Capital Healthplans, Inc., is evaluating two different methods for providing hom

Question

Capital Healthplans, Inc., is evaluating two different methods for providing home healht services to its memebers. Both methods involve contracting out for services, and the health outcomes and revenues are not affected by the method chosen. Therefore, the incremental cash flows for the decision are all outflows. Here are the projected flows: year: 0, 1,2,3,4,5, Method A: $300,000, 66,000,66,000, 66,000, 66,0000,Method B: $120,000, 96,000, 96,000, 96,000, 96,000, 96,000 (a) What is each alternative's IRR? (b) If the cost of capital for both methods is 9 percent, which method should be chosen? Why?

Explanation / Answer

NPV of Method A =$300,000 + 66,000/1.09 +66,000/1.09^2 + 66,000/1.09^3 + 66,0000/1.09^4 = $934,626.09 NPV of Method B =$120,000 + 96,000/1.09 + 96,000/1.09^2 + 96,000/1.09^3 + 96,000/1.09^4 + 96,000/1.09^5 = $493,406.52 NPV of cost of Method B is less and hence Method B should be chosen

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