Credit Policy Rework Chapter Review and Self-Test Problem 20.1 using the oneshot and accounts receivable approaches. As before, the required return is 2.0 percent per period, and there will be no defaults. Here is the basic information:

Question

Credit Policy Rework Chapter Review and Self-Test Problem 20.1 using the oneshot and accounts receivable approaches. As before, the required return is 2.0 percent per period, and there will be no defaults. Here is the basic information:

	Current Policy	New Policy
Price per unit	$175	$175
Cost per unit	$130	$130
Sales per period in units	1,000	1,100

Accepted Answer

As we saw earlier, if the switch is made, an extra 100 units per period will be sold at a gross profit 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.

For the accounts receivable approach, we interpret the $188,000 cost as the investment in receivables. At 2.0 percent per period, the carrying cost is $188,000 × .02 = $3,760 per period. The benefit per period we calculated as $4,500; so the net gain per period is $4,500 - 3,760 = $740. At 2.0 percent per period, the PV of this is $740 / .02 = $37,000.

Finally, for the one-shot approach, if credit is not granted, the firm will generate ($175 - 130 ) × 1,000 = $45,000 this period. If credit is extended, the firm will invest $130 × 1,100 = $143,000 today and receive $175 × 1,100 = $192,500 in one period. The NPV of this second option is $192,500 / 1.02 - 143,000 = $45,725.49. The firm is $45,725.49 - 45,000 = $725.49 better off today and in each future period because of granting credit. The PV of this stream is $725.49 + 725.49 / .02 = $37,000 (allowing for a rounding error).

Question 20A.S-TP.1: Credit Policy Rework Chapter Review and Self-Test Problem 20...

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