Extra Credit

Looking back at Locust Software, determine the NPV of the switch if the quantity sold is projected to increase by only 5 units instead of 10. What will be the investment in receivables? What is the carrying cost? What is the monthly net benefit from switching?

Question

Extra Credit

Looking back at Locust Software, determine the NPV of the switch if the quantity sold is projected to increase by only 5 units instead of 10. What will be the investment in receivables? What is the carrying cost? What is the monthly net benefit from switching?

Accepted Answer

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.

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

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