Question 20.S-TP.1: Credit Policy The Cold Fusion Corp. (manufacturer of the Mr....
Credit Policy The Cold Fusion Corp. (manufacturer of the Mr. Fusion home power plant) is considering a new credit policy. The current policy is cash only. The new policy would involve extending credit for one period. Based on the following information, determine if a switch is advisable. The interest rate is 2.0 percent per period:
| New Policy | Current Policy | |
| $175 | $175 | Price per unit |
| $130 | $130 | Cost per unit |
| 1,100 | 1,000 | Sales per period in units |
If the switch is made, an extra 100 units per period will be sold at a gross profi t of $175 – 130 = $45 each. The total benefit is thus $45 × 100 = $4,500 per period.
At 2.0 percent per period forever, the PV is $4,500 / .02 = $225,000.
The cost of the switch is equal to this period’s revenue of $175 × 1,000 units = $175,000 plus the cost of producing the extra 100 units: 100 × $130 = $13,000.
The total cost is thus $188,000, and the NPV is $225,000 – 188,000 = $37,000.
The switch should be made.