Healthcare Finance An Introduction to Accounting

Thus although we use the phrase business valuation

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to assess the value of ownership. Thus, although we use the phrase “business valuation,” the ultimate goal is to value the ownership stake in the business rather than its total value. Finally, business valuation is an imprecise process . The best that can be done, even by professional appraisers who conduct these valuations on a regular basis, is to attain a reasonable valuation rather than a precise one. Discounted Cash Flow Approach The discounted cash flow (DCF) approach to valuing a business involves the application of classical capital budgeting procedures to an entire business. To apply this approach, two key items are needed: (1) a set of statements that estimates the cash flows expected from the business and (2) a discount rate to apply to these cash flows. The development of accurate cash flow forecasts is by far the most important step in the DCF approach. Exhibit 18.4 contains projected profit and loss statements for Doctors’ Hospital, an investor-owned hospital that is being valued by its owners for possible future sale. The hospital currently uses 50 percent debt (at book values), and it has a 40 percent marginal federal- plus-state tax rate. Line 1 of Exhibit 18.4 contains the forecast for Doctors’ Hospital net revenues, including both patient services revenue and other revenue. Note EXHIBIT 18.4 Doctors’ Hospital: Projected Profit and Loss Statements and Retention Estimates (in millions) 2012 2013 2014 2015 2016 1. Net revenues $105.0 $126.0 $ 151.0 $174.0 $ 191.0 2. Patient services expenses 80.0 94.0 111.0 127.0 137.0 3. Other expenses 9.0 12.0 13.0 16.0 16.0 4. Depreciation 8.0 8.0 9.0 9.0 10.0 5. Earnings before interest and taxes (EBIT) $ 8.0 $ 12.0 $ 18.0 $ 22.0 $ 28.0 0 . 6 0 . 5 0 . 5 0 . 4 0 . 4 t s e r e t n I . 6 7. Earnings before taxes (EBT) $ 4.0 $ 8.0 $ 13.0 $ 17.0 $ 22.0 8. Taxes (40 percent) 1.6 3.2 5.2 6.8 8.8 9. Net profit $ 2.4 $ 4.8 $ 7.8 $ 10.2 $ 13.2 10. Estimated retentions $ 4.0 $ 4.0 $ 7.0 $ 9.0 $ 12.0
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C h a p t e r 1 8 : Le a s e F i n a n c i n g a n d B u s i n e s s Va l u a t i o n 667 that all contractual allowances and other adjustments to charges, including collection delays, have been considered, so Line 1 represents actual cash rev- enues. Lines 2 and 3 contain the cash expense forecasts, while Line 4 lists de- preciation—a noncash expense. Line 5, which is merely Line 1 minus lines 2, 3, and 4, contains the earnings before interest and taxes ( EBIT ) projections for each year. If the valuation were being conducted by another business that was considering making an acquisition bid for Doctors’ Hospital, the revenue and expense amounts would reflect any utilization, reimbursement, and cost efficiencies that would occur as a result of the acquisition. Note that the interest expense values shown on Line 6 include inter- est on current debt as well as interest on any newly issued debt required to fund business growth. In addition to interest expense, any debt principal repayments that will not be funded by new debt must be reflected in Exhibit 18.4. Because such payments are made from after-tax income, they would be placed on a line below net profit—say, on a new Line 9a. Line 7 contains the earnings before taxes (EBT), and Line 8 lists the taxes based on Doctors’s 40 percent marginal rate. Note here that any tax rate changes that would result
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