Communicating up the financial ladder medical finance 101
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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. 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

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
Topics

  • Value of Money

  • Stocks and Bonds

  • Risk and Return

  • Net Present Value


Questions
Questions

  • 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?


Time value of money
Time Value of Money

  • Most basic concept of finance

  • Money is worth more today than in the future.

  • Opportunity costs

  • Investment alternatives


Definitions
Definitions

  • Interest—money paid for use of your money

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

  • Present value—amount of money you start with


Interest
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


Compound interest payments
Compound Interest Payments

  • 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%


Why compounding matters
Why Compounding Matters

  • 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


Future present value
Future/Present Value

FV = PV (1 + r)t


Original questions
Original Questions

  • 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!


What is a stock
What is a stock?

  • 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


What is stock worth
What is Stock Worth

  • 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


What is a bond
What is a Bond?

  • 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


Bond example
Bond Example

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


Bond definitions
Bond Definitions

  • 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


Risk

  • 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!


Conundrum
Conundrum

  • 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?


Geometric mean
Geometric Mean

[Π (1+rt)]1/t – 1


Previous example
Previous Example

Geometric mean:

= [(1 + -0.5)(1 + 1)]1/2 – 1

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

= 11/2 – 1

= 1 – 1

= 0


Points
Points

  • Diversification reduces risk

  • Spreads risk across many investments

  • Lowers variance of portfolio


Questions1
Questions

  • 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?


Net present value
Net Present Value

  • Financial tool

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

  • Corrects for opportunity costs


Equation
Equation

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


Opportunity cost r
Opportunity Cost (r)

  • Can be thought of as an interest rate

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

  • Also called the “discount rate”


Calculating discount rate
Calculating 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)


Model summary
Model Summary

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

Corrected for Discount Rate


Present value
Present Value

PV = FV/(1 + r)t


Assumptions
Assumptions

  • 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



Conclusions
Conclusions

  • 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


Pearls
Pearls

  • 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



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