Deck 12: Financing and Ownership of Health Care Providers

Question 1

Since no one party owns a not-for-profit hospital, physicians really own the hospital's business.

Answer 1

False

Question 2

The value of any capital project can be assessed by estimating expected future cash flows from the project and discounting them to the present value. This procedure accounts for the time value of money.

Answer 2

True

Question 3

Consumer cooperatives have a long and successful history in development of the HMO.

Answer 3

False

Question 4

For-profit firms make up the bulk of hospital organizations.

Question 5

Kaiser Health Plan is the only HMO in the U.S. to consistently maintain its core competencies. That is, it has kept client satisfaction high, while keeping the growth rate of premiums higher than the growth rate of medical costs.

Question 6

When Allegheny Hospital System (AHERF) went bankrupt, the price of borrowing for all hospitals increased. This is an example of correlated system risk.

Question 7

The major reason for the demise of the Allegheny General Hospital group was the fact that its shareholders violated the shareholder/investor agency relationship when illegal accounting practices were discovered in the late 1990s.

Question 8

It could be argued that the federal and state governments provide an implicit guarantee of hospital borrowings because revenue from Medicare and Medicaid patients is assumed to be guaranteed.

Question 9

Venture capitalists are entrepreneurs who specialize in high-risk investments. Often they are the only available source of financing for small startup biotech companies, which very rarely are able to obtain bank loans to finance their research.

Question 10

The basic difference between a partnership and a corporation is that in partnerships the company is controlled/managed by its owners, while in corporations ownership is separated from management. It means that in case of bankruptcy, owners (shareholders) of a corporation will be held responsible for the corporation's debt obligations, while owners of a partnership will have a limited liability for the company's debts and will face the risk of losing only company's assets, but not their personal assets.

Question 11

One of the most important things an HMO should do to stay profitable is to make sure
a) the medical costs' rate of growth is below the rate of growth of premiums (revenues), and
b) customer satisfaction does not slip.

Question 12

Research studies indicate that when a non-profit healthcare organization is converted to a for-profit status, it might lead to higher prices and a reduction in the number of services offered, if the converting organization had significant monopolistic market power in that geographical area.

Question 13

Dr. Yuan opens a lab. The lab has an initial cost of $100,000. Expected net cash flow is $24,000 in the first year, growing by 15% per year. Net cash flow is revenue less expenses. Assume the lab has a 6 year life and there is no scrap value for the lab.

-If the time discount rate is 8%, what is the NPV of the lab? What is its IRR?

A) The NPV is $41,976; the IRR is 6.0%.
B) The NPV is $31,740; the IRR is 6.0%.
C) The NPV is $26,479; the IRR is 16.7%.
D) The NPV is $28,568; the IRR is 8.0%.
E) The NPV is $27,600; the IRR is 8.0%.

Question 14

Dr. Yuan opens a lab. The lab has an initial cost of $100,000. Expected net cash flow is $24,000 in the first year, growing by 15% per year. Net cash flow is revenue less expenses. Assume the lab has a 6 year life and there is no scrap value for the lab.

-Later that same year, Dr. Bhat opens a similar lab in the strip mall less than two miles away from Dr. Yuan. Dr. Yuan estimates her net cash flow in the first year will be considerably less than her initial estimate. She estimates it will be $16,000. All else equal, what happens to the NPV of Dr. Yuan's lab?

A) The NPV decreases, but is still positive. Dr. Yuan can still expect a positive return on her investment.
B) The IRR decreases, but is still positive. Dr. Yuan can still expect a positive return on her investment.
C) The IRR decreases, and becomes negative. Dr. Yuan should expect a loss on this investment.
D) The IRR and the NPV decrease. Dr. Yuan can still expect a positive return on her investment.
E) The IRR and the NPV decrease. Dr. Yuan should expect a negative return on her investment.

Question 15

Dr. Yuan opens a lab. The lab has an initial cost of $100,000. Expected net cash flow is $24,000 in the first year, growing by 15% per year. Net cash flow is revenue less expenses. Assume the lab has a 6 year life and there is no scrap value for the lab.

-Assume instead that Dr. Yuan forms a partnership with Dr. Bhat. They agree to share the $100,000 cost equally and to share the cash flow equally. Because of efficiency gains from longer operating hours, they expect the net cash flow to be $32,000 per year. Assume they expect net cash flow to grow at 15% per year. What is the consequence of the partnership to Dr. Yuan? Please compare the results to the original scenario described in question 13 (Dr. Yan opening the only lab in the area).

A) The NPV decreases, but is still positive. Dr. Yuan can still expect a positive return on her investment.
B) The NPV decreases, and becomes negative. Dr. Yuan should expect a loss on this investment.
C) The IRR decreases, but is still positive. Dr. Yuan can still expect a positive return on her investment.
D) The IRR and the NPV increase. Dr. Yuan can still expect a positive return on her investment.
E) The IRR and the NPV decrease. Dr. Yuan should expect a negative return on her investment.

Question 16

Dr. Yuan opens a lab. The lab has an initial cost of $100,000. Expected net cash flow is $24,000 in the first year, growing by 15% per year. Net cash flow is revenue less expenses. Assume the lab has a 6 year life and there is no scrap value for the lab.

-Assume instead that Dr. Yuan forms a partnership with Dr. Bhat. They agree to share the $100,000 cost equally and to share the cash flow equally. Because of efficiency gains from longer operating hours, they expect the cash flow to be $32,000 per year. Now assume they expect net cash flow to grow only at 10% per year. Please compare the results to the original scenario described in question 13 (Dr. Yan opening the only lab in the area).

A) The NPV decreases, but is still positive. Dr. Yuan can still expect a positive return on her investment.
B) The NPV decreases, and becomes negative. Dr. Yuan should expect a loss on this investment.
C) The IRR decreases, but is still positive. Dr. Yuan can still expect a positive return on her investment.
D) The IRR and the NPV increase. Dr. Yuan can expect a positive return on her investment.
E) The IRR and the NPV decrease. Dr. Yuan should expect a negative return on her investment.

Question 17

Dr. Yuan opens a lab. The lab has an initial cost of $100,000. Expected net cash flow is $24,000 in the first year, growing by 15% per year. Net cash flow is revenue less expenses. Assume the lab has a 6 year life and there is no scrap value for the lab.

-Assume the partnership is formed and net cash flows are expected to grow at 10% each year. All else equal, what are the social welfare implications from the partnership, compared to the scenario of each doctor setting up their own lab?

A) Social welfare is improved due to economies of scale.
B) Social welfare declines due to diseconomies of scale.
C) Social welfare declines due to economies of scale.
D) There is no way to determine the impact on social welfare.
E) Social welfare is not affected.

Question 18

Dr. Chey works in a small group practice. If Dr. Chey dies, and the practice is owned by a for-profit hospital corporation,

A) replacing Dr. Chey will most likely be more burdensome than adding another partner to a traditional practice.
B) tying up Dr. Chey's legal ties to the practice will probably be uncomplicated since Dr. Chey was essentially an employee of a corporation.
C) tying up Dr. Chey's legal ties to the practice will probably be complicated since Dr. Chey was essentially an employee of a corporation.
D) legal proceedings related to Dr. Chey's ownership interest in the firm will probably go on for years.
E) his children will inherit Dr. Chey's ownership interest in the firm.

Question 19

Which of the following statements is false?
Not-for-profit hospitals differ from traditional corporations in that

A) a hospital may raise money for a capital building project from charitable social events.
B) a hospital may raise money from charitable organizations to fund every day operating shortfalls.
C) a hospital may have a large endowment from previous benefactors.
D) a hospital is expected to provide a small, but significant portion of its services to patients who are unwilling or unable to pay for them.
E) a hospital is most often subject to systemic (correlated) risks, while a traditional corporation is mostly subject to independent (uncorrelated) risks.

Question 20

Joe is considering his options. This summer he will graduate with a B.S. degree in actuarial science and he can begin working this year. His other option is to apply to a medical school to pursue the physician assistant degree. The degree will cost $80,000 in tuition, will take 2 years to complete, and will result in an increase in his annual earnings by about $10,000 per year. Dividing the gain by the cost results in

A) a positive return, so Joe should apply to medical school.
B) a negative return, so Joe should stick with actuarial science career.
C) a negative return, but does not account for the opportunity cost of Joe's additional time in school and the uncertainty, time and effort involved in completing the application process and school.
D) a positive approximate return, but to get a more precise estimate Joe should also consider adding the following costs to the cost side of the equation: the opportunity cost of additional time in school and the uncertainty, time and effort involved in completing the application process and degree requirements.
E) a positive approximate return, but to get a more precise estimate Joe should also consider adding the opportunity cost of Joe's additional time in school and the uncertainty, time and effort involved in completing the application process and degree requirements to the cost side of the equation, while adding the value of the satisfaction Joe expects to receive from choosing a medical career (over the actuarial career) to the gain side of the equation.

Question 21

Below is the list of the most important risks an investor must evaluate when projecting an HMO's profitability. Which option does not belong to this list?

A) not obtaining enough enrollees
B) setting the capitation rate too high
C) underestimating business expenses
D) overestimating amount of capital and labor needed to run an HMO
E) having too much equity (relative to debt obligations).

Question 22

Which one of the following basic findings about for-profits is not true?

A) For profits tend to respond quicker to any changes in the market situation.
B) For profits have lower costs, higher prices, and consequently greater profits.
C) For profits are often engaged in cream skimming.
D) For profits are often engaged in overcompensated activities like teaching and research.
E) For profits avoid patients who are sicker, poor, or uninsured.

Question 23

Explain how not-for-profit hospitals financing methods differ from traditional firms.

Question 24

Multiple studies indicate that non-profit hospitals are usually less efficient than for profits, are slower to respond to changing market situations and most of them provide significantly less charitable care compared to the amount of tax breaks they receive from government for that particular purpose. What does the future hold for non-profit hospitals then? Will they become extinct in the near future, giving way to more efficient for-profit organizations?

Question 25

Consider this method for teaching: The Winners Curse (Thaler 1988). Next time that you find yourself a little short of cash for lunch, try the following experiment in your class. Take a jar and fill it with coins, noting the total value of the coins. Now auction off the jar to your class (offering to pay the winning bidder in bills to control for penny aversion). Chances are very high that the following results will be obtained: (1) the average bid will be significantly less than the value of the coins (bidders are risk averse); (2) the winning bid will exceed the value of the jar. Therefore, you will have money for lunch, and your students will have learned first-hand about the "winner's curse. Explain how you might argue that Aetna's 1996 purchase of the spectacular growth company U.S. Healthcare for $8 billion is an example of The Winner's Curse.

Question 26

"When the economy goes up, it floats all boats, when the economy goes down, it sinks all ships." Please explain why this is not true for the boat we are studying called the health care industry. Point out at least some areas in which it is true.

Question 27

Use the following equation to explain why a nursing home will have a higher business risk than a pharmaceutical company. Compare a hospital with a pharmaceutical company to determine which one has the higher business risk.
Business risk = (Revenue Risk) x (Operating Expense) x (Financial Leverage)

Question 28

What is the purpose of using an internal rate of return (IRR) for financial projections, if it can provide only an approximate estimate of any given project's profitability?

Question 29

What is the most important lesson learned from the story of the very first HMO in U.S. history: the Kaiser Health Plan?