Concept explainers
Evaluating Credit Policy Air Spares is a wholesaler that stocks engine components and test equipment for the commercial aircraft industry. A new customer has placed an order for eight high-bypass turbine engines, which increase fuel economy. The variable cost is $2.6 million per unit, and the credit price is $2.815 million each. Credit is extended for one period, and based on historical experience, payment for about 1 out of every 200 such orders is never collected. The required return is 2.9 percent per period.
- a. Assuming that this is a one-time order, should it be filled'' The customer will not buy if credit is not extended.
- b. What is the break-even probability of default in part (a)?
- c. Suppose that customers who don’t default become repeat customers and place the same order every period forever. Further assume that repeat customers never default. Should the order be filled? What is the break-even probability of default?
- d. Describe in general terms why credit terms will be more liberal when repeat orders are a possibility.
a.
To explain: Whether order should be accepted or not.
Credit Policy:
Credit policies are the guidelines of a business for customers. These policies contain the terms and conditions related to credit sales.
Explanation of Solution
Given,
A company’s variable cost is $2.6 million per unit.
Credit price is $2.815 million.
Required return is 2.9%.
Bad debt is 1/200.
The order must be accepted if the net present value is positive, that means inflows are greater than outflows.
Calculate net present value (NPV).
Formula to compute net present value,
Substitute $2721987.37 for inflow and $2,600,000 for outflow.
Working note:
Calculation of inflow,
Hence, order should be accepted since the NPV is positive.
b.
To compute: Break even probability.
Explanation of Solution
Solution:
At break even probability, inflows are equal to outflows that mean net present value is zero.
Formula to calculate breakeven probability,
Substitute 0 for net present value, $2,815,000 for sales, 0.029 for return percentage and $2,600,000 for outflow.
Hence, break even probability is 4.96%.
c.
To compute: Whether order must be accepted or not and break even probability.
Explanation of Solution
Solution:
The order should be accepted if the net present value is positive that means inflows are greater than outflows.
Calculate net present value.
Formula to compute net present value,
Substitute $7,376,724.14 for inflow and $2,600,000 for outflow.
At break even probability, inflows are equal to outflows that mean net present value is zero.
Formula to calculate breakeven probability,
Substitute 0 for net present value, $215,000 for sales, 0.029 for return percentage and $2,600,000 for outflow.
Working note:
Calculation of inflow,
Hence, order should be accepted and break even probability is 64.93%.
d.
To explain: Liberty in credit terms.
Answer to Problem 9QP
Solution:
Credit terms will be more liberal when there are repeat orders.
It is believed by the company that once a customer has paid his credit, he will also repay the future credit sales.
Explanation of Solution
- It is believed that once a good customer, is always a good customer.
- It is believed that if a customer has not defaulted in past, he will not default in future as well.
Hence, credit terms will be more liberal when there are repeating of orders.
Want to see more full solutions like this?
Chapter 28 Solutions
CONNECT 1 SEMESTER ACCESS CARD FOR CORPORATE FINANCE
- Philippine Airlines (PAL) plans to offer several new electronic services on flights between Manila and selected Asian destinations. The marketing director estimates that for a typical 24-hour period there is a 55% chance of having a net cash flow of P40,000 and a 25% chance of P95,000. He also estimates there is a small 5% chance of no cash flow and a 15% chance of a loss of P16,000, which is the estimated extra personnel and utility costs to offer the services. Determine the expected net cash flow.arrow_forwardRequired information Skip to question [The following information applies to the questions displayed below.] JCN Industries normally produces and sells 5,000 keyboards for personal computers each month. Variable manufacturing costs amount to $25 per unit, and fixed costs are $146,000 per month. The regular sales price of the keyboards is $86 per unit. JCN has been approached by a foreign company that wants to purchase an additional 1,000 keyboards per month at a reduced price. Filling this special order would not affect JCN 's regular sales volume or fixed manufacturing costs. Assume that the price offered by the foreign company is $43 per unit. Accepting the special order will cause JCN's operating income to:arrow_forwardLee Company produces and sells running shoes. Sales volumes have remained stable in recent years. Financial data relating to the running shoes are as follows: $ $ Selling price 45 Variable cost (35) Fixed cost apportionment (5) (40) Profit 5 Lee Company has recently been approached by a wholesale business that wishes to buy 40,000 pairs each year but has demanded a three-month credit period. Lee Company is concerned that if the demand is accepted, its other customers, who are allowed only a one-month credit, will make similar demands. The current level of sales is 150,000 pairs each year. If the wholesaler order is accepted, 15,000 extra pairs will have to be held in inventories (where inventories are valued at total cost) and trade payables will increase by $ 650,000. The business expects a return of 35 per cent on it net investment. Required: Assess the acceptability of the offer made by the wholesaler to Lee Company on the basis that: All customers will receive a credit period of…arrow_forward
- Decision on accepting additional business A manager of Varden Sporting Goods Company is considering accepting an order from an overseas customer. This customer has requested an order for 20,000 dozen golf balls at a price of 22 per dozen. The variable cost to manufacture a dozen golf balls is 18 per dozen. The full cost is 25 per dozen. Varden has a normal selling price of 35 per dozen. Vardens plant has just enough excess capacity on the second shift to make the overseas order. What are some considerations in accepting or rejecting this order?arrow_forwardCarpetland salespersons average 8,000 per week in sales. Steve Contois, the firms vice president, proposes a compensation plan with new selling incentives. Steve hopes that the results of a trial selling period will enable him to conclude that the compensation plan increases the average sales per salesperson. a. Develop the appropriate null and alternative hypotheses. b. What is the Type I error in this situation? What are the consequences of making this error? c. What is the Type II error in this situation? What are the consequences of making this error?arrow_forwardThe manager of an automobile dealership is considering a new bonus plan designed to increase sales volume. Currently, the mean sales volume is 14 automobiles per month. The manager wants to conduct a research study to see whether the new bonus plan increases sales volume. To collect data on the plan, a sample of sales personnel will be allowed to sell under the new bonus plan for a one-month period. a. Develop the null and alternative hypotheses most appropriate for this situation. b. Comment on the conclusion when H0 cannot be rejected. c. Comment on the conclusion when H0 can be rejected.arrow_forward
- Oberweis Dairy switched from delivery trucks with regular gasoline engines to ones with diesel engines. The diesel trucks cost $6,000 more than the ordinary gasoline trucks but costs $1,800 per year less to operate. Assume that Oberweis saves the operating costs at the end of each month. If Oberweis uses a discount rate of 1% per month, approximately how many months, at a minimum, must the diesel trucks remain in service for the switch to be sensible?arrow_forwardABC Office Furniture sells its primary product, an office chair, at R150 per unit. Total credit sales for the previous financial year were 4 000 units. The variable cost to manufacture one chair is R60 and the total fixed costs for the year are R80 000. The entity’s credit terms are 2/10 net 45 and it is considering tightening its credit standards to 3/7 net 30. This is expected to result in a 5% decrease in sales, but bad debt is expected to decrease from 2% of credit sales to 1%. The average collection period is expected to decrease from the current 45 days to 30 days. In the past, 20% of debtors accepted the discount. This percentage is not expected to change. The entity’s cost of capital is 14%. Assume 365 days per year. To calculate the effect of the tightening of credit standards, the entity needs to calculate the following: ■ the profit loss or gain from a decrease or an increase in sales ■ the cost of the marginal investment in accounts receivable ■ the cost of marginal bad…arrow_forwardMake or Buy - Home Grocery (HG) provides home delivery of groceries. Customers submit orders to the HG website by selecting the needed items from a menu. Currently, HG has employees who deliver the groceries, but the company is considering the option of contracting out deliveries. The fixed cost of the grocery delivery operation is $500,000 per year, of which, $200,000 is avoidable if grocery deliveries are contracted out. A statistical study suggests delivery costs vary with both the number of customers and the number of items purchased. On average, the fixed annual delivery cost per customer is $250 and the average variable delivery cost of each grocery item delivered is $0.50. On average, each customer purchases 1,000 grocery items per year. Therefore, if there are 2,000 customers budgeted, the number of grocery item deliveries will be 2 million. Custom delivery (CD) has offered to deliver groceries for HG as a flat rate of $850 per customer per year irrespective of the number of…arrow_forward
- Solar Engines manufactures solar engines for tractor-trailers. Given the fuel savings available, new orders for 170 units have been made by customers requesting credit. The variable cost is $11,000 per unit, and the credit price is $13,500 each. Credit is extended for one period. The required return is 1.6 percent per period. If Solar Engines extends credit, it expects that 15 percent of the customers will be repeat customers and place the same order every period forever and the remaining customers will be one-time orders. Calculate the NPV of the decision to grant credit. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)arrow_forwardAlternate cost structures, uncertainty, and sensitivity analysis. Corporate Printing Company currently leases its only copy machine for $1,500 a month. The company is considering replacing this leasing agreement with a new contract that is entirely commission based. Under the new agreement, Corporate would pay a commission for its printing at a rate of $20 for every 500 pages printed. The company currently charges $0.20 per page to its customers. The paper used in printing costs the company $0.05 per page and other variable costs, including hourly labor, amount to $0.10 per page. Required: What is the company’s breakeven point under the current leasing agreement? What is it under the new commission-based agreement? For what range of sales levels will Corporate prefer (a) the fixed lease agreement and (b) the commission agreement? Do this question only if you have covered the chapter appendix in your class. Corporate estimates that the company is equally likely to sell 20,000, 30,000,…arrow_forward
- EBK CONTEMPORARY FINANCIAL MANAGEMENTFinanceISBN:9781337514835Author:MOYERPublisher:CENGAGE LEARNING - CONSIGNMENTPrinciples of Cost AccountingAccountingISBN:9781305087408Author:Edward J. Vanderbeck, Maria R. MitchellPublisher:Cengage LearningManagerial AccountingAccountingISBN:9781337912020Author:Carl Warren, Ph.d. Cma William B. TaylerPublisher:South-Western College Pub
- Cornerstones of Financial AccountingAccountingISBN:9781337690881Author:Jay Rich, Jeff JonesPublisher:Cengage LearningEssentials of Business Analytics (MindTap Course ...StatisticsISBN:9781305627734Author:Jeffrey D. Camm, James J. Cochran, Michael J. Fry, Jeffrey W. Ohlmann, David R. AndersonPublisher:Cengage Learning