Group Chapt45- Fin Operational perf

Question 1

Maximization Framework and constant growth model

Answer 1

1. PEG ratio is stock’s price per earnings (P/E) divided by annual growth rate
2. Gordon Constant Growth Model
   
   2. 1 P = D/(k-G)
      
      2. 1.1 P = price per share
      3. 1.2 D = Dividend per share one year
      4. 1.3 k = Required rate of return for equity investor
      5. 1.4 G = Growth rate in dividends (in perpetuity)
   3. 2 Dividing by D, then P/E approximately = P/D = 1/(k-G)
      
      2. 2.1 For a constant discount rate k, maximizing value means maximizing growth

Question 2

Growth and Return on Equity

Answer 2

1. ROE =
   Netincome/ ShareholderEquity
2. Return on Equity is same as Sustainable Growth Rate when no dividends are paid
   2.1 Sustainable growth rate = Earning Retention rate * ROE
   2.2 = (1- dividends/earnings) * ROE

Question 3

Factors of Growth

Aka DuPont Formula

Answer 3

1. First part of DuPont formula is return on assets (aka return on investment ROI)
   
   1. 1 Total asset turnover * net profit margin = return on asset
   2. 2 revenues/total assets * net income/revenue = net income / total assets
2. Next, financial leverage amplifies return on assets into ROE
   
   2. 1 ROA * total leverage ratio = ROE
   3. 2 (net income/total assets) * (total assets/ShareholderEquity) = NetIncome/ShareholderEquity = ROE
   4. 3 (Net income/sales) * (sales/assets) * (assets/equity) = ROE
3. Total asset turnover: how much investment (equity and debt) required to meet the requirements of this business?
4. Profit margin: for every dollar of sales, what percent is profit?
5. Total leverage ratio: to what degree can creditors’ money magnify ROA?

Question 4

Discuss profit margins

Answer 4

1. The margins themselves
   
   1. 1 profit expressed as % of total revenues
   2. 2 denominator of profit margin includes premiums and ASO fee income, but exclude investment income
      
      1. 2.1 refer to as underwriting income
      2. 2.2 income with investment income is operating income
   3. 3 operating margin is operating profits divided by revenues
   4. 4 net margins is net income divide by revenues
   5. 4.1 operating income = revenues - health benefits - admin expenses
   6. 4.2 Net income = operating income - net interest expense - income taxes
2. Related ratios
   
   2. 1 1 - health benefit ratio - admin expense ratio = operating profit margin
   3. 2 Administrative expense ratio: administrative expenses divided by revenues
   4. 3 health benefit ratio
      
      2. 3.1 often called medical loss ratio: calc as a percent of premium, not total revenue
   5. 4 plans with capitated arrangement have higher benefit ratio and lower admin ratio
      
      2. 4.1 due to admin expenses included in the capitation and treated as benefit expenses

Question 5

The same size income statement

Answer 5

1. Expresses all income statement items as a percent of revenues
2. Changes in expense items can be understood in their impact on profit margins

Question 6

Profit margin

Adjustments for revenue reporting differences

Answer 6

1. Reinsurance: useful to consider reins Prems health expenses, and reinsurance recoveries as offsets to health care costs
2. Commissions: they should be considered admin expense, and revenues should include commissions
3. Investment income: helpful to group investment returns with capital costs as non-operating income
4. Administrative services only products
   
   4. 1 administrative expenses relative to revenues high
   5. 2 premium equivalents - estimating what premiums would have been if plan bore risk by adding health benefits to fee revenue
   6. 3 helpful to look at reports for each product separately (e.g. ASO vs insured products)

Question 7

PMPM analysis

Answer 7

1. Advantage
   
   1. 1 Same size income statement affected by changes in revenues
   2. 2 PMPM clearly isolated changes
2. Drawback
   
   2. 1 External audiences are less familiar with this approach
3. Decomposing PMPMs: Break expenses into functional areas rather than accounting categories
4. PMPM values may be expressed as:
   
   4. 1 plan’s staffing ratio X total cost per FTE (full time EE)
   5. 2 total costs per FTE = per FTE staffing cost + non-labor cost

Question 8

Discuss Return on Asset (ROA)

Answer 8

1. Income divided by total assets
2. How profitable relative to capital regardless of whether capital is equity or debt
3. Investments (or assets) include facilities, information systems, accounts receivable
4. Staff model plan has higher fixed assets than IPA and ASO
5. Environmental conditions of health plan affect assets required
   
   5. 1 Statutory requirements increase capital needed
   6. 2 External sources of capital
      
      5. 2.1 Publicly traded companies have greater access to equity, and tend to operate with thinner capital

Question 9

Discuss Total Leverage Ratio

Answer 9

1. Assets divided by equity also equals (Liability + Equity)/ Equity
2. Leverage amplifies ROA
3. Frequently, liabilities are current (due within a year) and relate to claims payable
4. Administrative cost of processing claims also included as a liability

Question 10

Other financial analyses and applications

Answer 10

1. Year-over-year better than successive quarter approach
2. Comparisons with Other, Similar Enterprises
   
   2. 1 To reflect similar environmental and capital cost conditions
   3. 2 Be careful concerning the quality of data
   4. 3 Be careful of product mix differences
3. Financial Planning and Analysis
   
   3. 1 Discount rate should reflect riskiness of business
   4. 2 Time horizons should reflect planning process
   5. 3 Interim results measured against long-term projections
   6. 4 Performance compared with peers

Question 11

External Manifestations of Shareholder Value

Answer 11

1. Maximization of owners’ value is useful for analysis
2. While stock prices reflect short-term phenomena, planning should be long term
   
   2. 1 analysts may not understand market realities
   3. 2 May be impossible to communicate strategies to analysts
3. External manifestations (through share price) best achieved through:
   
   3. 1 shrewd management of earnings and growth
   4. 2 maximum feasible transparency