Question

9.5 Capital Healthplans Inc. is evaluating two different methods for providing home health services to its members. Both methods involve contracting out for services, and the health outcomes and revenues are not affected by the method chosen. Therefore, the net cash flows for the decision are all outflows. Here are the projected flows:Year Method A Method B0 (300,000) (120,000)1 (66,000) (96,000)2 (66,000) (96,000)3 (66,000) (96,000)4 (66,000) (96,000)5 (66,000) (96,000)a. What is each alternative’s IRR? b. If the opportunity cost of capital for both methods is 9 percent, which method should be chosen? Why?

Answer 1

Answer:

present worth A: 513,821.51

present worth B:   431,013.1

We should choose option B as the present worth is lower.

the IRR cannot be calculated when all teh cashflow are negative as it the rate which makes the present value equal to zero. that means it will discount either the negative or postive subsequent cashflow to match an initial of the opposite sign.

Explanation:

For the intenal rate of return we must look for which rate makes the cost equal to zero.

For the opportunity cost, we solve for the present value of eahc discounted at the given rate of 9%

Method A

$\frac{Maturity}{(1 + rate)^{time} } = PV$  

discount rate 0.09

# Cashflow Discounted

0 300000         300000

1   66000           60550.46

2   66000           55550.88

3   66000           50964.11

4   66000           46756.06

NPV           513821.51

Method B

# Cashflow Discounted

0 120000 120000

1 96000 88073.39

2 96000 80801.28

3 96000 74129.61

4 96000 68008.82

NPV 431013.1