Case Study 2
****Make sure to show your calculations on your work!!! ***
GARYHUDSON WASborn and raised in Pensacola, Florida. He obtained his bachelor's degree in business from Florida State University, where he enrolled in the Naval Reserve Officers Training Corps program. After graduation, he received a commission in the US Marine Corps. Following his release from active duty, Gary used his GI Bill benefits to obtain a master's degree in health services administration from the University of Florida. His first job in healthcare was as a special projects coordinator/financial analyst at a large Miami hospital. He enjoyed his work there, but his ultimate goal was to return to Pensacola as the manager of a small healthcare business, where he would have more responsibility and authority. After five years in Miami, Gary became the chief operating and financial officer of Gulf Shores Surgery Centers, an investor-owned chain of ambulatory surgery centers with six locations in Florida's Panhandle.
Immediately after assuming his new position, Gary found himself facing several decisions. First, Gary had to select a bank or banks to meet the financial needs of Gulf Shores. He has approached two local banks—Sun Trust and BankSouth—about the interest rates they offer on a savings account and a certificate of deposit (CD) as well as the rate charged on a term loan. Sun Trust and BankSouth offer the same interest rate on each financial product and only differ in the frequency of compounding (EXHIBIT 11.1).
Second, a wealthy patient was so impressed with the care she received at Gulf Shores that she decided to make a series of donations to the facility. She will donate $75,000 a year for the first six years (t= 1 throught= 6, wheret= time) and $150,000 annually for the following six years (t= 7 throught= 12). The first deposit will be made a year from today (t= 1). In addition,she has just written a check for $250,000, which Gary will invest immediately (t= 0). Gary will invest all of the donations in a CD as they become available. CDs are generally offered in maturities of six months to ten years, and interest can be handled in one of two ways: the investor (buyer) can receive periodic interest payments, or the interest can automatically be reinvested in the CD. In the latter case, the buyer receives no interest during the life of the CD but receives the accumulated interest plus the principal amount at maturity. Because the goal of this investment is to accumulate funds for future use, as opposed to generating current income, all interest earned on the CD would be reinvested.
Third, Gulf Shores may launch substantial building renovations. In this circumstance, it would be forced to borrow $250,000 from a bank. Gary is considering two options for a term loan:
- A five-year term loan that would be repaid in equal annual installments, with the first payment due at the end of Year 1. Gary hopes to pay off the loan early—at the end of Year 3.
- A seven-year loan that would be repaid in annual installments of differing amounts, with the first payment due at the end of Year 1. For the first three years of the loan, the annual installment would be projected cash surpluses ($25,000 at the end of Year 1, $50,000 at the end of Year 2, and $75,000 at the end of Year 3). For the final four years of the loan, the annual installment would be a fixed (but currently unspecified) cash flow,X, at the end of each year from Year 4 through Year 7.
Finally, Gulf Shores has a board-designated building fund to pay for projected facility renovations starting in eight years and lasting for four years (att= 8, 9, 10, and 11). Current building renovation costs are estimated to be $14,500,000 a year, but they are expected to increase at a rate of 3.5 percent a year. So far, Gulf Shores has accumulated $15,000,000 (att= 0). Gary's long-run financial plan is to add $5,000,000 in each of the next four years (att= 1, 2, 3, and 4). Then, he plans to make equal annual contributions in each of the following three years (t= 5, 6, and 7).
All of the decisions Gary faces involve time value analysis.
Time Value Analysis (Answer all below)
1. Which bank should Gary choose for a savings account, which bank for a CD, and which bank for a term loan?
2. Gary will invest in CDs the donations from a wealthy investor. How much will the Center have accumulated on the day of the last donation? (Use the CD interest rate offered by the bank you selected for a CD in Question 1.)
3. If the Center takes out a five-year term loan that would be repaid in equal annual installments, how much will it owe to the bank if Gary decides to pay off the loan early, at the end of the third year? (Use the term loan interest rate offered by the bank you selected for a term loan in Question 1.)
4. If the Center takes out a seven-year term loan that would be repaid in different annual installments, with the first payment due at the end of Year 1, how much would the fixed annual installment be at the end of each year from Year 4 through Year 7? (Use the term loan interest rate offered by the bank you selected for a term loan in Question 1.)
5. Gary will invest the contributions to the board-designated building fund in CDs. How much will the equal annual contributions in Years 5, 6, and 7 have to be to ensure the Center will have sufficient funds to pay for projected facility renovations? (Use the CD interest rate offered by the bank you selected for a CD in Question 1.) (Hint: Use a timeline to lay out the Years 0 to 4 and Years 8 to 11 annual cash flows and then use Goal Seek in Excel to solve for the Years 5 to 7 cash flows.)
Instructions:
Answer the following questions:
- As a starting point, use last year’s allocation of $600,000 for base salary and $120,000 for bonuses. What would be the total compensation of each physician if performance pay is based solely on a productivity measure only? That is, 100 percent of performance pay based on patient visits (0 percent for all other productivity, financial, and quality measures), 100 percent based on work RVUs, or 100 percent based on professional procedures.
- Now, focus exclusively on a financial performance measure. That is, 100 percent of performance pay based on gross charges (0 percent for all other productivity, financial and quality measures), 100 percent based on net collections, or 100 percent based on net income before physician compensation.
- Finally, what if only a quality measure is used? That is, 100 percent of performance pay based on average patient satisfaction score (0 percent for all other productivity, financial and quality measures), 100 percent based on blood pressure control target met, or 100 percent based on breast cancer screening target met.
- One physician wants to base all compensation on performance. Assume that all of last year’s total compensation of $720,000 is allocated based on a single performance measure. What would be the total compensation of each physician based on each financial, productivity and quality measure? Would it be wise to use this approach?
****Make sure to show your calculations on your work!!! ***