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FINANCE FORMULAS

Contribution Margin = Price of the service Direct


Variable Costs

Number of patients needed for a particular service
to break even:
Divide fixed cost by the service contribution margin.

*If there is a desired income, add the desired income
to the fixed cost:
Number of patients needed for a particular service
with a desired income =
(Fixed cost + Desired income) / Contribution margin

As long as the contribution margin is positive, the
sale of product or service will ultimately result to the
break-even point.
However, if the contribution margin is negative, the
production of that product or service will only result to
further losses.

Proposed price to break even:
Find X = Proposed price to break-even
Fixed cost = number of patients to break even
X Variable Cost

Minimum price to be set for a procedure
Assume Y = number of patients assumed to be
undergoing the procedure
Find X = Minimum price to be set for a procedure
Fixed cost = Y
X Variable Cost

Capital Budgeting Techniques

Net Present Value
PV = FV
n

(1 + K)
n

where: PV = present value
FV = future value
K = discount rate
n = number of periods
If the PV is positive or zero, the project is acceptable.
If the PV is negative, the project is not acceptable.

Internal Rate of Return
Discount rate at which NPV is zero

Use 2 different discount rates such that:
rate
1
will yield positive NPV
rate
2
will yield negative NPV

Trial and error technique for IRRe:
1. Solve for NPV at rate
1
and rate
2
.
2. To calculate the true IRR, use the following formula:

IRR = rate
1
+ NPV
1
(rate
2
rate
1
)
NPV
1
NPV
2
Where: IRR = internal rate of return
rate
1
= discount rate at which NPV is positive
rate
2
= discount rate at which NPV is negative
NPV
1
= NPV at rate
1

NPV
2
= NPV at rate
2


If the IRR the projects cost of capital or minimum
required rate of return, the project is acceptable.
If the IRR < the projects cost of capital or minimum
required rate of return, the project is not acceptable.
The higher the IRR, the better.
Payback Period
1. Construct the projects cumulative cash flow.
Period Cash flow
(CF)
Cumulative cash flow
(CCF)
0 (50,000) (50,000)
1 15,000 CF for year 0 + CF for year 1
2 14,000 CCF for year 1 + CF for year 2
3 12,000 CCF for year 2 + CF for year 3
4 12,000 CCF for year 3 + CF for year 4
5 12,000 CCF for year 4 + CF for year 5

2. Find where the cumulative cash flow turns
positive. Designate that year as year n.
3. Solve for n-1.
4. Divide the negative of the cumulative cash flow
for year (n-1) by the cash flow for year n.
5. The payback period is (n-1) + the answer in
#4.

Profitability Index (p. 464)
= Present values of cash inflows
Initial investment
If PI 1, the project is acceptable.
If PI < 1, the project is not acceptable.