Question

Devour, Inc., is considering a change in its cash-only sales policy. The new terms of sale would be net one month. The required return is 1.2 percent per month.

    

	Current Policy	New Policy
Price per unit	$700	$700
Cost per unit	$455	$455
Unit sales per month	980	1,050

  

Required :

Based on the above information, determine the NPV of the new policy.

rev: 09_21_2012

$1,171,916.67

$1,372,000.00

$711,316.67

$739,769.33

$3,365,483.33

Answer 1

The cost of switching is the lost sales from the existing policy plus the incremental variable costs under the new policy, so:

Cost of switching = $700(980) + $455(1,050 – 980) = $686,000 + $31,850 = $717,850

The benefit of switching is the new sales price minus the variable costs per unit, times the incremental units sold, so:

Benefit of switching = ($700 – $455)(1,050 – 980) = $245 x 70 = $17,150

The benefit of switching is a perpetuity, so the NPV of the decision to switch is:

NPV = –$717,850 + [$17,150/0.012] = -$717,850 + $1,429,166.67 = $711,316.67

Hence, Option "C" is correct.