FORMULAS Shortcut

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 = FVn n (1 + K) 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:  rate1 will yield positive NPV  rate2 will yield negative NPV Trial and error technique for IRRe: 1. Solve for NPV at rate1 and rate2. 2. To calculate the true IRR, use the following formula: IRR = rate1 + NPV1(rate2 – rate1) NPV1 – NPV2 Where: IRR = internal rate of return rate1 = discount rate at which NPV is positive rate2 = discount rate at which NPV is negative NPV1 = NPV at rate1 NPV2 = NPV at rate2 If the IRR ≥ the project’s cost of capital or minimum required rate of return, the project is acceptable. If the IRR < the project’s 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 project’s cumulative cash flow. Period Cash flow Cumulative cash flow (CF) (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.