Question

Solar Engines manufactures solar engines for tractor-trailers. Given the fuel savings available, new orders for 160 units have been made by customers requesting credit. The variable cost is $10,600 per unit, and the credit price is $13,000 each. Credit is extended for one period. The required return is 1.4 percent per period. If Solar Engines extends credit, it expects that 25 percent of the customers will be repeat customers and place the same order every period forever, and the remaining customers will place one-time orders.

  

Calculate the NPV of the decision to grant credit. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

  

NPV

$

Answer 1

Repeat customers = 160 x 25% = 40 units

Non - repeat customers = 160 - 40 = 120 units

Now, the company expects contribution, i.e., Sales minus variable costs from repeat customers indefinitely.

Present value of indefinite cash flows = Cash flows / interest rate

Present value of Repeat orders = [ 40 x ($13000 - $10600) ] / 0.014 = $6,857,142.86

Also, non - repeat customers will pay after one period -

Present value of sales from non - receipt customers = [ 120 x $13000 ] / (1 + 0.014) = $1,538,461.54

Initial outflow = Total Variable cost = 160 x $10600 = $1,696,000

NPV = (-)Initial outfow + Present value of repeat orders + Present value of sales from non - repeat orders

or, NPV = (-)$1,696,0000 + $6,857,142.86 + $1,538,461.54 = $6,699,604.40