Ajax predicts that if a customer pays on the first sale, it is assured that it is a reliable customer.As such, it expects that customer to generate a net profit of $350 per year for 12 years.Ajax calculates present value with a 15% rate of return.There is a 90% probability that Ajax will secure a reliable customer.However, if the customer defaults, Ajax will have to incur a loss of $500.Determine the expected benefit if credit is granted.
A)$1,657
B)$1,757
C)$1,857
D)$1,957

Question

Quizplus · Accepted Answer

The expected benefit is the present value of the expected net profit minus the present value of the expected loss. The expected net profit is $350 per year for 12 years, which is $4,200. The present value of this amount at a 15% rate of return is $2,361. The expected loss is $500, and the present value of this amount at a 15% rate of return is $333. Therefore, the expected benefit is $2,361 - $333 = $2,028. However, there is only a 90% probability that Ajax will secure a reliable customer, so the expected benefit is $2,028 * 0.9 = $1,825.

Ajax Predicts That If a Customer Pays on the First