Your current sales consist of 25 units per month at a price of $200 a unit. You are weighing the pros and cons of switching to a net 30 credit policy from your current cash only policy. If you decide to
Switch your credit policy you also plan to increase the sales price to $215 a unit. If you make the
Switch you do not expect your total monthly sales quantity to change but you do expect a 2 percent
Default rate. The monthly interest rate is 2.5 percent. What is the net present value of the proposed
Credit policy switch?

Question

Quizplus · Accepted Answer

First, let's calculate the total revenue and cost for the current cash only policy:

Total revenue = 25 units/month * $200/unit = $5,000/month
Total cost = 0 since there is no default rate or interest rate

Now, let's calculate the total revenue and cost for the proposed net 30 credit policy:

Total revenue = 25 units/month * $215/unit = $5,375/month
Total cost = (2% default rate * $215/unit * 25 units/month) + (2.5% monthly interest rate * $215/unit * 25 units/month) = $215/month + $134.38/month = $349.38/month

Next, we need to calculate the net present value (NPV) of the proposed credit policy switch. We will assume a five-year time horizon and a discount rate of 10%.

NPV = (CF1/(1+r)^1) + (CF2/(1+r)^2) + ... + (CFn/(1+r)^n)

CF1 = -$349.38/month
CF2 = -$349.38/month
CF3 = -$349.38/month
CF4 = -$349.38/month
CF5 = -$349.38/month + $5,375 (one-time payment at the end of year 5)

NPV = (-$349.38/1.1^1) + (-$349.38/1.1^2) + (-$349.38/1.1^3) + (-$349.38/1.1^4) + ($5,375/1.1^5) = -$1,014.72 + -$924.29 + -$842.99 + -$770.90 + $3,377.60 = $5,700.30

Therefore, the net present value of the proposed credit policy switch is $5,700, which means it is a financially viable option and a good choice for the business to make.

Your Current Sales Consist of 25 Units Per Month at a Price