Assignment:
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
0 ($500,000) ($1,000,000)
1 ($500,000) ($300,000)
2 ($500,000) ($300,000)
3 ($500,000) ($300,000)
a. Assume initially that both systems 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?