Question 20.A.1: Extra Credit Looking back at Locust Software, determine the ...

If the switch is made, Locust gives up P × Q = $4,900 today. An extra five units have to be produced at a cost of $20 each, so the cost of switching is $4,900 + 5 × $20 = $5,000. The benefit each month of selling the extra five units is 5 × ($49 − 20) = $145. The NPV of the switch is −$5,000 + $145/.02 = $2,250, so the switch is still profitable.
The $5,000 cost of switching can be interpreted as the investment in receivables. At 2 percent per month, the carrying cost is .02 × $5,000 = $100. Because the benefit each month is $145, the net benefit from switching is $45 per month (= $145 − 100). Notice that the PV of $45 per month forever at 2 percent is $45/.02 = $2,250, as we calculated above.