An Eight-Bed Observation Unit for $2.8 Million: A Positive Net Present Value That Depends on Two Things Managers Must Actually Do
Student Name
American College of Education
HLTH5653: Financial Analysis and Assessment in Healthcare Administration
Module 5 Assignment
Instructor Name
July 31, 2028
The Request and the Evidence Behind It
The emergency department has requested $2.8 million, $2.4 million for renovation and $0.4 million for equipment, to convert unused space next to the department into an eight-bed observation unit. Observation patients, those not well enough to go home but not clearly needing admission, now wait in the department and are then placed in medical-surgical beds, where they stay an average of 34 hours. About 2,900 patients a year receive observation care, and 24 percent of them are eventually admitted. The unit would treat them under defined clinical protocols for common conditions such as chest pain, syncope and asthma, staffed by nurses and covered by emergency physicians.
The evidence for such units is substantial. Ross et al. (2013), comparing approaches to observation care using Georgia and national data, found that patients in dedicated units with defined protocols had 23 to 38 percent shorter stays and a 17 to 44 percent lower probability of subsequent inpatient admission than patients observed elsewhere in the hospital. Baugh et al. (2012) estimated that a hospital without an observation unit could save an average of $1,572 per short-stay patient by adding one. The clinical case is strong; the question for this module is whether the financial case holds for this hospital, whose patient care operations ran $2.2 million in the red last year, and which cannot afford a project that does not pay for itself. An observation unit saves money for the health system; whether it saves money for the hospital depends on what the hospital does with the beds it frees.
Incremental Cash Flows
Only cash flows that change because of the project are counted. Five lines change each year once the unit is fully running. The unit's operating cost is $1.72 million: about 8.4 nurse positions to staff two nurses around the clock, 4.2 technician positions, supplies and a share of physician coverage. Against that, observation patients would no longer occupy medical-surgical beds for an average of 34 hours, which frees about 4,100 bed-days a year, roughly 11 beds on an average day. If the medical-surgical units reduce staffing to match, flexing down the equivalent of eight beds' staffing on most days, the hospital saves about $1.30 million.
The freed beds also allow the hospital to keep patients it now loses. Last year, 310 patients were transferred to other hospitals or left the emergency department because no bed was available. The analysis assumes the hospital recaptures 180 of these admissions a year, each contributing about $6,500 after variable costs, for $1.17 million. Protocol-driven care is expected to reduce unnecessary testing by about $150 per patient, saving $0.44 million. Against these gains, a lower admission rate means fewer short inpatient stays. If admissions from observation fall from 24 to 17 percent, about 203 fewer patients are admitted, and because a short inpatient stay pays more than observation care, the hospital loses about $0.32 million in contribution. The net annual cash flow is $0.87 million.
Returns
The hospital uses a 6 percent discount rate for capital projects and a ten-year life for renovated space. The analysis assumes the unit reaches half its net cash flow in its first year, while protocols are established and staffing on the inpatient units is adjusted, and its full $0.87 million in years two through ten. On those assumptions, the net present value is $3.19 million, the internal rate of return is 24.6 percent and the investment is paid back during the fourth year.
Those are strong returns for a $2.8 million project, and if the analysis stopped here, the request would be easy to approve. But the net cash flow of $0.87 million is the difference between gains of $2.91 million and costs of $2.04 million, so a modest shortfall in any of the gains could erase it. The sensitivity analysis shows which ones.
What the Result Depends On
Two assumptions dominate. The first is the $1.30 million in medical-surgical staffing savings. The savings exist only if managers actually schedule fewer staff when observation patients leave their units. If they flex half as much as assumed, the annual cash flow falls to $0.22 million and the net present value to negative $1.28 million. If they do not flex at all, the unit loses $0.43 million a year. The second is the recapture of admissions now lost. If the hospital recaptures 90 rather than 180, the net present value becomes negative $0.84 million; the break-even point is about 110 recaptured admissions a year, assuming full staffing savings. The unit's own operating cost matters less: if it runs 10 percent over budget, the net present value is still $2.01 million.
The analysis also rests on the published effect sizes applying here. Ross et al. (2013) reported a range of reductions in length of stay and admission, and the midpoints used here are reasonable, but a unit that does not use protocols consistently will not achieve them. Taheri et al. (2000) found that the last day of a hospital stay accounts for only a small share of its cost, which is why this analysis does not count shorter stays as savings on their own but only through staffing actually reduced and beds actually refilled. The net present value is not a property of the unit; it is a property of the decisions managers make after it opens.
Non-Financial Considerations
Some effects are not in the cash flows. Patients observed in dedicated units spend less time in the hospital and are less often admitted, which matters to them and to their out-of-pocket costs. Emergency department crowding would fall, reducing the number of patients who leave without being seen. Against this, observation status can surprise Medicare patients, who may face higher cost sharing than inpatients for some services and whose observation days do not count toward the three-day inpatient stay required for skilled nursing coverage. The unit's protocols must include clear notification to patients about their status, and case management must review any patient likely to need post-acute care early in the stay.
Conditions for a Defensible Approval
The project is worth doing only if the two critical assumptions are made real. The analysis therefore recommends approval with three conditions. First, before construction begins, the chief nursing officer should present a staffing plan showing how the medical-surgical units will reduce scheduled staff by the equivalent of eight beds on most days, with the reduction built into the next year's budget. Second, the emergency department and patient transfer center should report monthly on recaptured admissions, with a target of 180 a year and a review if the number is below 110 after the unit's first six months. Third, the finance committee should review the unit's actual cash flow at the end of its first full year, comparing each of the five lines with this analysis. The next module considers whether the board should approve this project in the hospital's current financial position.
References
Baugh, C. W., Venkatesh, A. K., Hilton, J. A., Samuel, P. A., Schuur, J. D., & Bohan, J. S. (2012). Making greater use of dedicated hospital observation units for many short-stay patients could save $3.1 billion a year. Health Affairs, 31(10), 2314-2323. https://doi.org/10.1377/hlthaff.2011.0926
Ross, M. A., Hockenberry, J. M., Mutter, R., Barrett, M., Wheatley, M., & Pitts, S. R. (2013). Protocol-driven emergency department observation units offer savings, shorter stays, and reduced admissions. Health Affairs, 32(12), 2149-2156. https://doi.org/10.1377/hlthaff.2013.0662
Taheri, P. A., Butz, D. A., & Greenfield, L. J. (2000). Length of stay has minimal impact on the cost of hospital admission. Journal of the American College of Surgeons, 191(2), 123-130. https://doi.org/10.1016/S1072-7515(00)00352-5
How this HLTH 5653 Module 5 example is structured
HLTH 5653 Module 5 typically tests a capital request or service line against its projected returns; your classroom's instructions decide the methods and discount rate. This example states the request and the evidence behind it, then builds incremental cash flows line by line, including losses as well as gains. The returns section reports net present value, internal rate of return and payback with the arithmetic basis. A sensitivity section identifies which assumptions the result depends on, and the paper ends with conditions that would make approval defensible.
HLTH5653 Module 5 questions, answered
What does HLTH5653 Module 5 usually ask for?
HLTH5653 Module 5 typically asks students to evaluate a capital request or new service line using projected cash flows and methods such as net present value, internal rate of return and payback. Many sections also expect sensitivity analysis and a recommendation. Your classroom's instructions decide the discount rate and methods.
What are incremental cash flows in a capital analysis?
Incremental cash flows are the changes in cash that happen only because of the project: new costs, savings and revenue gained or lost. Include losses such as revenue that disappears when fewer patients are admitted, and exclude costs the organization would incur anyway.
How do I show which assumptions matter most?
Change one assumption at a time to a plausible less favorable value and recalculate net present value. Report which changes turn the result negative and find break-even points. Then recommend conditions or monitoring for the assumptions that decide the outcome.
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