<<

. 21
( 21)



(The free operating cash ¬‚ow approach focuses on cash ¬‚ows that are
available to service both debt and equity investors.)
• The market multiple approach identi¬es some proxy for value, such as
earnings before interest, taxes, depreciation, and amortization (EBITDA),
and then multiplies it by a multiple derived from recent market data.
• The discounted cash ¬‚ow approach has the strongest theoretical basis, but
its inputs”the projected cash ¬‚ows and discount rate”are very dif¬cult to
estimate. The market multiple approach is somewhat ad hoc but requires a
much simpler set of inputs.


This chapter concludes the book. We hope that you have found it both easy
to use and useful in your quest for competency in healthcare ¬nance.



Questions
18.1 Distinguish between operating and ¬nancial leases. Would you be
more likely to use an operating lease to ¬nance a piece of diagnostic
equipment or a hospital building?
18.2 Leasing companies often promote the following two bene¬ts of leasing.
Critique the merits of each hypothesized bene¬t.
a. Leasing preserves a business™s liquidity because it avoids the large
cash outlay associated with buying the asset.
b. Leasing (with operating leases) allows businesses to use more debt
585
Chapter 18: Lease Financing and Business Valuation



¬nancing than would otherwise be possible because leasing keeps
the liability off the books.
18.3 Assume that there were no IRS restrictions on what type of transaction
could qualify as a lease for tax purposes. Explain why some restrictions
should be imposed.
18.4 In the Nashville Radiology Group example given in the chapter, we
assumed that the lease did not have a cancellation clause. What effect
would a cancellation clause have on the analysis?
18.5 Discuss some of the asymmetries that drive lease transactions.
18.6 Describe the mechanics of the discounted cash ¬‚ow (DCF) approach
to business valuation.
18.7 Describe the mechanics of the market multiple approach to business
valuation.
18.8 Which approach do you think is best for valuing a business: the DCF
approach or the market multiple approach? Explain the rationale
behind your answer.



Problems
18.1 Suncoast Healthcare is planning to acquire a new x-ray machine that
costs $200,000. The business can either lease the machine using an
operating lease or buy it using a loan from a local bank. Suncoast™s
balance sheet prior to acquiring the machine is a follows:
Current assets $ 100,000 Debt $ 400,000
Net ¬xed assets 900,000 Equity 600,000
Total assets $1,000,000 Total claims $1,000,000


a. What is Suncoast™s current debt ratio?
b. What would the new debt ratio be if the machine were leased? If it
is purchased?
c. Is the ¬nancial risk of the business different under the two acquisition
alternatives?
18.2 Big Sky Hospital plans to obtain a new MRI that costs $1.5 million and
has an estimated four-year useful life. It can obtain a bank loan for the
entire amount and buy the MRI or it can lease the equipment. Assume
that the following facts apply to the decision:
• The MRI falls into the three-year class for tax depreciation, so
the MACRS allowances are 0.33, 0.45, 0.15, and 0.07 in Years 1
through 4, respectively.
• Estimated maintenance expenses are $75,000 payable at the
beginning of each year whether the MRI is leased or purchased.
• Big Sky™s marginal tax rate is 40 percent.
• The bank loan would have an interest rate of 15 percent.
586 Healthcare Finance



• If leased, the lease (rental) payments would be $400,000 payable
at the end of each of the next four years.
• The estimated residual (and salvage) value is $250,000.
a. What are the NAL and IRR of the lease? Interpret each value.
b. Assume now that the salvage value estimate is $300,000, but all
other facts remain the same. What is the new NAL? The new IRR?
18.3 HealthPlan Northwest must install a new $1 million computer to track
patient records in its three service areas. It plans to use the computer
for only three years, at which time a brand new system will be acquired
that will handle both billing and patient records. The company can
obtain a 10 percent bank loan to buy the computer or it can lease the
computer for three years. Assume that the following facts apply to the
decision:
• The computer falls into the three-year class for tax depreciation,
so the MACRS allowances are 0.33, 0.45, 0.15, and 0.07 in Years
1 through 4, respectively.
• The company™s marginal tax rate is 34 percent.
• Tentative lease terms call for payments of $320,000 at the end of
each year.
• The best estimate for the value of the computer after three years
of wear and tear is $200,000.
a. What are the NAL and IRR of the lease? Interpret each value.
b. Assume now that the bank loan would cost 15 percent, but all other
facts remain the same. What is the new NAL? The new IRR?
18.4 Assume that you have been asked to place a value on the ownership
position in Briarwood Hospital. Its projected pro¬t and loss statements
and equity reinvestment (asset) requirements are shown below (in
millions):

2005 2006 2007 2008 2009
Net revenues $225.0 $240.0 $250.0 $260.0 $275.0
Cash expenses 200.0 205.0 210.0 215.0 225.0
Depreciation 11.0 12.0 13.0 14.0 15.0
Earnings before interest and taxes (EBIT) $ 14.0 $ 23.0 $ 27.0 $ 31.0 $ 35.0
Interest 8.0 9.0 9.0 10.0 10.0
Earnings before taxes (EBT) $ 6.0 $ 14.0 $ 18.0 $ 21.0 $ 25.0
Taxes (40 percent) 2.4 5.6 7.2 8.4 10.0

Net pro¬t $ 3.6 $ 8.4 $ 10.8 $ 12.6 $ 15.0

Asset requirements $ 6.0 $ 6.0 $ 6.0 $ 6.0 $ 6.0


Briarwood™s cost of equity is 16 percent. The best estimate for
Briarwood™s long-term growth rate is 4 percent.
a. What is the equity value of the hospital?
b. Suppose that the expected long-term growth rate was 6 percent.
587
Chapter 18: Lease Financing and Business Valuation



What impact would this change have on the equity value of the
business? What if the growth rate were only 2 percent?
18.5 Assume that you have been asked to place a value on the fund capital
(equity) of BestHealth, a not-for-pro¬t HMO. Its projected pro¬t and
loss statements and equity reinvestment (asset) requirements are shown
below (in millions):

2005 2006 2007 2008 2009
Net revenues $50.0 $52.0 $54.0 $57.0 $60.0
Cash expenses 45.0 46.0 47.0 48.0 49.0
Depreciation 3.0 3.0 4.0 4.0 4.0
Interest 1.5 1.5 2.0 2.0 2.5

Net pro¬t $ 0.5 $ 1.5 $ 1.0 $ 3.0 $ 4.5

Asset requirements $ 0.4 $ 0.4 $ 0.4 $ 0.4 $ 0.4


The cost of equity of similar for-pro¬t HMO™s is 14 percent, while the
best estimate for BestHealth™s long-term growth rate is 5 percent.
a. What is the equity value of the HMO?
b. Suppose that it was not necessary to retain any of the operating
income in the business. What impact would this change have on the
equity value?


Notes

1. For more information about the motivating forces and extent of leasing in the
hospital industry, see Louis C. Gapenski and Barbara Langland-Orban, “Leasing
Capital Assets and Durable Goods: Opinions and Practices in Florida Hospitals,”
Health Care Management Review (Summer 1991): 73“81.
2. Financial Accounting Standards Board (FASB) Statement 13, “Accounting for
Leases,” spells out in detail both the conditions under which the lease must be
capitalized and the procedures for capitalizing it.
3. For a discussion of the lessor™s analysis, see Louis C. Gapenski, Understanding
Healthcare Financial Management (Chicago: Heath Administration Press,
2003), Chapter 8.
4. The use of the constant growth model to estimate a business™s terminal value
could create an upward bias in the valuation estimate because it assumes that the
business will be operated forever. However, the contribution of cash ¬‚ows after
40“50 years to the terminal value is inconsequential, so the constant growth
model does not really require constant growth into perpetuity. Still, if there is
some doubt about the life of the business, it might be best to either subjectively
reduce the resulting constant growth terminal value estimate or to use some
other methodology to estimate the terminal value.
588 Healthcare Finance



References
The following references are relevant to leasing:
Beggan, J. F., and L. K. McNulty. 1991. “Restrictions on Depreciation Where Tax-
Exempt Entities Are Involved.” Topics in Health Care Financing (Fall): 62“69.
Berg, I. J., and A. N. Frankel. 1988. “Equipment Leasing: How, When, and If.”
Health Progress (November 15): 22“26.
Conbeer, G. P. 1990. “Leasing Can Add Flexibility to High-Tech Asset Manage-
ment.” Healthcare Financial Management (July): 26“34.
Dine, D. D. 1988. “Equipment Leasing Firms Offer Deals to Hospitals.” Modern
Healthcare (November 18): 50“51.
Grant, L., and D. O™Donnell. 1990. “Watch for Pitfalls When Analyzing Lease Op-
tions.” Healthcare Financial Management (July): 36“43.
“Leasing: Three Experts Discuss the Advantages of Equipment Leasing.” 1989.
HealthWeek (November): 51“53.
Meyers, S. C., D. A. Dill, and A. J. Bautista. 1976. “Valuation of Financial Lease
Contracts.” Journal of Finance (June): 799“819.
Rosenthal, R. A. 1992. “Creative Leasing Strategies for Medical Of¬ce Buildings.”
Healthcare Financial Management (December): 30“34.

The following references are relevant to business valuation:
Baumann, B. H., and M. R. Oxaal. 1993. “Estimating the Value of Group Medical
Practices.” Healthcare Financial Management (December): 58“65.
Becker, S., and J. Callahan. 1996. “Physician-Hospital Transactions: Developing a
Process for Handling Valuation-Related Issues.” Journal of Health Care Fi-
nance (Winter): 19“31.
Becker, S., and R. J. Pristave. 1995. “Physician-Based Transactions: The Sale of Med-
ical Practices, Ambulatory Surgery Centers, and Dialysis Facilities.” Journal of
Health Care Finance (Winter): 13“26.
Cleverley, W. O. 1997. “Factors Affecting the Valuation of Physician Practices.”
Healthcare Financial Management (December): 71“73.
Collins, H., and G. Simpson. 1995. “Avoiding Pitfalls in Medical Practice Valuation.”
Healthcare Financial Management (March): 20“22.
Evans, C. J. 2000. “Measuring the Value of Healthcare Business Assets.” Healthcare
Financial Management (April): 58“64.
Federa, R. D., and J. S. Ketcham. 1993. “The Valuation of Medical Practices.” Topics
in Health Care Financing (Spring): 67“75.
Hahn, W. 1994. “Determining a Healthcare Organization™s Value.” Healthcare Fi-
nancial Management (August): 40“44.
Harrison, J. P., M. J. McCue, and B. B. Wang. 2003. “A Pro¬le of Hospital Acquisi-
tions.” Journal of Healthcare Management (May/June): 156“171.
Moore, B. E. 1999. “Nonpro¬t to For-Pro¬t Hospital Transactions: All Roads Lead
to the Attorney General™s Of¬ce.” Journal of Health Care Financing (Spring):
29“36.
Nanda, S., and A. Miller. 1996. “Risk Analysis in the Valuation of Medical Practices.”
Health Care Management Review (Fall): 26“32.
Reilly, R. F. 1990. “The Valuation of a Medical Practice.” Health Care Management
Review (Summer): 25“34.
589
Chapter 18: Lease Financing and Business Valuation



Reilly, R. F., and J. R. Rabe. 1997. “The Valuation of Health Care Intangible Assets.”
Health Care Management Review (Spring): 55“64.
Rimmer, T. B. 1995. “Physician Practice Acquisitions: Valuation Issues and Con-
cerns.” Hospital & Health Services Administration (Fall): 415“425.
Schwartzben, D., and S. A. Finkler. 1998. “Combining Accounting Approaches to
Practice Valuation.” Healthcare Financial Management (June): 70“76.
Strode, R. D. 2004. “Hospital-Physician Joint Ventures: Threat or Opportunity.”
Healthcare Financial Management (July): 80“86.
Unland, J. J. 1989. Valuation of Hospitals and Medical Centers. Chicago: Health
Management Research Institute.
This page intentionally left blank
INDEX




ABC. See Activity based costing Asset: balance sheet, 88; categories of, 90“
Accounting, 4; entity, 59; identity, 89, 111; 96, 111; management ratios, 538“39,
income, 429; methods, 62“65; period, 553; structure, 398
60 Asymmetric information, 382
Accounts, 65“67 Auditor™s opinion, 57“58
Accounts payable, 97, 109“10, 512“14, Automated clearinghouse, 500
519 Average age of plant, 539“40
Accounts receivable ¬nancing, 516 Average collection period (ACP), 503“5,
Accreditation, 8, 11 518
Accrual accounting, 62, 63“65, 81 Average cost, 125
Accruals, 97, 512 Average daily billings (ADB), 503“4
Accumulated depreciation, 95 Average length of stay (ALOS), 550“51
ACP. See Average collection period
Bad debt, 70, 75
Activity based costing (ABC), 176“79,
181 Balance sheet: accounting identity, 89;
Activity ratios, 538“39 assets, 88, 90“96; basics, 88“90;
Actual budget, 244 equity, 88, 98“101; ¬nancial analysis,
ADB. See Average daily billings 111; fund accounting, 102; income
Administrative costs, 208“9 statement interrelationship, 112;
Adverse opinion, 58 lease effects, 565“67; liabilities, 88,
Advertising, 108, 109 96“98; purpose of, 87“88, 111;
Agency problem, 30, 46 sections, 88, 90“101; structure, 88“
Aging schedule, 505, 518 89; time period, 68; transactions,
AICPA. See American Institute of Certi¬ed 106“10
Public Accountants Bank loan, 514“15, 519
Allocation rate, 159“60 Bankruptcy risk, 577“78
Allowable cost, 39 Base case analysis, 193“97, 212
ALOS. See Average length of stay Basic accounting equation, 89
Alternative minimum tax (AMT), 575 Benchmarking, 547“48, 553
Ambulatory care, 10“11, 18 Bene¬ts expense category, 73“74
American Institute of Certi¬ed Public Best efforts sale, 369
Accountants (AICPA), 57 Beta coef¬cient, 304“6
Amortization schedule, 280, 281 Billed charges, 40
Amortized loans, 278“81 Biotechnology, 4
AMT. See Alternative minimum tax Blanket lien, 517
Annual compounding, 276 Blue Cross/Blue Shield, 34“35
Annual report, 67 Blue sky laws, 368
Annuity, 265“68 Board of directors, 27
591
Annuity due, 265, 267“68, 281 Board of trustees, 28
592 Index



Bond, 328; basic valuation model, 344“48; Capital in excess of par, 100
general valuation model, 342“43; Capital gain (loss), 291, 326
indenture, 352; insurance, 335, 352; Capitalization ratio, 535“36
interest rate risk, 349“51; rate of return, Capital structure: balance sheet, 112;
352; ratings, 333“34; semiannual basics, 389; debt ¬nancing impact,
compounding, 348“49 390“93; judgmental analysis, 396“98;
Book value, 540 not-for-pro¬t business, 398“99; ratios,
Bottom-up budget, 227“28, 244 535“38; theory, 393“96
Breakeven: analysis, 133“36, 151, 199“ Capitation, 39; ¬nancial risk, 44; price
200, 442“43; point, 133“35; pricing setting under, 193“201; pro¬t analysis,
decisions, 192“93; volume, 133 143“50; projected P&L statement
Budget, 6; bottom-up approach, 227“28, analysis, 147“50; provider incentives,
244; conventional approach, 226“27, 43; provider risk, 152; revenue, 71;
243; participatory, 227“28; process, utilization, 148“50
243; purpose, 222“23, 243; time CAPM. See Capital Asset Pricing Model
periods, 226; top-down approach, 228, Carriers, 37
244; types, 223“26, 243; zero-based, Carved out bene¬ts, 205
227, 243 Cash, 91; accounting, 62“63, 81; budget,
225“26, 239“43, 244, 495; equipment
Business organization, 21“25
purchase, 107; management, 498“
Business risk, 396“97
501, 518; net increase (decrease),
Business valuation, 24, 561, 578“83
106; out¬‚ow, 476“78; receipt from
Bylaws, 24
third-party, 110
Calculator: annual compounding, 276; Cash ¬‚ow: accounting income versus,
future value, 257, 266, 267, 271“72; 429; analysis, 436“41; cannibalization
present value, 260, 266, 268, 270; effect, 431“32; coverage ratio, 537“38;
semiannual compounding, 277 estimate, 81, 235“42, 428“34; from
Call premium, 332, 352 ¬nancing activities, 105“6; incremental,
Call provision, 330, 332“33, 352 429; in¬‚ation effects, 433“34; from
Call risk premium (CRP), 337“38 investing activities, 105; net income
Cancellation clause, 562 versus, 78“79; net working capital, 432“
Cannibalization, 431“32 33; from operating activities, 103“5;
Capital: allocation, 325“26; components, opportunity costs, 431; project life,
400; cost of, 68, 399“401; forms of, 430; register, 270; replacement analysis,
325, 351; investments, 105; lease, 441“42; shipping/installation cost, 432;
565“67; projects, 426“27; rationing, strategic value, 434; stream, 342; sunk
481“82, 483; supply and demand costs, 430“31; timing, 429“30
factors, 326; tax effects, 400“401 C corporation, 25
Capital Asset Pricing Model (CAPM), CE. See Certainty equivalent method
313“16, 317, 404“6 Centers for Medicare and Medicaid
Capital budgeting: breakeven analysis, Services (CMS), 37
442“43; cash ¬‚ow, 428“34; decision Certainty equivalent (CE) method, 473“74
process, 479“81; de¬nition of, 451; Certi¬cate of need (CON), 14“15
¬nancial analysis, 427“28, 451; Charge-based reimbursement, 40, 42, 43
importance of, 425“26; investment Charge master price, 70
decisions, 6; net working capital, 451; Charitable contributions, 71“72, 371“72,
not-for-pro¬t business, 446“50; post 384
audit, 449“50; pro¬tability analysis, Charitable organization, 28
443“46; project classi¬cations, 426“ Charity care, 70“73
27; project risk, 472“76; purpose Chart of accounts, 66
of, 320; quantitative analysis, Charter, 24
481 Churning, 42
593
Index



Classi¬ed stock, 363 Cost allocation: activity based costing,
Closely held companies, 26“27, 384 176“79, 181; basics, 159“62; de¬nition
CMS. See Centers for Medicare and of, 156; direct method, 161, 164“71,
Medicaid Services 181; drivers, 160“61; goal of, 159, 180;
Coef¬cient of variation (CV), 295 importance of, 180; overhead costs, 158;
Collateral, 516 process, 161“62; reciprocal method,
Collection ¬‚oat, 499 161“62, 181; step-down method, 162,
Collections worksheet, 239“40 174“76, 181; tests, 180
Commercial health insurance, 35“36 Cost-based reimbursement, 39, 41“43
Common size analysis, 544, 553 Cost-bene¬t issue, 167
Common stock, 26; balance sheet account, Cost of capital, 478“82
100; direct purchase plan, 365; dividend Cost per discharge, 551
reinvestment plan, 364“65; employee Costly trade credit, 514
stock purchase plan, 364; market, Cost-volume-pro¬t (CVP) analysis,
365“67; private placement, 364; public 128“29; basic data, 129“31;
offerings, 364; rights offerings, 263; breakeven analysis, 133“36; capitation
sale methods, 384; type of, 362“63; environment, 143“50; contribution
valuation, 373“79 margin, 132“33; discounted fee-for-
Comparative analysis, 541“42, 553 service environment, 138“43; operating
Compensating balance, 515 leverage, 136“38; projected P&L
Competitive environment, 224 statement, 131“32
Compounding, 255“59, 276“77, 281 Coupon payment, 344
CON. See Certi¬cate of need Coupon rate, 343“44
Concentration banking system, 500, 518 Coverage ratio, 536“38
Constant growth stock, 376“79, 384 Covered life, 39
Contra accounts, 66 Credit: advertising purchase, 108;
Contra-asset, 95 enhancement, 335, 352; policy, 512“13;
Contract analysis, 208“12 services rendered for, 108; supply
Contract management, 7 purchase, 107“8; terms, 97, 512“13
Contributed capital, 100 Creditor, 96
Contribution margin, 132“33, 151“52 Cross-subsidization, 191, 212
Control, 27 CRP. See Call risk premium
Controlled disbursement account, Cumulative cash ¬‚ow, 442
500“501 Current asset: balance sheet, 91“94;
Corporate bonds, 328 cash, 498“501; ¬nancial policy, 493,
Corporate cost of capital, 399“401, 518; investment policy, 493“95, 517;
412“15 marketable securities, 501“2
Corporate ¬nance, 4 Current liabilities, 97, 111
Corporate risk, 306“7, 317, 462“64, 482 Current ratio, 332, 534
Corporate taxes, 33 CV. See Coef¬cient of variation
Corporation, 23“24 CVP. See Cost-volume-pro¬t analysis
Corporation commissioner, 368, 384
Correlation, 464 Days-cash-on-hand ratio, 534“35
Correlation coef¬cient, 298“300 Days in patients accounts receivable, 539
Cost: see also Expenses; accounting, Days™ sales outstanding (DSO), 539
122; behavior, 124“26, 130, DCF. See Discounted cash ¬‚ow
151; classi¬cations, 122, 123“28; Debenture, 329
containment programs, 15; de¬nition of, Debt: capacity, 398, 478, 566; categories,
122; driver, 159“61, 166“67, 171“74, 351; contract, 331“33; cost, 417; cost of
176, 181; pool, 159, 165“66; reduction, capital, 401“3; ¬nancing, 325, 327“31;
200“201; structure, 210“11; variance, ratios, 111, 535“38, 553; security, 338;
236, 237 valuation, 341“51
594 Index



Debt cost plus risk premium, 408“9 EBITDA. See Earnings before interest,
Debt service requirement, 330, 344 taxes, depreciation, and amortization
Debt-to-capitalization ratio, 535“36 Economic breakeven, 192
Debt-to-equity ratio, 536 Economic events, 55, 60
Decision process, 472“76, 479“81 Economic income, 77
Default, 96, 328“29 Economic Value Added (EVA), 546“47,
Default risk premium (DRP), 336“37 553
Deferred annuity, 265 Economies of scale, 138
Deferred call, 332 EDI. See Electronic data interchange
Degree of operating leverage (DOL), Effective annual rate (EAR), 278“79, 282
137“38, 152 Ef¬ciency variance, 237
Demand deposits, 91 Ef¬cient Market Hypothesis (EMH),
Depreciation: accumulated, 95; cash 380“82
¬‚ow, 78“79; expense category, 74“75; Electronic claims processing, 508
straight-line method, 75 Electronic data interchange (EDI), 508
Diagnosis related group (DRG), 40 EMH. See Ef¬cient Market Hypothesis
Direct allocation method, 163, 164“71, Employee stock purchase plan, 364, 384
181 Enrollee, 39
Direct cost, 157“58, 180 Environmental category, 427
Disbursement control, 500“501 EPO. See Exclusive provider organization
Disbursement ¬‚oat, 498“99 Equilibrium, 379“80
Disclosure, 61 Equipment, 107
Discount, 70, 259“61 Equity: balance sheet, 88, 98“101; capital,
Discounted cash ¬‚ow (DCF), 406“8, 325, 403“12; cost of, 417; de¬nition of,
578“84 112; ¬nancing, 359“62; not-for-pro¬t
Discounted charges, 40 business, 371“73
Discounted fee-for-service, 138“43 EVA. See Economic Value Added
Discounted rate schedules, 38 Exchanges, 26
Discount rate, 262 Exclusive provider organization (EPO),
Discretionary replacement category, 426 38
Diversi¬able risk, 301“3, 317 Expansion category, 426“27
Dividend: growth, 360“61; payments, Expected dividend stream, 373“74
77; probability distributions, 291; from Expected earnings stream, 373
residual earnings, 27; stream, 360, Expected rate of return: constant growth
valuation model, 374“75 model, 377“79; equation, 384;
Dividend reinvestment plan (DRIP), equilibrium, 379; explanation of,
364“65, 384 292“93; on portfolio, 296“97
Divisional cost of capital, 415, 483 Expense budget, 225
DOL. See Degree of operating leverage Expenses: accrued, 97; categories, 73“76;
Dollar cost analysis, 570“72 classi¬cation, 68; de¬nition of, 81;
Dollar return, 273“74 income statement categories, 73“76;
Double entry system, 66“67 payment of, 109
DRG. See Diagnosis related group External audit, 57“58
DRIP. See Dividend reinvestment plan
Factoring receivables, 516
DRP. See Default risk premium
Fair market value, 94
DSO. See Days™ sales outstanding
FASB. See Financial Accounting Standards
Du Pont analysis, 542“44, 553
Board
EAR. See Effective annual rate Federal hospitals, 9
Earnings before interest, taxes, Fee-for-service: ¬nancial risk, 43;
depreciation, and amortization institutional rate setting, 202; pro¬t
(EBITDA), 582“83 analysis, 138“43; provider incentives,
595
Index



Fixed costs, 123, 151
41“42; reimbursement methods, 39“41;
Flexible budget, 232“34, 244
revenue, 71
Financial Accounting Standards Board Float, 498“501, 518
(FASB), 57 Floating interest rate, 328
Financial analysis, 427“28, 451 Footnotes, 67
Financial asset, 253, 342“43 Founders™ shares, 363
Financial calculator: annual compounding, Free trade credit, 514
277; bond value, 345“46; dollar return, Full cost pricing, 189“90
274; future value, 257“58, 266, 267, Functional classi¬cation, 73
272; interest rate, 264, 275; periodic Fund accounting, 102, 112
payment amount, 280; present value, Fund capital, 325, 359, 409“12
261, 266, 268, 270“71; semiannual Funded depreciation, 94“95
compounding, 277, 349; time solution, Funded depreciation portfolio, 502
265; yield to maturity, 348 Future value: of annuity, 265“67; of
Financial condition, 527; benchmarking, annuity due, 267; of lump sum,
547“48; Du Pont analysis, 542“44; 255“59; uneven cash ¬‚ow stream,
¬nancial statement analysis, 527“31; 271“72
operating indicator analysis, 549“51;
GAAP. See Generally accepted accounting
ratio analysis, 531“42
principles
Financial counseling, 507
Gatekeeper, 38
Financial interest, 55“56
General acute care hospital, 8“9
Financial lease, 562“63
General ledger, 65“66
Financial leverage, 391, 535
Generally accepted accounting principles
Financial management, 4
Financial performance analysis, 551“54 (GAAP), 57“59, 81
Financial plan, 220“21, 243 General obligation bonds, 329“30
Financial return, 273“76 General partner, 25
Financial risk: business risk versus, 396“97; Global pricing, 40“44
complicating factors, 288; concept of, Going concern, 59“60
289“90; cost structure impact, 150“51, Governmental hospitals, 9
de¬nition of, 316; management, 7; Government grants, 371, 384
nature of, 288; probability distributions, Graphical analysis, 134“35
291“92; rate of return, 292“93; risk Gross patient service revenue,
aversion and, 290“91; stand-alone risk, 72
293“95 Guideline lease, 563“54, 583
Financial statement: accounting entity,
Healthcare Financial Management
59, 60; analysis, 553; balance sheet.
Association (HFMA), 57
See Balance sheet; comparability, 62;
Health insurance, 4
conservatism, 61“62; consistency, 62;
Health Insurance Portability and
footnotes, 67; full disclosure, 61; going
Accountability Act (HIPAA), 508
concern, 59“60; income statement. See
Health Maintenance Act, 38
Income statement; materiality, 61; mone-
Health maintenance organization (HMO),
tary unit, 60“61; objectivity, 60; purpose
4, 38, 201“6, 208“12
of, 9, 53, 54“55; regulation, 56“59; rel-
Hedging, 302
evance, 61; reliability, 60; standards, 57;
HFMA. See Healthcare Financial
statement of cash ¬‚ows. See Statement of
Management Association
cash ¬‚ows; transactions, 106“10
Fiscal year, 60 HIPAA. See Health Insurance Portability
Five-year plan, 220, 221 and Accountability Act
Fixed assets: balance sheet category, 95“96; Historical cost, 95, 401
depreciation expense, 74“75; turnover HMO. See Health maintenance
ratio, 538 organization
596 Index



Holding period, 351 Investor-owned business: cash ¬‚ow analysis,
Home health care, 18 439“41; corporate cost of capital, 412“
Hospital: challenges, 8; classi¬cation, 13; cost of equity, 403“9; features,
8“9; function, 18; ownership, 9“10, 26“27; goal, 30, 46; leasing, 563“64;
18; service, 8, 10; service plans, organization of, 24; ownership, 45; risk
34 measures, 310“11; tax implications,
Hostile takeover, 362“62 32“33
Hurdle rate, 415, 417 IP. See In¬‚ation premium
IPO. See Initial public offering
ICF. See Intermediate care facilities IRR. See Internal rate of return
IDS. See Integrated delivery system IRS. See Internal Revenue Service
Income statement: balance sheet
interrelationship, 112; components, JCAHO. See Joint Commission
68; expenses, 73“76; investor-owned on Accreditation of Healthcare
¬rms, 79; net income, 76“79; purpose Organizations
of, 67“68; ratio analysis, 80; revenues, JIT. See Just-in-time system
69“73; structure, 81; time period, 68; Joint Commission on Accreditation of
title section, 68 Healthcare Organizations (JCAHO), 8,
Incremental cash ¬‚ow, 429 11
Indenture, 331, 352 Journal entry, 66
Indigent patients, 70 Junior lien, 329
Indirect cost, 158, 168“69, 180 Junior mortgage, 329
Industry averages, 398 Junk bonds, 333
In¬‚ation, 326, 433“34, 452 Just-in-time (JIT) system, 93, 509, 518
In¬‚ation premium (IP), 336
Labor variance, 237
Informational ef¬ciency, 380“82
Lease: balance sheet effects, 565“67;
Information costs, 577
basics, 561“63; dollar cost analysis,
Insider, 368
570“72; evaluation, 567“70; expense
Institutional investors, 366
category, 74; motivation, 574“78, 584;
Institutional rates, 202
percentage cost analysis, 573; tax effects,
Insurance, 74, 507
563“64
Integrated delivery system (IDS), 37“38,
Lender, 397
12“13, 19
Length of stay (LOS), 550“51
Interest expense, 75“76
Lessee, 562
Interest rate: components, 335“38, 352;
Lessor, 562
corporate bonds, 328; de¬nition, 325;
Liabilities, 88, 96“98;
risk, 349“51; solutions, 264; term loan,
Liability: corporation, 23, 24;
327“28; term structure, 339“41, 352;
proprietorship/partnership, 22;
time preference, 326
unlimited, 22
Intermediaries, 37
Intermediate care facilities (ICF), 11 Licensure, 14
Internal rate of return (IRR), 275, 444“46, Limited liability, 23, 24
452 Limited liability company (LLC), 25
Internal Revenue Service (IRS): charitable Limited liability partnership (LLP), 25
organization under, 28; Tax Code Limited partner, 25
Section 501 (c)(3) or (4), 28 Limited partnership, 24“25
Intial public offering (IPO), 366 Line of credit, 515, 519
Inventory management, 93, 508“10 Liquid asset, 337
Investment: banker, 369“71, 384; grade Liquidation, 27, 96“97, 430
bonds, 333; horizon, 288, 351; Liquidity: current assets, 91; current ratio,
opportunity, 326; by owner, 107 332; investment value and, 24; planning,
Investor, 55“56 242; ratios, 533“35, 553
597
Index



Liquidity premium (LP), 337 Materials management. See Supply chain
LLC. See Limited liability company management
LLP. See Limited liability partnership Maturity date, 343
Loan agreement, 331 Maturity matching policy, 495“97
Lockbox, 499“500, 518 M/B. See Market/book ratio
Long-term care, 11“12, 18 Medicaid, 37
Long-term debt, 98, 327“31 Medical equipment and supplies, 4
Long-term investment, 94“95 Medicare, 36“37
Long-term liabilities, 111 Medicare payment percentage, 549“50
Long-term securities management, Mission statement, 31
502“3 Monetary unit, 60“61
LOS. See Length of stay Money, 325“27
LP. See Liquidity premium Mortgage bonds, 328“29
Lump sum, 259“61, 355“59 MSO. See Management service
organization
Maintenance margin, 368 Municipal bonds, 328, 329“30
Maintenance services, 577 Mutual company, 35
Malpractice litigation, 15 MVA. See Market Value Added
Managed care, 4; plan types, 37“39;
precerti¬cation, 507; premium rates, NAL. See Net advantage to leasing
201“6; purpose, 46 NASD. See National Association of
Managed fee-for-service plans, 39 Securities Dealers
Management service organization (MSO), National Association of Securities Dealers
13 (NASD), 366
Management variance, 236“37, 238 Natural classi¬cation, 73
Managerial accounting: basics, 121“22; Negotiated charges, 40
cost classi¬cations, 123“28; ¬nancial risk, Net advantage to leasing (NAL), 572, 574
150“51; operating leverage, 136“38; Net assets, 98“101
pro¬t analysis, 128“36, 138“50 Net cash gain (loss), 241
Mandatory replacement category, 426 Net ¬‚oat, 499
Marginal analysis, 142“43, 152 Net income, 68; cash ¬‚ow versus, 78“79;
Marginal cost pricing, 190“91 de¬nition of, 81; income statement entry,
Marginal costs, 401 76“77; payout ratio, 77; reinvestment,
Margin call, 368 77; retention ratio, 77
Margin requirements, 368 Net loss, 68
Marketable securities, 91“92, 501“2, 518 Net operating pro¬t after taxes (NOPAT),
Market beta, 308“9, 463 546
Market/book (M/B) ratio, 540“41 Net patient accounts receivable, 92
Market multiple approach, 582“83, 584 Net present social value (NPSV), 446“48,
Market portfolio, 301“3 452
Market price equilibrium, 379 Net present value (NPV), 271, 443“46,
Market risk: capital budgeting, 462, 463; 452
explanation of, 482; measurement, 317; Net price per discharge, 549
premium, 314; relationships, 464; stock Net working capital, 432“33, 451
portfolio, 307“9 New issue, 344
Market Value Added (MVA), 545“46, 547, New issue market, 366
553 New York Stock Exchange (NYSE), 366
Market values ratio, 540 Nonconstant growth stock, 379
Master account, 500 Nonmedical costs, 208“9
Master budget. See Budget Non-tax-oriented lease, 564
Matching principle, 64“65 NOPAT. See Net operating pro¬t after
Materiality principle, 61 taxes
598 Index



Notes payable, 97, 514“15 P/E. See Price/earnings ratio
Not-for-pro¬t business: capital budgeting, Percentage change analysis, 544, 553
446“50; capital structure, 398“99; cash Percentage cost analysis, 573
¬‚ow analysis, 436“39; contributions, 33; Percentage return, 274“76
Per day reimbursement, 40
corporate cost of capital, 413; cost of
Per diagnosis reimbursement, 40
equity, 409“12; equity, 371“73; features,
Per diem overhead rate, 159
27“29; goals, 30“32, 46; leasing, 564;
Per diem reimbursement, 40
ownership, 46; risk measures, 311“12;
Perfect negative correlation, 298“99
tax-exempt debt, 33
Perfect positive correlation, 299
NPSV. See Net present social value
Performance indicator, 76
NPV. See Net present value
Periodic interest rate, 279
Nursing home care, 11
Periodic interim payment (PIP), 39
NYSE. See New York Stock Exchange
Periodic payment amount, 280
Obsolescence risk, 575“76 Periodic rate, 282
Occupancy percentage rate, 550 Permanent accounts, 66
Off-balance sheet ¬nancing, 565 Permanent asset, 495, 517“18
Offering price, 370 Permanent capital, 400
Operating budget, 225, 228“30, 244 Per member per month (PMPM), 196“99;
Operating costs, 68 contract analysis, 208“12; ¬nal rate,
Operating indicator analysis, 527, 549“51, 205“6; institutional rates, 202; physician
553 rates, 202“4
Operating lease, 562 Perpetuity, 268“69, 281
Operating leverage, 136“38, 152 Per procedure reimbursement, 40
Operating plan, 220, 221 Personal taxes, 32“33
Opportunity cost, 261“63; capital Pharmaceuticals, 4
investment analysis, 431; cost of capital PHO. See Physician-hospital organization
Physical assets, 54, 55, 342“43
and, 414; principle, 404; rate, 259, 262
Physician-hospital organization (PHO), 13
Optimal capital structure, 395“98, 416
Physician rates, 202“4
Option pricing techniques, 373
PIP. See Periodic interim payment
Ordinary annuities, 265“67, 281
P&L. See Pro¬t and loss statement
Organizational goals, 29“32
Planning activities, 6
OTC. See Over the counter
Planning process, 219“22, 243
Outcomes, 291
Pledging receivables, 516
Outpatient care, 10“11, 18
PMPM. See Per member per month
Outpatient revenue percentage, 550
Point of service (POS) plan, 38
Outstanding bond, 344
Point-of-service distribution, 510
Overhead costs, 158
Poison pill, 362“63
Over the counter (OTC), 366
Portfolio: beta coef¬cient, 304“8, 309“10,
PA. See Professional association 317; corporate risk, 306“7; expected
Participatory budget, 227“28 rate of return, 296“97; many assets,
Partnership, 22“23 300“301; market risk, 307“9; returns,
Par value, 100, 343 296“97; risk, 297“303, 304“9, 317; two
Patient accounts manager, 505 assets, 297“300
Patient capture, 12 POS. See Point of service plan
Patient service revenue, 69“71, 72 Post audit, 449“50, 452
Payables centralization, 500“501 Power of compounding, 259
Payback, 442 PPO. See Preferred provider organization
Payback period, 442, 452 Preemptive right, 362, 363
Payout ratio, 77 Preferred provider organization (PPO), 38
PC. See Professional corporation Premium rates, 202“4
599
Index



Premium revenue, 71 Project risk: analysis illustration, 464“65;
Present value: of annuity, 266“67; of cash out¬‚ow adjustment, 476“78;
annuity due, 268; of lump sum, 259“61; decision process, 472“76; scenario
of perpetuities, 268“69; of uneven cash analysis, 469“71; sensitivity analysis 465,
¬‚ow stream, 270“71; 467“69; subjective approach, 472; types
Price/earnings (P/E) ratio, 540 of, 462“64, 482
Price risk, 349, 353 Project scoring, 448“49, 452
Price risk premium (PRP), 337 Promissory note, 331, 515, 519
Price setter, 189“91, 212 Property and equipment category, 95“96
Price shift, 191, 212 Proprietorship, 22“23
Price taker, 188“89, 191“92, 212 Prospective payment system, 40“44
Price variance, 237 Prospectus, 367“68
Pricing decisions: base case analysis, Provider: ¬nancial risks, 43“45; legal issues,
193“97; capitation environment, 15; panel, 38; as price setter, 189; as
193“201; explanation of, 187; full cost price taker, 188“89
pricing, 189“90; importance of, 187“88; PRP. See Price risk premium
individual services, 192“93; marginal Public hospitals, 9
cost pricing, 190“91; relative value units, Public insurers, 36“37
206“7; scenario analysis, 197“201; Public issue, 330“31
target costing, 191“92 Publicly held corporation, 26, 30, 384
Primary accounts, 65 Public offering, 364, 384
Primary market, 366“67
Quali¬ed opinion, 58
Primary market transaction, 26
Quantitative analysis, 481, 482“83
Prime rate, 402
Private insurers, 34“36
RADR. See Risk-adjusted discount rate
Privately held companies, 26“27
method
Private placement, 330“31, 364, 384
Rate of return, 274“76, 293“293
Probability distributions, 291“92
Rate review system, 15
Probability of occurrence, 291
Rate variance, 237
Professional association (PA), 25
Ratio analysis, 80“82, 531“42, 553
Professional corporation (PC), 25
Real asset, 253
Professional liability, 15
Realized rate of return, 293
Pro¬tability: analysis, 443“46; formula, 68;
Real risk-free rate (RRF), 336
measurement of, 77; ratios, 532“33, 553
Receivables management, 499“500, 503“8
Pro¬t analysis: basic data, 128“31;
Reciprocal allocation method, 163“64,
breakeven analysis, 133“36; capitation
181
environment, 143“50; contribution
Reconciliation, 106
margin, 132“33; discounted fee-
Redemption price, 332
for-service environment, 138“43;
Red herring prospectus, 367
operating leverage, 136“38; projected
Refunding decision, 333
P&L statement, 131“32; purpose,
Registration statement, 367
151
Regulation, 14“15, 19
Pro¬t and loss (P&L) statement, 131“32,
Reimbursement: capitation method, 39,
230
41; fee-for-service method, 39“41;
Pro¬t margin, 532“33
¬nancial risk, 43“45; provider incentives,
Pro¬t penalty, 494“95
Pro¬t variance, 234“35 41“43
Project cost of capital, 461, 475“76, 483 Reinvestment risk, 349, 353
Projected P&L statement, 151 Relative value ratio (RVR), 213
Project life, 430 Relative value units (RVU), 206“7
Project life risk, 576“77 Relevant range, 123
Project portfolio, 296, 306“7 Remote disbursement, 501
600 Index



Replacement analysis, 441“42 SEC. See Securities and Exchange
Required rate of return, 342, 414 Commission
Reserve borrowing capacity, 397 Secondary market, 26, 367
Residential care facilities, 11 Second mortgage bonds, 329
Residual earnings, 27, 360“61 Securities: issuance, 369“70; portfolio,
Residual value, 570 295“96; regulations, 367“69; market
Residual value risk, 575“76 equilibrium, 379“80
Restricted accounts, 102 Securities and Exchange Commission
Restrictive covenants, 331“32, 352 (SEC), 56“57, 367“69, 384
Retailers, 371 Security Market Line (SML), 313“15,
Retained earnings, 100“101 317“18, 404“6
Retention ratio, 77 Self-insurance, 36
Return on assets (ROA), 533 Selling group, 371
Return on equity (ROE), 391, 533 Semiannual compounding, 276“77,
Return on investment (ROI), 443“46 348“49
Semi-¬xed costs, 127“28, 151
Revenue: bonds, 329“30, 352; budget,
Sensitivity analysis, 465, 467“69, 482
224“25; capitation, 71; categories, 81;
Service decision: contract analysis, 208“12;
centers, 164, charitable contributions,
explanation of, 187; ¬nancial approach,
71“72; cycle, 506“8, 518; de¬nition
188“89; importance of, 187“88; price
of, 81; fee-for-service, 71; forecast,
setting, 192“93
225; income statement footnote on,
Service lease, 562
70“71; interest earned, 71; patient
Shareholder wealth maximization, 30, 46
service, 69“70; source, 68, 72; variance,
Short-term ¬nancial management: cash,
235“36
498“501; current asset policies, 493“98;
Revolving credit agreement, 515, 519
¬nancing decisions, 510“19; marketable
Right of control, 27
securities, 501“2; overview, 491“93
Rights offerings, 363, 384
Short-term investment, 91
Risk: analysis, 464“65; aversion, 290“
Skilled nursing facilities (SNF), 11
91; de¬nition of, 289; management,
SML. See Security Market Line
7; measures, 310“12; reduction,
SNF. See Skilled nursing facilities
317
Social value, 447
Risk-adjusted discount rate (RADR)
Sole proprietorship, 22“23
method, 474“75
Special tax bonds, 329
Risk free investment, 289
Specialty hospitals, 8“9
Risk (pro¬t) margin, 208“9
Spreadsheet: annual compounding, 277;
Risk/return trade-off, 383
dollar return, 274; future value, 258“59,
ROA. See Return on assets
266, 267, 272, 274; interest rate,
ROE. See Return on equity
264; internal rate of return, 275“76;
ROI. See Return on investment
periodic payment amount, 280; present
RRF. See Real risk-free rate
value, 261, 267, 268, 271; semiannual
Rural hospitals, 9
compounding, 277; time solution,
RVR. See Relative value ratio
265
RVU. See Relative value units
Stakeholder, 30“31, 46, 55“56
Safety stocks, 494, 509 Stand-alone risk: capital budgeting, 462;
Salary expense, 73“74 explanation of, 305, 482; measurement
Sale and leaseback, 563 of, 317; relationships, 464; and required
Salvage value, 75 return, 293“95
Sarbanes-Oxley Act, 58 Standard deviation, 294, 295, 297“98
Scenario analysis, 197“201, 212, 469“71, Stated interest rates, 278, 281
482 Statement of activities. See Income
S corporation, 25 statement
601
Index



Statement of cash ¬‚ows, 102“6, 112, 226, discounting, 259“61; ¬nancial return,
526“31 272“76; interest rate, 263“65;
Statement of ¬nancial position. See Balance opportunity costs, 261“63; perpetuities,
sheet 268“69; time, 265“66; time lines, 254;
Statement of operations. See Income uneven cash ¬‚ow stream, 269“72
statement TNPV. See Total net present value
Static budget, 231“32, 244 Top-down budget, 228, 244
Statistics budget, 223“24 Total asset turnover ratio, 539
Step-down allocation method, 164, Total liabilities, 98
174“76, 181 Total margin, 532“33
Step-variable costs, 127“28 Total net present value (TNPV), 447
Stock: company, 35; portfolio, 307“9; Total pro¬t margin, 80
purchase, 363; repurchase, 27 Trade credit, 97, 512“14, 519
Stockholder (shareholder), 27, 45 Trade-off theory, 394“95
Stockless inventory, 509“10 Treasury bills, 338
Strategic plan, 220, 243 Trend analysis, 541“42, 553
Strategic value, 434, 451“562 Trustee, 332, 352
Strati¬ed rates, 40
Subordinated debt, 329 Unbundling, 42“43
Subsidiary accounts, 65“66 Underlying cost structure, 124“28
Subsidiary cost of capital, 478“82 Underwriting syndicate, 371
Sunk costs, 430“31 Underwritten issue, 369“70
Supplies: bill payment, 110; expense Uneven cash ¬‚ow stream, 269“72, 281
category, 74; purchase, 107“8; used, Unquali¬ed opinion, 58
109; worksheet, 240 Upcode, 42
Supply chain management, 508“10, 518 Usage variance, 237
Surplus/de¬cit summary, 241 Utilization management: capitation and,
148“50; ratios, 538“39; review, 38; risk,
T accounts, 66 44, 576; value, 200“201
Target capital structure, 395“98, 416
Target costing, 191“92, 212 Valuation models, 342“43, 344“48
Tax differentials, 575 Variable costs, 123“24, 151
Tax-exempt debt, 33 Variable interest rate, 328
Tax-exempt status, 27“29, 564 Variance: analysis, 223, 231“39; 244;
Tax laws, 32“33 de¬nition of, 231, 244; of return
Tax-oriented lease, 563“64, 583 distribution, 294
Technical default, 332 Volume forecast, 224, 226
Temporary accounts, 66 Volume variance, 235“36
Temporary assets, 495, 517“18
Terminal value, 430, 581 Wholesalers, 371
Term loan, 327“28, 351 Working capital management, 6, 94, 221
Third-party payer: claim submission,
507; classi¬cation, 46; follow-up, 507; Yield to call (YTC), 348
private insurers, 34“36; public insurers, Yield curve, 339“41, 352
36“37 Yield to maturity (YTM), 348, 352“53,
TIE. See Times interest earned 402
Time line, 254 YTC. See Yield to call
Times interest earned (TIE), 536“37 YTM. See Yield to maturity
Time solutions, 264“65
Time value analysis, 253; amortized ZBA. See Zero-balance account
loans, 279“81; annuities, 265“68; Zero-balance account (ZBA), 500“501
compounding, 255“59, 276“79; Zero-based budget, 227, 243
This page intentionally left blank
ABOUT THE AUTHOR



Louis C. Gapenski, Ph.D., is a professor in both health services administration
and ¬nance at the University of Florida. He received a B.S. degree from the
Virginia Military Institute; a M.S. degree from the U.S. Naval Postgraduate
School; and M.B.A. and Ph.D. degrees from the University of Florida, the
latter two in ¬nance. In addition to teaching at the University of Florida,
he was on the national faculty of the University of Wisconsin™s Program
in Administrative Medicine and has taught in programs at numerous other
universities.
Dr. Gapenski is the author or coauthor of over twenty textbooks on
corporate and healthcare ¬nance. His books are used worldwide, with Cana-
dian and international editions as well as translations into Russian, Bulgarian,
Chinese, Indonesian, Italian, Polish, Portuguese, and Spanish. In addition,
he has published over 40 journal articles related to corporate and healthcare
¬nance and has authored a self-study program in healthcare ¬nance for the
American College of Healthcare Executives.
Dr. Gapenski is a member of the Association of University Programs in
Health Administration, the American College of Healthcare Executives, the
Medical Group Management Association, and the Healthcare Financial Man-
agement Association. He has acted as academic advisor, chaired sessions, and
presented papers at numerous national meetings. Additionally, Dr. Gapenski
has been an editorial board member and reviewer for many academic and
professional journals.

<<

. 21
( 21)