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Q: Credit Policy Calculation ( Answered ,   1 Comment )
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 Subject: Credit Policy Calculation Category: Business and Money > Finance Asked by: wombat319-ga List Price: \$20.00 Posted: 12 May 2005 06:02 PDT Expires: 11 Jun 2005 06:02 PDT Question ID: 520845
 ```A firm makes only cash sales. It estimates that allowing trade credit on terms of net 30 would increase monthly sales from 200 to 220 units per month. The price per unit is \$101 and the cost (in present value terms) is \$80. The interest rate is 1%/month. What is the PV of revenue per unit & the PV of profits? What is the PV of profits if 5% of all customers fail to pay?``` Clarification of Question by wombat319-ga on 12 May 2005 06:10 PDT ```ASSUMPTIONS: Price per unit \$101 Cost per unit \$80 Current profits \$4,200 based on 200 units sold Interest rate 1% per month Current sales 200/month Projected sales 220/month```
 ```Hi wombat319! I will assume here that if the firm allows credit sales at the same price (\$101), then all customers will take advantage of this policy, as there is no incentive to pay \$101 today if there exists the possibility of paying \$101 in 1 month. In order to find the PV of the revenue per unit, since the price receives for each unit is \$101, we must find the present value of \$101 in 1 month. Since the 1-month interest rate is 1%, then the PV of \$101 in a month is: \$101/1.01 = \$100 So the PV of revenue per unit is \$100. The PV of profits is calculated in the following way: PV of profits = PV of revenue minus PV of costs We know that the PV of the cost per unit is \$80. Since the firm will sell 220 units, then the PV of total costs is 80*220 = \$17,600. Also, using the fact that the PV of revenue per unit is \$100, we get that the PV of total revenue is 220*100=\$22,000. Therefore: PV of profits = 22,000 - 17,600 = \$4,400 Now, let's assume 5% of customers fail to pay. This will reduce the revenues but not the costs. If 5% of customers don't pay, then the PV of total revenues will be 95% of what it was when all customers paid. Therefore, we find that, if 5% of customers don't pay: PV of profits = 0.95*22,000 - 17,600 = \$3,300 Notice, thus, that if all customers pay, the company will be better off by adopting this trade credit policy (profits of \$4,400 vs the current \$4,200); while, if 5% of customers fail to pay, then the company should not adopt this policy (profits of \$3,300 are smaller than current \$4,200 profits) I hope this helps! Best wishes, elmarto```
 wombat319-ga rated this answer: `Thanks for all your help! :-)`
 ```Assuming only additional 20 units sold are credit sales and not all 220 units PV of revenue = 20 * 101 * .99 = 2000 PV of cost = 20 * 80 = 1600 PV of profit = 400 (2000 - 1600) 5% fail to pay that means 20 units * 5% = 1 unit does not pay SAles value = 1 * 101 = 101 PV of this sale = 101 * .99 = \$100 PV of profit given 5% fail = 400 - 100 = 300```