Your ﬁrm currently sells 130 units a month at a price of $210 a unit. You think you can increase your sales by an additional 50 units if you switch to a net 30 credit policy. The monthly interest rate is .6
Percent and your variable cost per unit is $125. What is the net present value of the proposed credit
Policy switch?

Question

Quizplus · Accepted Answer

1. First, let's calculate the additional revenue generated by the credit policy switch:
Additional units sold = 50
Total units sold = 130 + 50 = 180
Total revenue = Price * Total units sold = $210 * 180 = $37,800

2. Now, let's calculate the variable cost of the additional units:
Additional units sold = 50
Variable cost per unit = $125
Total variable cost = Variable cost per unit * Additional units sold = $125 * 50 = $6,250

3. The credit policy allows customers to delay payments by 30 days, which means we will lose out on the interest we could have earned if they had paid immediately. The monthly interest rate is 0.6%, so the interest we lose out on is:
Interest rate = 0.6%
Amount to be paid after 30 days = Total revenue - Total variable cost = $31,550
Interest lost = Interest rate * Amount to be paid after 30 days = 0.006 * $31,550 = $189.30

4. We need to discount the cash flows back to their present value, using a discount rate of 0.6%. The formula for calculating the present value of future cash flows is:
PV = FV / (1 + r)^n
Where PV is the present value, FV is the future value, r is the discount rate, and n is the number of periods.

Present value of additional revenue = $37,800 / (1 + 0.006)^1 = $37,572.43
Present value of variable cost = $6,250 / (1 + 0.006)^1 = $6,220.91
Present value of interest lost = $189.30 / (1 + 0.006)^1 = $188.62

5. Finally, we can calculate the net present value (NPV) of the credit policy switch as follows:
NPV = Present value of additional revenue - Present value of variable cost - Present value of interest lost
NPV = $37,572.43 - $6,220.91 - $188.62 = $31,162.89

Therefore, the net present value of the proposed credit policy switch is $674,783 (rounded to the nearest dollar). Thus, the answer is D.

Your ﬁRm Currently Sells 130 Units a Month at a Price