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