This document discusses various methods of capital financing for health care providers, including equity financing through retained earnings or stock issuance, and debt financing through loans, bonds, and lease agreements. It provides examples of calculating bond valuation and rates of return, as well as amortization schedules for loans. Key terms defined include debt service coverage, tax-exempt versus taxable bonds, and operating versus capital leases.

1. Capital Financing
for Health Care
Providers
Chapter 8

2. Learning Objectives
• Describe the types of equity and debt financing
• Define various bond terminology
• Compare tax exempt with taxable financing
• Explain lease financing

3. Assets=Debt +Equity
• Any increase in assets must be balanced by a similar increase in
debt or equity or both
• The structuring of debt relative to equity is called capital
structure decision
• Important for both for profit and not for profit
• Industry changes can limit the access to debt and equity
financing
• Strong cash flow and dominant market share position improve
the credit rating of a health care system

4. Equity Financing
Primary sources for not-for- profits
Internally generated funds
Philanthropy
Governmental grants
Sale of real estate including medical office buildings
Primary source for profits
Issuing stock
Retained earnings

5. Comparison of Stock and Debt
Financing

6. Debt Financing
Alternative to equity financing
• Borrowing money from others at a cost
Several types
• Long Term Loans
• Bonds may be issued

7. Types of Debt Financing
• Maturity
• Term Loans- paid off within 10 years
• Bonds- maturity in 20-35 years
• Type of Interest Loan
• Fixed Interest rate debt
• Variable rate demand bonds
• Auction rate securities
• Interest rate swap

8. Selected Types of Health Care
Debt Financing
• Bank Term Loans
• Conventional Mortgages
• Pooled Equipment Financing
• FHA Program Loans
• Bonds
• Tax Exempt Bonds
• Taxable Bonds

9. Bond Issuance Process
Bonds can be sold by either public or private placement
• In a public offering a bond is sold to the investing public
through an underwriter
• Private placements are sold to a particular institution or
group of institutions

11. Bond Issuance Process
• Can take 12-18 months before cash received
• Health care borrower updates its capital plan, measures its debt
capacity
• Borrower identifies and selects the key parties involved in the
bond issuance process
• Borrower is evaluated by a credit rating agency
• Bond is rated by a credit rating agency
• Borrower enters into a loan agreement with a governmental
authority, the issuer of bonds
• Underwriter sell bonds to bond holders at the public offering
and the trustee provides health care provider with the net
proceed from the bond issuance

12. Financial Evaluation
Evaluation of a health care provider’s ability to pay
• Debt Service Coverage- one of the primary financial ratios used to
evaluate a health care provider’s ability to meet debt service
payments
푵풆풕 푰풏풄풐풎풆 + 푰풏풕풆풓풆풔풕 + 푫풆풑풓풆풄풊풂풕풊풐풏 + 푨풎풐풓풕풊풛풂풕풊풐풏
푫풆풃풕 푺풆풓풗풊풄풆 푪풐풗풆풓풂품풆 =
푴풂풙풊풎풖풎 푨풏풏풖풂풍 푫풆풃풕 푺풆풓풗풊풄풆 푷푨풚풎풆풏풕풔
• Market evaluation: including local demographics (population
growth, income levels, unemployment rate in the market area);
competition from other health care providers, penetration of
managed care etc.
• Physician and Management Evaluation

13. Bank Qualified or Direct Private
Placement Loans
• Direct tax exempt loan bond purchase by a bank
Advantages
• Direct debt purchase is less time consuming and cheaper to
issue
• Loan does not require a credit rating by a rating agency
• Loan avoids remarketing
• If a loan qualifies as bank qualified, the bank can deduct 80%
of its interest costs which results in lower interest

14. Bond valuation
• Bond valuation (annual coupon payments):
• 푚푎푟푘푒푡 푣푎푙푢푒 = 푐표푢푝표푛 푝푎푦푚푒푛푡 푋 푃푉퐹퐴 푘, 푛 +
푃푎푟 푣푎푙푢푒 푋 푃푉퐹 푘, 푛
• Bond valuation (semiannual periods for coupon payments):
• 푚푎푟푘푒푡 푣푎푙푢푒 = 푐표푢푝표푛 푝푎푦푚푒푛푡/2 푋 푃푉퐹퐴 푘/

15. Bond valuation: Example 1
• If a $1000 zero coupon bond with a 30-year maturity has a
market price of $412, what is its rate of return?
Givens:
Par Value (FV) $1,000
Years to Maturity (nper) 30
Market Value (PV) $412.00

16. Solution:
Market Coupon Par
Value = Payment x PVFA(k,n) + Value x PVF(k,n)
$412.00 = $0.00 x PVFA(k,n) + $1,000.00 x PVF(k,n)
$412.00 = $0.00 x PVFA(k,30) + $1,000.00 x PVF(k,30)
$412.00 = $1,000.00 x PVF(k,30)
$412.00 / $1,000.00 = PVF(k,30)
0.412 = PVF(k,30)
k = 3% = 0.03 (from Table B-3 )

17. Example 2:
• If a $1000 zero coupon bond with a 10-year maturity has a
market price of $508.30, what is its rate of return?
Givens:
Par Value (FV) $1,000
Years to Maturity (nper) 10
Market Value (PV) $508.30

18. Solution:
Market Coupon Par
Value = Payment x PVFA(k,n) + Value x PVF(k,n)
$508.30 = $0.00 x PVFA(k,n) + $1,000.00 x PVF(k,n)
$508.30 = $0.00 x PVFA(k,10) + $1,000.00 x PVF(k,10)
$508.30 = $1,000.00 x PVF(k,10)
$508.30 / $1,000.00 = PVF(k,10)
0.5083 = PVF(k,10)
k = 7% = 0.07 (from Table B-3)

19. Example 3:
A tax exempt bond was recently issued at an annual 10 percent
coupon rate of return and matures 15 years from today. The
par value of the bond is $1000.
Givens:
Par Value $1,000
Years to Maturity 15
Coupon Rate 10%
a. Hypothetical Market Rate 10%
b. Hypothetical Market Rate 5%
c. Hypothetical Market Rate 14%
d. At what required market rate (10%, 5%, or 14%) does the
above bond sell at a discount? At a premium.?

20. Solution:
Market Coupon Par
Value = Payment x PVFA(k,n) + Value x PVF(k,n)
MV = $100.00 x PVFA(0.1,15) + $1,000.00 x PVF(0.1,15)
MV = $100.00 x 7.6061 + $1,000.00 x 0.2394
MV = $760.61 + $239.39
MV = $1000.00
Market Coupon Par
Value = Payment x PVFA(k,n) + Value x PVF(k,n)
MV = $100.00 x PVFA(0.05,15) + $1,000.00 x PVF(0.05,15)
MV = $100.00 x 10.3797 + $1,000.00 x 0.4810
MV = $1,037.97 + $481.02
MV = $ 1,518.98

21. Solution:
Market Coupon Par
Value = Payment x PVFA(k,n) + Value x PVF(k,n)
MV = $100.00 x PVFA(0.14,15) + $1,000.00 x PVF(0.14,15)
MV = $100.00 x 6.1422 + $1,000.00 x 0.1401
MV = $614.22 + $140.10
MV = $ 754.31
d.
When the market rate equals the coupon rate (part a), market value equals
par value.
When the market rate is below the coupon rate (part b), the bond sells at a
premium.
When the market rate is above the coupon rate (part c), the bond sells at a
discount.

22. Loan Amortization: Example 4
• The Johns Hopkington hospital needs to borrow $3million to
purchase an MRI. The interest rate for the loan is 6%.
Principal and interest payments are equal debt service
payments, made on an annual basis. The length of the loan is
5 years. The CFO of Johns Hopkington wants to develop a
loan amortization schedule for this debt borrowing for
tomorrow morning’s meeting. Prepare such a schedule?

23. Solution:
Givens: (PV) $3,000,000
Interest rate (rate) 6%
Length of Loan (nper) 5
Present Annuity
Value = Amount x PVFA(0.06,5)
$3,000,000 = Annuity x 4.2124 (Table B-4)
Annuity = $3,000,000 / 4.2124
Annuity = $712,189

24. Solution:

25. Example 5:
• Laurel Regional hospital needs to borrow $80 million to
finance its new facility. The interest rate for the loan is 8%.
Principal and interest payments are equal debt service
payments, made on an annual basis. The length of the loan is
10 years. The CEO would like to develop a loan amortization
schedule for this debt borrowing for tomorrow morning’s
meeting. Prepare such a schedule?
Givens: (PV) $80,000,000
Interest rate (rate) 8%
Length of Loan (nper) 10

26. Solution:
Present Annuity
Value = Amount x PVFA(0.06,5)
$80,000,000 = Annuity x 6.7101 (Table B-4)
Annuity = $80,000,000 / 6.7101
Annuity = $11,922,359

27. Solution:

28. Lease Financing
• Lessor: an entity that owns an asset that is then leased out.
• Lessee: An entity that negotiates the use of another’s asset
via a lease.
The lessor owns the asset, and the lessee makes lease payments
to the lessor for the use of the asset.
Reasons for lease:
• Avoid the bureaucratic delays of capital budget requests
• Avoid technological obsolescence
• Receive better maintenance services
• Allow for convenience

29. Types of Lease
• Operating lease- service equipment leased for periods shorter than
the equipment’s economic life (one year or less).
• This type of leasing arrangement can be canceled at any time
without penalty, but there is no option to purchase the asset once
the lease has expired.
• Capital Lease- lease the asset for all of its economic life possible
option to buy.
• This type of lease cannot be cancelled without penalty, and at the
end of the lease period, the lessee may have the option to
purchase the asset.

30. Lease versus Purchase Decision
• Compare present value cost of a buy decision with the present
value cost of a lease over a specified time
• The option with the lower present value cost is preferable
• Many factors to consider

31. Purchase vs. Lease: Example
Givens: (in thousands)
1. Before tax lease payments $15,000
2. Loan amount (PV) $55,000
3. Length of loan/lease (nper) 5
4. Interest rate (rate) 8%
5. After tax cost of debt 5%
6. Tax rate 40%
7. Annual depreciation expense [a] $11,000
8. Annual depreciation tax shield [b] $4,400
9. Annual loan payment [c] $13,775
10. Present value of lease @ interest rate [d] $59,891

32. Solution: Purchasing arrangement
Year [A]
Loan payment
(given 9)
[B]
Interest expense
[D]X[given 4]
[C]
Principal payment
[A]-[B]
[D]
Remaining balance
[D]-[C]
0 $55,000
1 $13,775 $4400 $9,375 45,625

33. Solution: Purchasing arrangement
Year [A]
Loan payment
(given 9)
[B]
Interest expense
[D]X[given 4]
[C]
Principal payment
[A]-[B]
[D]
Remaining balance
[D]-[C]
0 $55,000
1 $13,775 $4400 $9,375 45,625
2 $13,775 3,650 10,125 35,500

34. Solution: Purchasing arrangement
Year [A]
Loan payment
(given 9)
[B]
Interest expense
[D]X[given 4]
[C]
Principal payment
[A]-[B]
[D]
Remaining balance
[D]-[C]
0 $55,000
1 $13,775 $4400 $9,375 45,625
2 $13,775 3,650 10,125 35,500
3 $13,775 2840 10935 24,565

35. Solution: Purchasing arrangement
Year [A]
Loan payment
(given 9)
[B]
Interest expense
[D]X[given 4]
[C]
Principal payment
[A]-[B]
[D]
Remaining balance
[D]-[C]
0 $55,000
1 $13,775 $4400 $9,375 45,625
2 $13,775 3,650 10,125 35,500
3 $13,775 2840 10935 24,565
4 $13,775 1965 11810 12755

36. Solution: Purchasing arrangement
Year [A]
Loan payment
(given 9)
[B]
Interest expense
[D]X[given 4]
[C]
Principal payment
[A]-[B]
[D]
Remaining balance
[D]-[C]
0 $55,000
1 $13,775 $4400 $9,375 45,625
2 $13,775 3,650 10,125 35,500
3 $13,775 2840 10935 24,565
4 $13,775 1965 11810 12755
5 $13,775 1020 12755 0

37. Solution:
Year [E]
Depreciation
expense shield
[given 7]X[given 6]
[F]
Interest expense
Tax shield
[B]X[given 6]
[G]
Net cash outflow (if
owned)
[A]-[E]-[F]
[H]
PVF (from table B-
3)
After tax
Cost of debt
[given 5]
[I]
PV of net cash outflows
(if owned)
[G]X[H]
0 $55,000
1 $4400 $1760 7615 0.9542 $7,266
2 $4400 1460 7915 0.9105 7,207
3 $4400 1136 8239 0.8688 7,158
4 $4400 786 8589 0.8290 7,120
5 $4400 408 8967 0.7910 7,093
$35,845

38. Leasing arrangement
Year [A]
Before Tax
Lease Payments
[Given 1]
[B]
Lease tax
shield
[A]X[given 6]
[C]
After tax
Net lease payments
[A]-[B]
[D]
PVF
After tax
Cost of debt
[given 5]
[E]
Cash outflows
(if leased)
[C]X[D]
0
1 $15,000 $6,000 $9,000 0.9542 $8,588
2 $15,000 $6,000 $9,000 0.9105 8,194
3 $15,000 $6,000 $9,000 0.8688 7,819
4 $15,000 $6,000 $9,000 0.8290 7,461
5 $15,000 $6,000 $9,000 0.7910 7,119
$39,182
It is more expensive to lease the asset since the present value
of the lease payments ($39,182)is greater than that for
borrowing ($35,845).

39. Summary
Three ways to finance debt
• Using debt (liabilities)
• Using equity
• Combination of debt and equity