1. What is the net present value (NPV) of the practice based on the Director's assumptions and the salary offer of $350,000 each? Your NPV calculation should incorporate the cash flows for 2019-2023, the terminal value, and should be discounted appropriately.

The Director plans to offer the four physicians a salary of $350,000 each for 2019 (as part of a five-year contract), and the salary would increase by 4% per year. The system's discount rate or cost of capital is 13%, and the terminal growth rate of the cash flows for the years beyond 2023 is assumed to be 3%. By law, the salaries that a non-profit health system (such as this one) offers to its employed physicians must be based on fair market value (FMV), which means that ideally the practice should have a positive net present value for the system once the salaries are paid. If the health system employs the physicians, it may need to present to regulators a financial analysis that justifies the salaries based on the practice's outpatient practice-based activity only. If the offered salary exceeds the FMV, the system needs to justify why.

2. After making the $350,000 salary offer to the four physicians, the physicians notified the Director that another local health system offered salaries of $380,000 per year for 2019, with 4% growth per year through 2023. Before throwing in the towel, the Director met with the system CFO who reminded the Director that the practice generates about $750,000 in annual facility net revenues for the system (e.g., DRG payments for admitted Medicare patients, outpatient imaging payments in the ambulatory imaging center), which results in an estimated $150,000 per year in profits (these profits are expected to grow at 2% per year). Although these facility profits cannot be formally included in a fair market value calculation, they are very real from the system's perspective and could and should be included in the system's "internal" return on investment (ROI) calculations. Should the system match the competing offer? What factors should they consider when deciding? Regardless of your recommendation, how could the system justify the $380,000 as being consistent with fair market value if they were audited? Consider that $350,000 is the median compensation for physicians in this specialty. Fifty percent of physicians receive compensation above the median. How might they justify to regulators that these physicians deserve compensation that is above the median value nationally?

Historical Assumed Projected 201 B G rowth 201 0 2020 2021 2022 2023 Revenues $2,275,420 4.515 $2,378,859 $2,485,908 $2,597,773 $2,714,573 $2,835,833 Operating Expenses Administrative supplies and services $19,632 3.0% $20,221 $20,828 $21,452 $22,096 $22,759 Building and occupancy depreciation $11,312 3.0% $11,651 $12,001 $12,361 $12,732 $13,114 Furniture and equipment $4,172 4.0% $4,339 $4,512 $4,693 $4,881 $5,076 Medical and surgical supply $35,684 5.0% $37,468 $39,342 $41,309 $43,374 $45,543 Clinical laboratory operating cost $6,804 5.0% $7,144 $7,501 $7,876 $8,270 $8,684 Professional liability insurance $33,636 1.0% $33,972 $34,312 $34,655 $35,002 $35,352 Building and occupancy $177 772 2.5% $182,216 $186,772 $191,441 $196,227 $201,133 Subtotal Nonlabor Operating Expenses $289,012 $297,012 $305,268 $313,788 $322,582 $331,660 Non-Physician Stafl Salary Total employed support Staff $531,895 3.51% $550,512 $559,780 $589,723 $510,353 $531,725 Total employed support staff benets $157 964 4.5% $165,072 $172,501 $180,263 $188,375 $196,852 Subtotal NonPhysician Staff Salary $589,860 $715,585 $742,281 $759,986 $798,738 $828,577 Operating Income Available for Physician Comper 1 297 548 Physician Compensation $324,387 4.0% $1,400,000 $1,456,000 $1,514,240 $1,574,810 $1,637,802 per MD Operating Income $33,133 33 LE! :$240 mg Era38$ Plus: depreciation $11,651 $12,001 $12,361 $12,732 $13,114 Less: capital expenditures $30,000 $30 000 $30,000 $30 000 $30,000 Cash Flow From Operations {$52,087} {$35,640} {$17,879} $1,276 $21 ,908 Terminal value Net Present Value Discount rate 1 3.0% Growth rate for terminal value 3.0%