Question

Consider the case of the Cast Iron Company. On each nondelinquent sale, Cast Iron receives revenues with a present value of $1,360 and incurs costs with a present value of $1,000. Cast Iron’s costs have increased from $1,000 to $1,210. Assuming that there is no possibility of repeat orders and that the probability of successful collection from the customer is p = 0.85, answer the following. a-1. What is the expected profit of granting credit? (Do not round intermediate calculations. Round your answer to 2 decimal places.) a-2. Should Cast Iron grant or refuse credit? 0.89 Refuse b. What is the break-even probability of collection? (Enter your answer as a percent rounded to 1 decimal place.)

Answer 1

A-1)

Revenues = $1360

Collection from customers = $1360 * 0.85 i.e. 1156

Cost increased to $1210

Hence expected profit on granting credit = Collection from customer - Cost

= $1156 - $1210

= - $54

A-2)

Cast iron should refuse credit as because due to credit the company suffers loss of $54 as calulated above.

B)

Break even probability is the probability where collection meets the cost

i.e. succesful Collection from customers must be equal to cost i.e. $1,210

Hence Break even probability for collection = Cost / Revenue i.e. $1210 / $1360 i.e. 0.89.