Lewis Companies sells 2,600 units a month for cash at a price of $299 a unit and a variable cost of $187 a unit.The firm estimates it can increase its sales by 200 units a month if it switches to a net 30 credit policy while keeping its price and costs at their current levels.If the monthly cost of capital is .85 percent,what is the NPV of switching?

Question

Quizplus · Accepted Answer

To calculate the NPV of switching, we need to first find the incremental cash flows associated with the switch:

Incremental revenue from additional sales: 200 units x $299 per unit = $59,800

Incremental variable costs: 200 units x $187 per unit = $37,400

Therefore, incremental contribution margin = incremental revenue - incremental variable costs = $59,800 - $37,400 = $22,400

Next, we need to calculate the present value of this incremental contribution margin. Assuming a monthly cost of capital of .85%, the present value factor for one month is 1/(1+0.0085) = 0.9916.

So, the present value of the incremental contribution margin is:

PV = $22,400 x 0.9916 = $22,184

Finally, we need to subtract the initial investment required to switch to the net 30 credit policy. Assuming no additional expenses are incurred, the initial investment is zero.

Therefore, the NPV of switching is $22,184, which is answer choice D.

Lewis Companies Sells 2,600 Units a Month for Cash at a Price