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# Communicating up the Financial Ladder: Medical Finance 101 - PowerPoint PPT Presentation

Communicating up the Financial Ladder: Medical Finance 101. Marc J. Kahn, MD MBA (to be) Professor of Medicine Sr. Associate Dean Tulane University School of Medicine. Topics. Value of Money Stocks and Bonds Risk and Return Net Present Value. Questions.

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### Communicating up the Financial Ladder: Medical Finance 101

Marc J. Kahn, MD

MBA (to be)

Professor of Medicine

Sr. Associate Dean

Tulane University School of Medicine

• Value of Money

• Stocks and Bonds

• Risk and Return

• Net Present Value

• Would you rather have \$1,000,000 now or \$250,000 each year for the next 4 years?

• What is \$250,000 a year for 4 years worth today?

• Most basic concept of finance

• Money is worth more today than in the future.

• Opportunity costs

• Investment alternatives

• Interest—money paid for use of your money

• Future value—amount to which an investment grows after earning interest

Simple—interest earned on initial investment

Example: You invest \$100 at 6% annual interest.

=\$100 (1.06) = \$106 after one year

Compound—interest earned on interest

Example: You invest \$100 at 6% interest compounded monthly.

=\$100 (1 + .06/12)12 = \$106.17

If compounded daily = \$100(1 + .06/365)365 = \$106.18

• APR = Annual Percentage Rate (most common)

• EAR = Effective Annual Rate

Example: You have a credit card with an APR of 18%. What is the “real” interest rate annually?

APR = monthly rate x 12

Monthly rate = 18/12 = 1.5%

EAR = (1 + 1.5%)12 – 1 = 19.56%

• Grains of wheat on a chessboard

• One grain in square one, double each successive square

• Total wheat is more than that in the entire world!!

= 1.92 x 10109

FV = PV (1 + r)t

• Would you rather have \$1,000,000 now or \$250,000 each year for 4 years?

Obviously, money is worth more now!

• What is \$250,000 a year for 4 years worth today?

Assuming 5% interest rate per year =\$886,488

Looking at this another way, you would need \$282,012 per year for 4 years to have the same amount of money as \$1,000,000 now!

• Common Stock—Ownership (Equity) in a company

• Preferred Stock—preference over dividends but no voting rights

• Dividends—cash distributions to shareholders

• Market Value—current stock price

• Short sale—borrowing stock, selling the borrowed stock and paying it back later hopefully at a lower price

• Present Value of all future cash flows OR

• Present value of all future dividend payments discounted to proper rate of return

• Even for a stock that does not pay dividends!

• Rate of return is same for all stocks of equal risk

• Bond--an IOU—obligates issuer to make payments to bondholder

• Maturity—date that bond principle is to be repaid

• Face Value—payment at maturity

• Coupon rate—annual interest rate paid as % of face value

10 year \$10,000 Treasury Note with 6% coupon rate

Maturity in 10 years

Face value is \$10,000

Coupon payments are 6% of \$10,000 = \$300 payment every 6 months

Value = present value of coupon payments + present value of face value

• Discount Bond (zero coupon)—promises single payment at maturity. Sold at discount to face value—all T-bills

• US Government Bonds—T-bills < 1 yr

• T-notes 1-10 yrs

• T-bonds 10-30 yrs

• Higher rates of return for HIGHER RISK

• Rewarded for RISK

• Treasuries are considered risk free

• Extra payment is “risk premium”

• Historically treasuries have paid 3%, S & P has averaged 5.7% so historic market return is 8.7%

• Remember importance of standard deviation and variance!

• You invest \$100 and loose half the first year

• Next year gain the \$50 back

• So, average rate of return = (-50% + 100%)/2 = 25%

• How can this be?

[Π (1+rt)]1/t – 1

Geometric mean:

= [(1 + -0.5)(1 + 1)]1/2 – 1

= (0.5)(2)1/2 -1

= 11/2 – 1

= 1 – 1

= 0

• Diversification reduces risk

• Spreads risk across many investments

• Lowers variance of portfolio

• How much is an MD degree worth over a physicians lifetime?

• At what cost of medical school attendance is an MD no longer financially advantageous?

• Financial tool

• Takes into account costs/revenues at various points of time

• Corrects for opportunity costs

NPV = C0 + SCt/(1 + r)t

• Can be thought of as an interest rate

• Considers what could have been done with money if used differently

• Also called the “discount rate”

• Capital Asset Pricing Model (CAPM)

Expected return = Risk Free Return + b(risk premium)

• Risk free return = T-bill rate = 3%

• Risk Premium = 5.7% (historical average)

• b = 0.7 – 1.2 for health care stocks (measurement of market risk)

Value of MD = total change in salary– cost of attendance – lost wages

Corrected for Discount Rate

PV = FV/(1 + r)t

• Discount rate = 8.7%

• Expected salary after college without medical school = \$50,000 per year with 3% annual growth

• Residency training is 4 years in duration

• Salary of a resident is equivalent to that of a college graduate

• Incremental salary increase after completing residency is +\$130,000

• 35% tax rate

• Physician salary is expected to increase 3% per year for 30 years of practice

• Setting NPV = \$0 and solving for annual cost of attendance results in the breakeven cost of medical education

• Obtaining an MD has high NPV, even at the highest costs of attendance

• Only at a cost of attendance of over \$160,000 is the NPV less than zero

• In the current economic climate, the discount rate is less than 8.7%; this would make an MD degree MORE valuable

• Based on economic considerations, the supply of future physicians ought to be secure

• You want your money NOW

• Investing early can compound earnings

• Rate of return is related to risk

• Variance defines range of risk

• Diversification minimizes variance and risk

• Getting an MD is a good financial deal