A&M Hardware assumes new customers will default 8 percent of the time but if they don't default,they will become repeat customers who always pay their bills.Assume the average sale is $383 with a variable cost of $260,and a monthly required return of 1.65 percent.What is the NPV of extending credit for one month to a new customer?
A)$5,589.09
B)$6,103.47
C)$6,598.18
D)$5,748.09
E)$6,858.18

Question

Quizplus · Accepted Answer

To calculate the NPV, we need to find the expected cash flows from extending credit to a new customer for one month.

Probability of the customer defaulting = 8%
Probability of the customer paying on time = 92% (1 - 0.08)

Expected cash flow from a defaulting customer = $0
Expected cash flow from a paying customer = 92% * $383 = $352.36

Expected cash flow = (0.08 * $0) + (0.92 * $352.36) = $324.96

Variable cost per sale = $260
Contribution margin per sale = $383 - $260 = $123
Required return = 1.65%

NPV = ($324.96 / (1 + 0.0165)) - $260 = $6,598.18 - $260 = $6,338.18.

Therefore, the best choice is C.

A&M Hardware Assumes New Customers Will Default 8 Percent of the Time