0. 6022 1995 = 0. 6754 B. Acid-Test Ratio 1994 = 0. 5230 1995 = 0. 5863 C. Fixed Asset Turnover 1994 = 1. 27X 1995 = 1. 55X D. Total Asset Turnover 1994 = 0. 840X 1995 = 0. 959X E. Debt Ratio 1994 = 2. 50 1995 = 2. 52 F. Times Interest Earned 1994 = 3. 44X 1995 = 5. 92X G. Net Profit Margin 1994 = -8. 83% 1995 = -6. 63% H. Return on Total Assets 1994 = 8. 39% 1995 = 6. 14% I. Return on Net Worth 1994 = -0. 1286 1995 = -0. 1117 2. Z-SCORE 1994 = 1. 2($2,696,392 – $4,477,630) + 1. (-$787,446)  + 3. 3($121,056) + $10,600,209 $10,600,209$10,600,209  +0. 6($10,600,209 – $26,449,701)  + 1($8,914,668) $10,600,209$10,600,209 =-. 020164 – 0 . 10400+0. 376798 – 0. 8971+0. 84098 = 0. 197 1995 = 1. 2($3,065,309 – $4,538,653) + 1. 4 (-$671,004)  + 3. 3($645,533) + $10,543,410 $10,543,410$10,543,410 +0. 6($10,543,410- $26,540,041) + 1($8,914,668) $10,543,410$10,543,410 =-0. 16768+(-0. 08909) +0. 202046 – 0. 9103+0. 84552) = -0. 119 3. CAPM (K) CAPM= 5%+. 97(10%-5%) =9. 85 CAPM without free risk rate= 0+. 97(10%-0) =9. 7

CAPM with a 3% free risk rate= 3%+. 97(10%-3%) =9. 79 4. Net Present Value 1/(1 + R)m  = 1/(1+0. 05)2 = 1 / 1. 1025 = . 907 Cost (1994) = $752,930; Cost (1995) = – $461,838 NPV (1994) = $597,986 (. 907) – ($752,930) = $542,373 – $752,930 = – $210,556 NPV (1995) = – $503,203 (. 907) – (– $461,838) = – $456,405 + $461,838 = $5433 1994 and 1995 = –205,123 IV. CONCLUSION A. The Risk Management Association reports that the average debt ratio for most companies range from 0. 57 to 0. 67, with relatively little variable from company to company, and anything above will be considered as high risk.

In Community General Hospital it’s debt ratio appears that their assets financed are in a huge debt. In 1994, a debt of 2. 5 means that debt finances are two times and half the assets. As for 1995, the hospital debt ratio is 2. 52, this indicated they are in more trouble. The hospital’s assets couldn’t meet to its debt for those two years stating that the hospital didn’t have enough assets and cash to pay off its debt. Furthermore, the ROTA figure gives investors an idea of how affectively the company is converting the money it has to invest into net income. The higher he ROTA number, the better, because the company is earning more money on less investment. For 1994, the ROTA of Community General Hospital is roughly 1. 14%; however, the hospital has 6. 12% of its ROTA. Therefore, the Community General Hospital did a little bit better at converting its investment into profit in the year of 1995 than 1994. B. According to the Z- Score Value (bankruptcy ratio) calculation for Community General Hospital, the firm can be classified as “Failure”. The Z-Value for both years (1994 & 1995) is in negative indicating that it is way below the 1. 875. We believe that this hospital is going to be in bankrupt.

C. The CAPM uses variation of discounted cash flows; only instead of giving hospital a marginal of safety by being conservative in its earnings estimates. D. With the given cost of capital at 5% the project has a negative NPV of 205,123. Therefore, we should reject the project since the NPV is less than zero or negative. The fraud relates to management embezzlement: -We know that the shareholder’s are not having any wealth at all. -We know the Hospital has no cash. -The financial deficit for the institution increased from ‘94-’95. In its current condition, it should be inoperable and out of service. It should be bankrupt at the least.

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