Your ﬁrm currently has a cash sales only policy. Under this policy, you sell 340 units a month at a price of $120 a unit. Your variable cost per unit is $94 and your carrying cost per unit is $1.80. The
Monthly interest rate is 1.5 percent. You think that you can increase your sales to 600 units a month
If you institute a net 30 credit policy. What is the net present value of the switch using the one-shot
Approach?

Question

Quizplus · Accepted Answer

To calculate the net present value (NPV) of the switch, we need to find the present value of the cash inflows and outflows associated with the new policy.

Under the cash sales only policy, the monthly revenue is:

340 units x $120/unit = $40,800

The monthly variable cost is:

340 units x $94/unit = $31,960

The monthly carrying cost is:

340 units x $1.80/unit = $612

So the monthly cash flow is:

$40,800 - $31,960 - $612 = $8,228

If the company switches to the net 30 credit policy, the monthly revenue will increase from $40,800 to:

600 units x $120/unit = $72,000

Assuming a credit period of 30 days, the company will receive payment at the end of the month. Therefore, the average collection period is 15 days. The monthly cash flow with the credit policy is:

($72,000/30) x (1-0.015x15) - $31,960 - $600 = $7,960

(Note that we reduced the revenue by 1.5% for the 15-day period before payment is received.)

To calculate the NPV, we need to discount the monthly cash flows at the monthly interest rate of 1.5%. Using the one-shot approach, we can use the following formula:

NPV = (CF x (1 - (1+r)^-n)) / r

Where CF is the monthly cash flow, r is the monthly interest rate, and n is the total number of months. Assuming a 12-month period, we have:

NPV = ($7,960 x (1 - (1+0.015)^-12)) / 0.015 = $385,427

Therefore, the net present value of the switch to the net 30 credit policy is $385,427.

Your ﬁRm Currently Has a Cash Sales Only Policy