Concept explainers
(a)
To evaluate: Whether the company should fill the order.
Introduction:
Credit policy refers to a set of procedures that include the terms and conditions for providing goods on credit and principles for making collections.
(a)
Answer to Problem 9QP
The
Explanation of Solution
Given information:
AS is a wholesaler of stock engine components and test equipment. AS got an order. The variable cost and credit price is $1.9 million per unit and $2.015 million per unit respectively, 1 out of 200 such orders of payment are never collected. The require return is 1.8% per period.
If the order is one time, then the
The formula to calculate the net present value:
Compute the net present value:
Hence, the net present value is $69,474.45.
Since the amount of NPV is positive, the company should fill the order.
(b)
To determine: The break-even default probability.
Introduction:
Credit policy refers to a set of procedures that include the terms and conditions for providing goods on credit and principles for making collections.
(b)
Answer to Problem 9QP
The break-even default probability is 4.009%. It is recommended that the firm was not able to accept the order when the default probability is higher than 4.009%.
Explanation of Solution
Given information:
AS is a wholesaler of stock engine components and test equipment. AS got an order. The variable cost and credit price is $1.9 million per unit and $2.015 million per unit respectively, 1 out of 200 such orders of payment are never collected. The require return is 1.8% per period.
Consider
The formula to calculate the break-even default probability by using the NPV formula:
Compute the net present value:
Hence, the break-even default probability is 4.009%.
(c)
To determine: The net present value.
Introduction:
Credit policy refers to a set of procedures that include the terms and conditions for providing goods on credit and principles for making collections.
(c)
Answer to Problem 9QP
The net present value (NPV) is $4,456,944.444 and the default probability is 70.26%. Since the amount of NPV is positive, the company can take up the order.
Here, all the customers become repeat customers. So, cash inflow will be credit price minus variable cost. Hence, AS needs to make arrangements for on more engines for one period, cash inflow becomes perpetuity.
Explanation of Solution
Given information:
AS is a wholesaler of stock engine components and test equipment. AS got an order. The variable cost and credit price is $1.9 million per unit and $2.015 million per unit respectively, 1 out of 200 such orders of payment are never collected. The require return is 1.8% per period.
The formula to calculate the net present value:
Compute the net present value:
Hence, the net present value (NPV) is $4,456,944.444 per unit.
(d)
To discuss: Credit terms are more liberal when repeated orders are a possibility.
(d)
Explanation of Solution
When repeat orders are feasible then the credit terms become more moderate. This is because the likely losses from granting credit for the first time can be compensated from the future period’s possible gain.
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Chapter 20 Solutions
Fundamentals of Corporate Finance Alternate Edition
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