Terminal Value - Taking the Temperature of Health Care Valuations

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value using the Gordon Growth Model assumes cash flows grow at a constant rate after the last year and discounts residual value, and interim cash flows back to their present value to capture risk and reward. The last year cash flow multiplied by one plus a long-term growth rate of 5% divided by the discount rate minus the rate of growth period or g.

The constructed Excel spreadsheet calculates enterprise value at $10.2 million as of December 31, 2000, using a discount rate of 16% and growth of 5%, and company value takes into consideration both present value of operating cash flows and the present value of the residual value.

Dividends paid with cash for sustainable dividend growth with cash flow available for distribution to shareholders depends on profitability, intelligent investments in operating capital and equity and debt allocation.

The excel DCF EV matrix spreadsheet tab highlights both the error of mismatching cash flow with 17% and 18% discount rates, however, the duplicated discount rate of 16% and the 5% growth rates align with the enterprise value in the article.

Revenues, EBITDA, EBITDA margin and depreciation, calculates price multiples (market capital to revenues and market capital to EBITDA) and selects the multiples to apply to the subject company’s operating performance making adjustments based on various factors such as size and profitability. The evaluator chose a 20% reduction to the selected median multiples due to size differences because the subject company is smaller than each of the guideline companies ($30 million vs. an average of $135 million).

The subject company is on the higher end of profitability (4% EBITDA margin vs. the 3.2 % median EBITDA margin), and an assigned 10% upward adjustment to the market revenues multiple applies, in general, the higher the profitability of a company, the greater the company’s market capital to revenue multiple.

A price multiple is any ratio that uses the share price of business in conjunction with some specific per-share financial metric to evaluate a company’s financial situation. The share price is typically divided by a chosen per-share metric to form a ratio, for example, the Price Multiple equals Share Price divided by a Per Share Metric.

Market Capital/Sales is the sum of market equity plus market debt (outstanding debt plus preferred debt/equity), and Market Capital/EBIT or earnings before interest and taxes and Market Capital/EBITDA which is earnings before interest, taxes, depreciation and amortization are standard measures to track.

Summary

We must replace today’s fragmented system, in which a local provider offers a full range of services with a system in which services for particular medical conditions are concentrated in health delivery organizations and in the right locations to deliver high-value care.

The first step in solving any problem is to define a true goal, and efforts to reform health care hobbled by a lack of clarity about the goal, or even by the pursuit of the wrong objective. Narrow goals such as improving access to care, containing costs, and boosting profits have been a distraction. Access to poor care is not the objective, nor is reducing cost at the expense of quality, and furthermore, increasing profits is today misaligned with the interests of patients, because profits depend on increasing the volume of services, not delivering good results.

Business valuation is not just plugging numbers into formulas, but it is both a science and an art, still managed care and health care reform continue to force drastic restructuring of the health care system.

CPAs who perform medical valuations work in a dynamic environment examining internal and external factors to develop a most reasonable and reliable entity value projection, and they play a pivotal role in the development of economic growth, finance, and quality of life for society.

References

Garutto, L., & Loud, O. (2001, October 1). “Taking the temperature of health care valuations,” Journal of Accountancy, .Retrieved from http://www.journalofaccountancy.com/issues/2001/oct/takingthetemperatureofhealthcarevaluations.html

Ross, Westerfield, Jaffe, Jordan. (2016). Corporate Finance (11 ed.). New York, New York: Mc-Graw Hill Education.