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Formulas for finance

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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.

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