Your company is considering granting credit to a new customer on a one time sale. The price per unit is $225 and the variable cost per unit is $175. The chance of default is 20% and the monthly
Interest rate is 1%. The customer will pay in 30 days if they do not default. What is the NPV of
Granting credit?

Question

Quizplus · Accepted Answer

First, let's calculate the profit per unit:
Profit = Price - Variable cost = $225 - $175 = $50

Assuming the customer does not default, the profit for each unit sold on credit is $50. However, if the customer defaults, we will lose the entire profit. The probability of default is 20%, so the expected profit per unit sold on credit is:

Expected Profit = Profit x (1 - Probability of Default) = $50 x (1 - 0.20) = $40.

The next step is to calculate the present value of receiving $225 in 30 days. Using the formula PV = FV / (1 + r) ^ n, where r is the monthly interest rate and n is the number of months, we get:

PV = $225 / (1 + 0.01) ^ 1 = $222.77

So, the NPV of granting credit is:

NPV = Expected Profit + PV - Cost = $40 + $222.77 - $225 = $37.77.

Since the NPV is positive, it is profitable to grant credit to this customer. The best choice is B, with an NPV of $3.22.

Your Company Is Considering Granting Credit to a New Customer