v

BRIEF CONTENTS

Preface .....................................................................................................xix

Part I The Healthcare Environment

Chapter 1. Introduction to Healthcare Financial Management ............3

Chapter 2. Health Insurance .............................................................35

Chapter 3. Payments to Providers .....................................................69

Part II Basic Financial Management Concepts

Chapter 4. Time Value Analysis ......................................................105

Chapter 5. Financial Risk and Required Return ..............................147

Part III Capital Acquisition

Chapter 6. Debt Financing .............................................................191

Chapter 7. Equity Financing ...........................................................239

Chapter 8. Lease Financing.............................................................281

Part IV Cost of Capital and Capital Structure

Chapter 9. Cost of Capital ..............................................................317

Chapter 10. Capital Structure ...........................................................359

Part V Capital Allocation

Chapter 11. Capital Budgeting .........................................................407

Chapter 12. Project Risk Analysis .....................................................459

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Part VI Financial Condition Analysis and Forecasting

Chapter 13. Financial Condition Analysis .........................................507

Chapter 14. Financial Forecasting .....................................................549

Part VII Other Topics

Chapter 15. Revenue Cycle and Current Accounts Management ......589

Chapter 16. Business Combinations and Valuation ...........................625

Glossary .................................................................................................661Appendix: Key Formulas in Chapters ......................................................685Index .....................................................................................................701About the Authors ..................................................................................739

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vii

DETAILED CONTENTS

Preface .....................................................................................................xix

Part I The Healthcare Environment

Chapter 1. Introduction to Healthcare Financial Management .............3Learning Objectives ..........................................................3Introduction .....................................................................3How to Use This Book .....................................................5The Role of Financial Management in the

Health Services Industry ...............................................6Current Challenges ...........................................................8Organizational Goals .........................................................9Tax Laws .........................................................................13Depreciation ...................................................................21Health Reform and Financial Management .....................26Chapter Key Concepts ....................................................31Chapter Models, Problems, and Minicases .......................32Selected Bibliography ......................................................33Selected Websites ............................................................33Notes ..............................................................................33

Chapter 2. Health Insurance .............................................................35Learning Objectives ........................................................35Introduction ...................................................................35Insurance Concepts .........................................................36Major Health Insurers (Third-Party Payers) ....................43Development of Premium Rates ......................................49Consumer-Directed Health Plans ....................................57Value-Based Benefit and Insurance Design ......................61Health Reform and Health Insurance ..............................61Chapter Key Concepts ....................................................65Selected Case ..................................................................66Selected Bibliography ......................................................67

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Selected Websites ............................................................67Notes ..............................................................................68

Chapter 3. Payments to Providers .....................................................69Learning Objectives ........................................................69Introduction ...................................................................69Coding: The Foundation of Fee-for-Service

Reimbursement ..........................................................69Generic Reimbursement Methods ...................................71Financial Incentives to Providers .....................................76Financial Risks to Providers .............................................79Reimbursement Methods Used by Medicare ...................82Value-Based Purchasing ...................................................87Health Reform and Payments to Providers ......................95Chapter Key Concepts ....................................................99Chapter Models, Problems, and Minicases .....................101Selected Case ................................................................101Selected Bibliography ....................................................101Selected Websites ..........................................................102Note .............................................................................102

Part II Basic Financial Management Concepts

Chapter 4. Time Value Analysis ......................................................105Learning Objectives ......................................................105Introduction .................................................................105Time Lines ....................................................................106Future Value of a Lump Sum (Compounding) ..............107Present Value of a Lump Sum (Discounting) .................113Opportunity Costs ........................................................117Solving for Interest Rate and Time ................................119Annuities .......................................................................122Perpetuities ...................................................................126Uneven Cash Flow Streams ...........................................128Using Time Value Analysis to Measure ROI ..................130Semiannual and Other Compounding Periods ...............133Amortized Loans ..........................................................137A Review of Interest Rate Types ....................................139Chapter Key Concepts ..................................................141Chapter Models, Problems, and Minicases .....................142

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Selected Case ................................................................142Selected Resources ........................................................142Notes ............................................................................143

Integrative Application ...................................................144The Problem .................................................................144The Analysis ..................................................................144The Decision .................................................................146

Chapter 5. Financial Risk and Required Return ...............................147Learning Objectives ......................................................147Introduction .................................................................147The Many Faces of Financial Risk ..................................148Returns on investments .................................................149Introduction to Financial Risk .......................................150Risk Aversion ................................................................152Probability Distributions ...............................................152Expected and Realized Rates of Return .........................154Stand-Alone Risk...........................................................157Standard Deviation of a Historical Return Distribution .159Portfolio Risk and Return .............................................160The Relevant Risk of a Stock .........................................170Estimating Beta .............................................................172The Relationship Between Risk and Return

and the Capital Asset Pricing Model .........................174Required Return and Changes in Expected Inflation

or Risk Aversion .......................................................178Comparison of Required Return to Expected Return ....180Some Final Thoughts About Beta and the CAPM .........180Chapter Key Concepts ..................................................181Chapter Models, Problems, and Minicases .....................183Selected Case ................................................................183Selected Bibliography ....................................................183Selected Websites ..........................................................184Notes ............................................................................184

Integrative Application ...................................................186The Problem .................................................................186The Analysis ..................................................................186The Decision .................................................................187

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Part III Capital Acquisition

Chapter 6. Debt Financing ..............................................................191Learning Objectives ......................................................191Introduction .................................................................191The Cost of Money .......................................................192Long-Term Debt ..........................................................193Term Loans ...................................................................194Bonds ...........................................................................195Short-Term Debt ..........................................................199Credit Ratings ...............................................................201Interest Rate Components ............................................203Term Structure of Interest Rates ...................................208Advantages and Disadvantages of Debt Financing .........211Securities Valuation .......................................................212The General Valuation Model .......................................213Debt Valuation ..............................................................215Chapter Key Concepts ..................................................230Chapter Models, Problems, and Minicases .....................232Selected Cases ...............................................................232Selected Bibliography ....................................................232Selected Websites ..........................................................233Notes ............................................................................233

Integrative Application ...................................................235The Problem .................................................................235The Analysis ..................................................................235The Decision .................................................................237

Chapter 7. Equity Financing ............................................................239Learning Objectives ......................................................239Introduction .................................................................239Rights and Privileges of Common Stockholders ............240Selling New Common Stock .........................................243The Market for Common Stock ....................................246The Decision to Go Public ............................................248Advantages and Disadvantages of Common

Stock Financing ........................................................251Equity in Not-for-Profit Corporations ...........................253Common Stock Valuation .............................................255

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Security Market Equilibrium .........................................267Informational Efficiency ................................................268The Risk/Return Trade-Off ..........................................272Chapter Key Concepts ..................................................273Chapter Models, Problems, and Minicases .....................274Selected Case ................................................................275Selected Bibliography ....................................................275Selected Websites ..........................................................276Notes ............................................................................276

Integrative Application ...................................................277The Problem .................................................................277The Analysis ..................................................................277The Decision .................................................................278

Chapter 8. Lease Financing ............................................................281Learning Objective ........................................................281Introduction .................................................................281Lease Parties and Types .................................................281Per Procedure Versus Fixed Payment Leases ..................284Tax Effects ....................................................................285Balance Sheet Effects ....................................................288Evaluation by the Lessee ...............................................289Evaluation by the Lessor ...............................................299Lease Analysis Symmetry ...............................................301Setting the Lease Payment ............................................302Leveraged Leases ...........................................................302Motivations for Leasing .................................................304Chapter Key Concepts ..................................................308Chapter Models, Problems, and Minicases .....................309Selected Case ................................................................310Selected Bibliography ....................................................310Selected Websites ..........................................................311Notes ............................................................................311

Integrative Application ...................................................312The Problem .................................................................312The Analysis ..................................................................312The Decision .................................................................313

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Part IV Cost of Capital and Capital Structure

Chapter 9. Cost of Capital ...............................................................317Learning Objectives ......................................................317Introduction .................................................................317Overview of the Cost-of-Capital Estimation Process ......318Estimating the Cost of Debt .........................................319Estimating the Cost of Equity to Large

Investor-Owned Businesses .......................................323Estimating the Cost of Equity to Not-for-Profit

Businesses .................................................................327Estimating the Corporate Cost of Capital ......................339An Economic Interpretation of the Corporate Cost of

Capital ......................................................................341Flotation Costs ..............................................................344Divisional Costs of Capital ............................................345Warning! Warning! Warning! .........................................346Cost-of-Capital Estimation for Small Businesses ............347Factors That Influence a Business’s Cost of Capital .......350Chapter Key Concepts ..................................................351Chapter Models, Problems, and Minicases .....................353Selected Case ................................................................353Selected Bibliography ....................................................354Selected Websites ..........................................................355Notes ............................................................................355

Integrative Application ...................................................357The Problem .................................................................357The Analysis ..................................................................357The Decision .................................................................358

Chapter 10. Capital Structure ...........................................................359Learning Objectives ......................................................359Introduction .................................................................359Impact of Debt Financing on Risk and Return ..............360Business and Financial Risk ...........................................364Capital Structure Theory ...............................................368The Miller Model ..........................................................375Criticisms of the MM and Miller Models .......................378Financial Distress Costs .................................................380Trade-Off Models .........................................................381

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Asymmetric Information Model of Capital Structure .....384Summary of the Capital Structure Models .....................386Application of Capital Structure Theory to

Not-for-Profit Firms .................................................389Making the Capital Structure Decision ..........................391Capital Structure Decisions for Small Investor-Owned

Businesses .................................................................395Chapter Key Concepts ..................................................396Chapter Models, Problems, and Minicases .....................398Selected Case ................................................................398Selected Bibliography ....................................................398Selected Websites ..........................................................399Notes ............................................................................400

Integrative Application ...................................................402The Problem .................................................................402The Analysis ..................................................................403The Decision .................................................................404

Part V Capital Allocation

Chapter 11. Capital Budgeting .........................................................407Learning Objectives ......................................................407Introduction .................................................................407Project Classifications ....................................................408The Role of Financial Analysis in Health Services

Capital Budgeting .....................................................410Overview of Capital Budgeting Financial Analysis .........411Cash Flow Estimation ...................................................411Opportunity Costs ........................................................414Strategic Value ..............................................................419Cash Flow Estimation Example .....................................420Breakeven Analysis ........................................................428Return on Investment Analysis ......................................431Some Final Thoughts on Breakeven and

Profitability Analysis .................................................438Evaluating Projects with Unequal Lives .........................439Economic Life Versus Physical Life

(Abandonment Value) ..............................................442Capital Budgeting in Not-for-Profit Businesses ..............444The Postaudit................................................................449

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Using Capital Budgeting Techniques in Other Contexts ....................................................450

Chapter Key Concepts ..................................................451Chapter Models, Problems, and Minicases .....................453Selected Case ................................................................453Selected Bibliography ....................................................454Selected Website ............................................................454Notes ............................................................................455

Integrative Application ...................................................456The Problem .................................................................456The Analysis ..................................................................456The Decision .................................................................457

Chapter 12. Project Risk Analysis .....................................................459Learning Objectives ......................................................459Introduction .................................................................459Types of Project Risk ....................................................460Relationships Among Stand-Alone, Corporate,

and Market Risks ......................................................462Risk Analysis Illustration ...............................................463Sensitivity Analysis .........................................................465Scenario Analysis ...........................................................468Monte Carlo Simulation ................................................471Qualitative Risk Assessment ...........................................475Incorporating Risk into the Decision Process ................476Final Risk Assessment and Incorporation for the

MRI Project .............................................................479Incorporating Debt Capacity into the

Decision Process .......................................................481Adjusting Cash Outflows for Risk..................................483Real (Managerial) Options ............................................485The Real Option of Abandonment ................................488An Overview of the Capital Budgeting

Decision Process .......................................................492Capital Rationing ..........................................................494Chapter Key Concepts ..................................................496Chapter Models, Problems, and Minicases .....................498Selected Cases ...............................................................498Selected Bibliography ....................................................499

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Selected Websites ..........................................................499Notes ............................................................................499

Integrative Application ...................................................501The Problem .................................................................501The Analysis ..................................................................501The Decision .................................................................503

Part VI Financial Condition Analysis and Forecasting

Chapter 13. Financial Condition Analysis ..........................................507Learning Objectives ......................................................507Introduction .................................................................507Financial Reporting in the Health Services Industry ......508Financial Statement Analysis ..........................................515Ratio Analysis ................................................................515Tying the Ratios Together: Du Pont Analysis ................528Limitations of Financial Statement and

Operating Indicator Analyses ....................................537Economic Value Added .................................................539Benchmarking ...............................................................541Key Performance Indicators and Dashboards .................542Chapter Key Concepts ..................................................543Chapter Models, Problems, and Minicases .....................545Selected Cases ...............................................................545Selected Bibliography ....................................................545Selected Websites ..........................................................546Notes ............................................................................546

Integrative Application ...................................................547The Problem .................................................................547The Analysis ..................................................................547The Decision .................................................................548

Chapter 14. Financial Forecasting .....................................................549Learning Objectives ......................................................549Introduction .................................................................549Strategic Planning .........................................................549Operational Planning ....................................................552Financial Planning .........................................................554Revenue Forecasts .........................................................556

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Creating Forecasted Financial Statements ......................559Constant Growth Forecasting .......................................560Factors That Influence the External

Financing Requirement ............................................567Problems with the Constant Growth Method ................570Real-World Forecasting .................................................571Use of Financial Forecasting Models in Practice ............576Financial Controls .........................................................577Chapter Key Concepts ..................................................578Chapter Models, Problems, and Minicases .....................580Selected Cases ...............................................................580Selected Bibliography ....................................................580Selected Websites ..........................................................581Notes ............................................................................581

Integrative Application ...................................................583The Problem .................................................................583The Analysis ..................................................................584The Decision .................................................................586

Part VII Other Topics

Chapter 15. Revenue Cycle and Current Accounts Management .........589Learning Objectives ......................................................589Introduction .................................................................589Cash Management ........................................................590Marketable Securities Management ...............................599Revenue Cycle Management .........................................601Supply Chain Management ...........................................610Current Liability Management ......................................612Chapter Key Concepts ..................................................616Chapter Models, Problems, and Minicases .....................618Selected Cases ...............................................................618Selected Bibliography ....................................................619Selected Websites ..........................................................619Notes ............................................................................620

Integrative Application ...................................................621The Problem .................................................................621The Analysis ..................................................................621The Decision .................................................................623

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Chapter 16. Business Combinations and Valuation ...........................625Learning Objectives ......................................................625Introduction .................................................................625Level of Merger Activity ................................................626Motives for Mergers: The Good, the Bad,

and the Ugly ............................................................627Types of Mergers ..........................................................631Hostile Versus Friendly Takeovers .................................632Mergers Involving Not-for-Profit Businesses .................633Business Valuation .........................................................636Unique Problems in Valuing Small Businesses ...............643Setting the Bid Price .....................................................645Structuring the Takeover Bid ........................................647Due Diligence Analysis ..................................................649Corporate Alliances .......................................................650Goodwill .......................................................................651Chapter Key Concepts ..................................................653Chapter Models, Problems, and Minicases .....................654Selected Cases ...............................................................655Selected Bibliography ....................................................655Selected Websites ..........................................................656

Integrative Application ...................................................657The Problem .................................................................657The Analysis ..................................................................658The Decision .................................................................659

Glossary .................................................................................................661Appendix: Key Formulas in Chapters ......................................................685Index .....................................................................................................701About the Authors ..................................................................................739

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