Saxon Corporation sells a product for $48 with costs of $33 per unit.Saxon uses a 9% rate of return for all its calculations.The CFO estimates that there is a 20% probability of a prospective new customers seeking credit will go bankrupt within the next 6 months.Customer wishes to place an order for 1,000 units of the product.

Question

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The total benefit of extending credit can be calculated by considering the profit per unit, the probability of bankruptcy, and the total number of units. Profit per unit is $48 (selling price) - $33 (cost) = $15. If the customer does not go bankrupt, the total profit from selling 1,000 units would be $15 * 1,000 = $15,000. However, there's a 20% chance the customer will go bankrupt, which means there's an 80% chance they won't. Therefore, the expected benefit is 80% of $15,000, which is $12,000. Since the company uses a 9% rate of return for its calculations, we must also consider this in the expected benefit. The expected benefit without considering the rate of return is $12,000, but to find the net benefit, we subtract the cost of the product (1,000 units * $33 = $33,000) from the expected revenue without considering bankruptcy ($48,000). This gives us an expected profit of $15,000, of which 80% is $12,000 due to the bankruptcy risk. The calculation provided directly leads to an incorrect interpretation of how the rate of return and bankruptcy risk are applied. The correct approach is to calculate the expected profit considering the bankruptcy risk and then apply any additional financial metrics separately. The mistake was in the direct application of the rate of return and misunderstanding the calculation of expected profit with the bankruptcy risk. The correct calculation should focus solely on the expected outcome based on the probability of bankruptcy and the profit per unit, which leads to an expected benefit calculation as follows: Expected profit = (Probability of not going bankrupt * Total profit if not bankrupt) - (Probability of going bankrupt * Loss if bankrupt). Since the loss if bankrupt wasn't directly provided and considering the rate of return isn't directly applicable to the calculation of expected profit in this context, the initial explanation led to a confusion in the calculation process.

Saxon Corporation Sells a Product for $48 with Costs of $33