DETAILED CONTENTSxvi Detailed Contents Final Risk Assessment and Incorporation for the MRI Project ..... 539 Incorporating Debt Capacity into the

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DETAILED CONTENTS

Preface .....................................................................................................xxi

Part I The Healthcare Environment

Chapter 1. Introduction to Healthcare Financial Management .............3Learning Objectives ..........................................................3Introduction .....................................................................3How to Use This Book .....................................................4The Role of Financial Management in the

Health Services Industry ...............................................6Current Challenges ...........................................................8Organizational Goals .........................................................9Tax Laws .........................................................................13Depreciation ...................................................................21Health Reform and Financial Management .....................25Chapter Key Concepts ....................................................29Chapter Models, Problems, and Mini-Cases ....................30Selected Bibliography ......................................................31Selected Websites ............................................................32Notes ..............................................................................32

Supplement. Forms of Business Organization,

Ownership, and Structure ............................................33Supplement Learning Objectives .....................................33Forms of Business Organization ......................................33Alternative Forms of Ownership ......................................38Organizational Structures ................................................42Supplement Key Concepts ...............................................46Supplement Bibliography ................................................47Supplement Websites .......................................................47Supplement Notes ...........................................................47

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Chapter 2. Health Insurance .............................................................49Learning Objectives ........................................................49Introduction ...................................................................49Insurance Concepts .........................................................50Major Health Insurers (Third-Party Payers) ....................57Private Insurers ...............................................................57Public Insurers ................................................................61Development of Premium Rates ......................................63Consumer-Directed Health Plans ....................................71Value-Based Benefit and Insurance Design ......................75Health Reform and Health Insurance ..............................76Chapter Key Concepts ....................................................79Selected Case ..................................................................81Selected Bibliography ......................................................81Selected Websites ............................................................81Notes ..............................................................................82

Chapter 3. Payments to Providers .....................................................83Learning Objectives ........................................................83Introduction ...................................................................83Coding: The Foundation of Fee-for-Service

Reimbursement ..........................................................83Generic Reimbursement Methods ...................................85Financial Incentives to Providers .....................................89Financial Risks to Providers .............................................93Reimbursement Methods Used by Medicare ...................95Pay for Performance ......................................................100Health Reform and Payments to Providers ....................109Chapter Key Concepts ..................................................112Chapter Models, Problems, and Mini-Cases ..................114Selected Case ................................................................114Selected Bibliography ....................................................115Selected Websites ..........................................................116Note .............................................................................116

Supplement. Risk Sharing Under Capitation ...................117Supplement Learning Objectives ...................................117The Need for Risk Sharing ............................................117Primary Care Withhold: Single Risk Pool ......................118Primary Care and Referral Withholds:

Two Risk Pools ........................................................120

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Supplement Key Concept ..............................................124Supplement Case ...........................................................124

Part II Basic Financial Management Concepts

Chapter 4. Time Value Analysis ......................................................127Learning Objectives ......................................................127Introduction .................................................................127Time Lines ....................................................................128Future Value of a Lump Sum (Compounding) ..............129Present Value of a Lump Sum (Discounting) .................135Opportunity Costs ........................................................139Solving for Interest Rate and Time ................................141Annuities .......................................................................143Perpetuities ...................................................................148Uneven Cash Flow Streams ...........................................150Using Time Value Analysis to Measure ROI ..................152Semiannual and Other Compounding Periods ...............155Amortized Loans ..........................................................159A Review of Interest Rate Types ....................................160Chapter Key Concepts ..................................................162Chapter Models, Problems, and Mini-Cases ..................163Selected Case ................................................................164Selected Resources ........................................................164Selected Website ............................................................164Notes ............................................................................164

Integrative Application ...................................................166The Problem .................................................................166The Analysis ..................................................................166The Decision .................................................................168

Chapter 5. Financial Risk and Required Return ...............................169Learning Objectives ......................................................169Introduction .................................................................169The Many Faces of Financial Risk ..................................170Introduction to Financial Risk .......................................171Risk Aversion ................................................................173Probability Distributions ...............................................173Expected and Realized Rates of Return .........................175Stand-Alone Risk...........................................................177

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Portfolio Risk and Return .............................................180Portfolio Risk of Business Investments ..........................190Portfolio Risk of Stocks (Entire Businesses) ...................196Portfolio Betas ..............................................................197Relevance of the Risk Measures .....................................198Interpretation of the Risk Measures ...............................200The Relationship Between Risk and Return ...................201Some Thoughts About Beta and the CAPM ..................204Chapter Key Concepts ..................................................205Chapter Models, Problems, and Mini-Cases ..................207Selected Case ................................................................207Selected Bibliography ....................................................207Selected Websites ..........................................................208Notes ............................................................................208


Part III Capital Acquisition

Chapter 6. Debt Financing ..............................................................215Learning Objectives ......................................................215Introduction .................................................................215The Cost of Money .......................................................216Long-Term Debt ..........................................................217Term Loans ...................................................................217Bonds ...........................................................................219Short-Term Debt ..........................................................223Credit Ratings ...............................................................224Interest Rate Components ............................................227Term Structure of Interest Rates ...................................232Advantages and Disadvantages of Debt Financing .........234Securities Valuation .......................................................235The General Valuation Model .......................................236Debt Valuation ..............................................................238Chapter Key Concepts ..................................................251Chapter Models, Problems, and Mini-Cases ..................253Selected Cases ...............................................................253

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Selected Bibliography ....................................................254Selected Websites ..........................................................254Notes ............................................................................255


Supplement. Interest Rate Levels, Types of Short-

Term Debt, Debt Contracts, Bond Insurance, Debt

Refunding, and Economic Factors That Influence

Interest Rate Levels ...................................................259Supplement Learning Objectives ...................................259Interest Rate Levels .......................................................259Types of Short-Term Debt ............................................261Debt Contracts .............................................................266Bond Insurance .............................................................268Debt Refunding ............................................................269Economic Factors That Influence Interest

Rate Levels ...............................................................275Supplement Key Concepts .............................................276

Chapter 7. Equity Financing ............................................................279Learning Objectives ......................................................279Introduction .................................................................279Rights and Privileges of Common Stockholders ............280Selling New Common Stock .........................................283The Market for Common Stock ....................................286The Decision to Go Public ............................................288Advantages and Disadvantages of Common

Stock Financing ........................................................291Equity in Not-for-Profit Corporations ...........................292Common Stock Valuation .............................................294Security Market Equilibrium .........................................306Informational Efficiency ................................................307The Risk/Return Trade-Off ..........................................311Chapter Key Concepts ..................................................312Chapter Models, Problems, and Mini-Cases ..................313Selected Case ................................................................313

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Selected Bibliography ....................................................313Selected Websites ..........................................................314Notes ............................................................................314


Supplement. Classified Stock, Preferred Stock, Securities

Regulation, and the Investment Banking Process .......318Supplement Learning Objectives ...................................318Classified Stock .............................................................318Preferred Stock .............................................................319Securities Regulation .....................................................323The Investment Banking Process ...................................325Supplement Key Concepts .............................................330Supplement Websites .....................................................331

Chapter 8. Lease Financing ............................................................333Learning Objective ........................................................333Introduction .................................................................333Lease Parties and Types .................................................333Per Procedure Versus Fixed Payment Leases ..................335Tax Effects ....................................................................336Balance Sheet Effects ....................................................339Evaluation by the Lessee ...............................................342Evaluation by the Lessor ...............................................351Lease Analysis Symmetry ...............................................353Setting the Lease Payment ............................................354Leveraged Leases ...........................................................354Motivations for Leasing .................................................356Chapter Key Concepts ..................................................361Chapter Models, Problems, and Mini-Cases ..................362Selected Case ................................................................362Selected Bibliography ....................................................362Selected Websites ..........................................................363Notes ............................................................................363

Integrative Application ...................................................364The Problem .................................................................364

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The Analysis ..................................................................364The Decision .................................................................365

Part IV Cost of Capital and Capital Structure

Chapter 9. Cost of Capital ...............................................................369Learning Objectives ......................................................369Introduction .................................................................369Overview of the Cost-of-Capital Estimation Process ......369Estimating the Cost of Debt .........................................371Estimating the Cost of Equity to Large Investor-

Owned Businesses ....................................................374Estimating the Cost of Equity to Not-for-Profit

Businesses .................................................................389Estimating the Corporate Cost of Capital ......................392An Economic Interpretation of the Corporate Cost

of Capital .................................................................394Flotation Costs ..............................................................397Divisional Costs of Capital ............................................398Warning! Warning! Warning! .........................................399Cost-of-Capital Estimation for Small Businesses ............400Factors That Influence a Business’s Cost of Capital .......403Chapter Key Concepts ..................................................404Chapter Models, Problems, and Mini-Cases ..................406Selected Case ................................................................406Selected Bibliography ....................................................407Selected Websites ..........................................................407Notes ............................................................................408


Supplement. Measuring the Cost of Fund Capital ............412Supplement Learning Objectives ...................................412Measuring the Cost of Fund Capital ..............................412Supplement Key Concepts .............................................415

Chapter 10. Capital Structure ...........................................................417Learning Objectives ......................................................417

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Introduction .................................................................417Impact of Debt Financing on Risk and Return ..............418Business and Financial Risk ...........................................422Capital Structure Theory ...............................................426The Miller Model ..........................................................433Criticisms of the MM and Miller Models .......................436Financial Distress Costs .................................................437Trade-Off Models .........................................................438Asymmetric Information Model of Capital Structure .....441Summary of the Capital Structure Models .....................443Application of Capital Structure Theory to

Not-for-Profit Firms .................................................446Making the Capital Structure Decision ..........................448Capital Structure Decisions for Small Investor-

Owned Businesses ....................................................451Chapter Key Concepts ..................................................453Chapter Models, Problems, and Mini-Cases ..................454Selected Case ................................................................454Selected Bibliography ....................................................455Selected Websites ..........................................................455Notes ............................................................................455


Supplement. The Debt Maturity Decision ........................461Supplement Learning Objectives ...................................461The Concept of Temporary and Permanent Assets ........461Alternative Debt Maturity Policies .................................462Conclusions Regarding Debt Maturities ........................464Supplement Key Concepts .............................................465

Part V Capital Allocation

Chapter 11. Capital Budgeting .........................................................469Learning Objectives ......................................................469Introduction .................................................................469Project Classifications ....................................................470

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The Role of Financial Analysis in Health Services Capital Budgeting .....................................................472

Overview of Capital Budgeting Financial Analysis .........472Cash Flow Estimation ...................................................473Cash Flow Estimation Example .....................................482Breakeven Analysis ........................................................489Return on Investment Analysis ......................................492Some Final Thoughts on Breakeven and Profitability

Analysis ....................................................................498Evaluating Projects with Unequal Lives .........................499Economic Life Versus Physical Life

(Abandonment Value) ..............................................503Capital Budgeting in Not-for-Profit Businesses ..............505The Post-Audit .............................................................508Using Capital Budgeting Techniques in

Other Contexts ........................................................510Chapter Key Concepts ..................................................511Chapter Models, Problems, and Mini-Cases ..................513Selected Case ................................................................513Selected Bibliography ....................................................514Selected Website ............................................................514Notes ............................................................................515


Chapter 12. Project Risk Analysis .....................................................519Learning Objectives ......................................................519Introduction .................................................................519Types of Project Risk ....................................................520Relationships Among Stand-Alone, Corporate, and

Market Risks .............................................................522Risk Analysis Illustration ...............................................523Sensitivity Analysis .........................................................525Scenario Analysis ...........................................................528Monte Carlo Simulation ................................................531Qualitative Risk Assessment ...........................................534Incorporating Risk into the Decision Process ................536

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Final Risk Assessment and Incorporation for the MRI Project .............................................................539

Incorporating Debt Capacity into the Decision Process .......................................................541

Adjusting Cash Outflows for Risk..................................542Real (Managerial) Options ............................................544The Real Option of Abandonment ................................548An Overview of the Capital Budgeting

Decision Process .......................................................551Capital Rationing ..........................................................553Chapter Key Concepts ..................................................555Chapter Models, Problems, and Mini-Cases ..................557Selected Cases ...............................................................557Selected Bibliography ....................................................558Selected Websites ..........................................................558Notes ............................................................................558


Part VI Financial Condition Analysis and Forecasting

Chapter 13. Financial Condition Analysis ..........................................565Learning Objectives ......................................................565Introduction .................................................................565Financial Reporting in the Health Services Industry ......566Financial Statement Analysis ..........................................572Ratio Analysis ................................................................573Tying the Ratios Together: Du Pont Analysis ................586Operating Indicator Analysis .........................................588Limitations of Financial Statement and

Operating Indicator Analyses ....................................593Economic Value Added .................................................595Benchmarking ...............................................................597Key Performance Indicators and Dashboards .................598Chapter Key Concepts ..................................................599Chapter Models, Problems, and Mini-Cases ..................601Selected Cases ...............................................................601Selected Bibliography ....................................................601

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Selected Websites ..........................................................602Notes ............................................................................603


Supplement. Market Value Ratios, Common Size Analysis,

and Percentage Change Analysis ...............................606Supplement Learning Objectives ...................................606Market Value Ratios ......................................................606Common Size Analysis ..................................................607Percentage Change Analysis ..........................................609Supplement Key Concepts .............................................611

Chapter 14. Financial Forecasting .....................................................613Learning Objectives ......................................................613Introduction .................................................................613Strategic Planning .........................................................613Operational Planning ....................................................616Financial Planning .........................................................617Revenue Forecasts .........................................................619Creating Forecasted Financial Statements ......................623Constant Growth Forecasting .......................................623Factors That Influence the External Financing

Requirement .............................................................630Problems with the Constant Growth Method ................633Real-World Forecasting .................................................634Computerized Financial Forecasting Models .................638Financial Controls .........................................................640Chapter Key Concepts ..................................................641Chapter Models, Problems, and Mini-Cases ..................642Selected Cases ...............................................................643Selected Bibliography ....................................................643Selected Websites ..........................................................644Notes ............................................................................644


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Part VII Other Topics

Chapter 15. Revenue Cycle and Current Accounts Management .........651Learning Objectives ......................................................651Introduction .................................................................651Cash Management ........................................................652Marketable Securities Management ...............................661Revenue Cycle Management .........................................662Supply Chain Management ...........................................671Current Liability Management ......................................673Chapter Key Concepts ..................................................677Chapter Models, Problems, and Mini-Cases ..................678Selected Cases ...............................................................679Selected Bibliography ....................................................679Selected Websites ..........................................................681Notes ............................................................................681


Supplement. Long-Term Securities Management,

Credit Policy, and the EOQ Model ...............................686Supplement Learning Objectives ...................................686Long-Term Securities Management ...............................686Credit Policy .................................................................687The Economic Ordering Quantity Model .....................691Supplement Key Concepts .............................................697

Chapter 16. Business Combinations and Valuation ...........................699Learning Objectives ......................................................699Introduction .................................................................699Level of Merger Activity ................................................700Motives for Mergers: The Good, the Bad,

and the Ugly ............................................................702Types of Mergers ..........................................................706Hostile Versus Friendly Takeovers .................................707Mergers Involving Not-for-Profit Businesses .................708Business Valuation .........................................................710Unique Problems in Valuing Small Businesses ...............718

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Setting the Bid Price .....................................................719Structuring the Takeover Bid ........................................722Due Diligence Analysis ..................................................723Corporate Alliances .......................................................724Goodwill .......................................................................726Chapter Key Concepts ..................................................727Chapter Models, Problems, and Mini-Cases ..................728Selected Cases ...............................................................729Selected Bibliography ....................................................729Selected Websites ..........................................................730Notes ............................................................................730


Supplement. Merger Regulation, the Role of Investment

Bankers, and Who Wins? The Empirical Evidence ........734Supplement Learning Objectives ...................................734Merger Regulation ........................................................734The Role of Investment Bankers ...................................739Who Wins? The Empirical Evidence ..............................741Supplement Key Concepts .............................................743

Glossary .................................................................................................745Appendix: Key Formulas in Chapters ......................................................771Index .....................................................................................................785About the Authors ..................................................................................817

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DETAILED CONTENTSxvi Detailed Contents Final Risk Assessment and Incorporation for the MRI Project ..... 539 Incorporating Debt Capacity into the