Question 20.S-TP.2: Credit Where Credit Is Due You are trying to decide whether ...
Credit Where Credit Is Due You are trying to decide whether or not to extend credit to a particular customer. Your variable cost is $15 per unit; the selling price is $22. This customer wants to buy 1,000 units today and pay in 30 days. You think there is a 15 percent chance of default. The required return is 3 percent per 30 days. Should you extend credit? Assume that this is a one-time sale and that the customer will not buy if credit is not extended.
If the customer pays in 30 days, then you will collect $22 × 1,000 = $22,000.
There’s only an 85 percent chance of collecting this; so you expect to get $22,000 × .85 = $18,700 in 30 days. The present value of this is $18,700 / 1.03 = $18,155.34. Your cost is $15 × 1,000 = $15,000; so the NPV is $18,155.34 – 15,000 = $3,155.34. Credit should be extended.