Problem 3

Capitol Health Plans, 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 incremental cash flows for the decision are all outflows.

Here are the projected flows:

Year Method A Method B

0 -$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 cost of capital for both methods is 9 percent, which method should be chosen? Why?