Question & Answer: For questions 14 and 15, use the following scenario: The AHS system is evaluating two different…..

For questions 14 and 15, use the following scenario: The AHS system 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. AHS’s corporate cost of capital is 10%. Here are the net cash flow estimates in thousands of dollars: Year System X System Y 0 -$900 -$1,500 1 $1,500 $800 2 $250 $900 3 $300 $1,200 Select a Choice Below current question choices A.System X, because it has the higher NPV, at about $895,000. B.System Y, because it has the lower NPV, at about $872,000. C.System X, because it has the lower NPV, at about $872,000. D.System Y, because it has the higher NPV, at about $895,000. Assume that System X is judged to have high risk. AHS accounts for differential risk by adjusting its corporate cost of capital by 2 percentage points. Which system should be chosen? Select a Choice Below current question choices A.System X, because the net cash flow for System X will increase to $852,000. B.System X, because the net cash flow for System X will increase to $852,000. C.System Y, because the net cash flow for System X will decrease to $852,000. D.System Y, because the net cash flow for System X will increase to $895,000.

Expert Answer

For System X:

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Net present value (in thousands of dollar) = 1500/1.1 + 250/1.1^2 + 300/1.1^3 – 900

Net present value (in thousands of dollar) = 895.6424

Hence, net present value = $895642.4

For System Y:

Net present value (in thousands of dollar) = 800/1.1 + 900/1.1^2 + 1200/1.1^3 – 1500

Net present value (in thousands of dollar) = 872.652

Hence, net present value = $872652

Since system X gives relatively higher NPV, hence system X should be selected.

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Correct Answer:

C.System Y, because the net cash flow for System X will decrease to $852,000.

Working note:

When 2% points are added for system X due to high risk:

Net present value (in thousands of dollar) = 1500/1.12 + 250/1.12^2 + 300/1.12^3 – 900

Net present value (in thousands of dollar) = 852.1183

Hence, net present value = $852118.3

Since system Y has higher NPV due to high risk consideration of X, then system Y should be selected.

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