HEALTHCARE MANAGED CARE COMPANY IS EVALUATING TWO DIFFERENT COMPUTER SYSTEMS FOR
ID: 1234285 • Letter: H
Question
HEALTHCARE MANAGED CARE COMPANY IS EVALUATING TWO DIFFERENT COMPUTER SYSTEMS FOR HANDLING PROVIDER CLAIMS. There are no incremental revenues attached to the projects, so the decision will be made on the basis of the present value of costs. Helathcare management co. cost of capital is 10%. here are the net cash flow estimates of dollars.
Year System X System Y
0-$500 -$1000
1 -$500 -$300
2 -$500 -$300
3 -$500 -$300
A. Assume initially that the systems both have average risk. Which one should be chosen?
B. Assume that System X is judged to have high risk. Allied accounts for differential risk by adjusting its corporate cost of capital up or down by 2 percentage points. What system should be chosen?
Explain. Show your work.
Explanation / Answer
A Present value of cost of System X =500 + 500/1.1 +500/1.1^2 +500/1.1^3 =$1743.426 Present value of cost of System Y =1000 + 300/1.1 +300/1.1^2 +300/1.1^3 =$1746.0556 System X should be chosen as it as lower present value of cost B Present value of cost of System X with cost of capital 12% =500 + 500/1.12 +500/1.12^2 +500/1.12^3 =$1700.915634 Present value of cost of System X with cost of capital 8% =500 + 500/1.08 +500/1.08^2 +500/1.08^3 =$1788.548494 System X is risky and the costs may go upto $1788.548 if the cost of capital dips to 8%. Therefore System Y should be chosen as it is risk free
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