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PROBLEM 5 Allied Managed Care Company is evaluating two different computer systems for handling provider claims. There are no incremental revenues attached to the projects,

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PROBLEM 5 Allied 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. Allied's corporate cost of capital is 10 percent. Here are the net cash flow estimates in thousands of dollars: Year System X System Y $500 $1,000 -$500 -$300 INP $500 $300 $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. Which system should be chosen? ANSWER a. ) Year 0 1 2 3 System X -500 -500 -500 -500 Cost of capital 0.909091 0.826446 0.751315 PV -500 -454.545 -413.223 -375.657 NPV = 1743.426 Year 0 1 2 3 System Y 1000 -300 -300 -300 Cost of capital 0.909091 0.826446 0.751315 PV -1000 -272.727 -247.934 -225.394 NPV = 1746.056 Assuming that the systems both have average risk, System X should be chosen as it's net present valu b.) Year 0 1 2 3 Year 0 System X -500 -500 -500 -500 System X -500 500 Cost of capital 0.925926 0.857339 0.793832 Cost of capital 0.892857 PV -500 -462.963 -428.669 -396.916 PV -500 -446.429 NPV 1788.548 NPY 1700.916

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