Capitol Health Plans Inc. Is Evaluating Two Different Method
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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 unaffected by the method chosen. Therefore, the incremental cash flows for the decision are all outflows. The projected cash flows are as follows:
| Year | Method A | Method B |
|---|---|---|
| 0 | ($300,000) | ($120,000) |
Paper For Above instruction
The evaluation of investment alternatives is a critical aspect of financial decision-making within healthcare organizations. In this context, Capitol Health Plans, Inc. is assessing two methods for delivering home health services. Each approach involves contracting out services, with no expected differences in health outcomes or revenues, implying that the only relevant cash flows are initial outflows. This paper will analyze the internal rates of return (IRR) for both methods and determine the preferable option based on a cost of capital of 9 percent.
Calculating IRR involves finding the discount rate that makes the present value of cash inflows equal to the present value of cash outflows. In this scenario, since only initial outflows are present and there are no cash inflows, the IRR calculation simplifies to assessing the rate of return that would equate to these outflows over time. However, as the cash flows are only at the outset and no subsequent cash inflows are specified, the IRR essentially reflects the approximate rate of return that balances these costs over the project's life. This requires assumptions about the project's duration, which is not specified, but for this analysis, we will consider a standard investment horizon to derive the IRR.
For Method A, the initial cost is $300,000, and for Method B, it is $120,000. Given that these are the only cash flows, and no other inflows are projected, a simple IRR calculation is potentially meaningless unless additional cash flows are provided, such as savings or benefits that offset initial costs. In practice, healthcare organizations would consider the net cash flows over the project's life, including savings, efficiencies, or other benefits, to determine the IRR. In the absence of these, the investment's attractiveness depends primarily on its relationship with the cost of capital.
The decision rule is to select the method with the higher IRR if it exceeds the cost of capital, which is 9%. Given the data, Method B has a significantly lower initial expenditure ($120,000) compared to Method A ($300,000). This suggests that Method B might be the more financially viable option, assuming similar benefits and risks. Since only initial investments are noted, and no further cash flows are projected, the decision aligns with the non-quantitative factors, favoring the method with the lower initial cash outflow.
In conclusion, based on the available data, Method B appears to be the preferable alternative due to its lower initial investment and the absence of any offsetting inflows. The IRR calculations, limited by the data provided, indicate that both methods require additional detailed cash flow projections for more precise evaluation, but from a straightforward analysis, the lower-cost method is favored under typical criteria.
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