Question

A company makes only cash sales (i.e., it has no receivables). It currently sells 1,000 units per month at a sales price of $45 and a present value of costs of $35 per unit. Firm plans to allow credit sales to increase its sales to 1,100 units per month, in which case all sales will be made on credit and 5% of sales will end up being uncollectible after the 30- day payment period. If the discount rate is 1% per month, should the firm extend the credit? Assume that under credit sale, production costs were paid at the time of sale and that outstanding receivables have an average of one month?

Answer 1

NPV of all- credit sales --1100 units
Month	0	1
Prodn. Costs(1100 units* $ 35/unit)	-38500
Sales collections(1100*45*(1-5%))		47025
Cash loss on a/c of Uncollectible(1100*45*5%)		-2475
Net Cash flow	-38500	44550
PV F at 1% p.m.(1/1.01^ mth. N)	1	0.99010
PV at 1%(Net CF*PV F)	-38500	44108.91
NPV of credit sales (sum of above row)	5608.91
NPV of cash sales(1000*(45-35))=	10000
NPV of all- credit sales	5608.91
Should the firm extend the credit?
NO--
as NPV of extending the same is less than that for cash sales