Question

Microbiotics currently sells all of its frozen dinners cash on delivery but believes it can increase sales by offering supermarkets 1 month of free credit. The price per carton is $140, and the cost per carton is $85. The unit sales will increase from 1,090 cartons to 1,150 per month if credit is granted. Assume all customers pay their bills and take full advantage of any credit period offered.

a. If the interest rate is 1% per month, what will be the change in the firm's total monthly profits on a present value basis if credit is offered to all customers? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Change in total monthly profit=

b. If the interest rate is 1.5% per month, what will be the change in the firm's total monthly profits on a present value basis if credit is offered to all customers? (Do not round intermediate calculations. Round your answer to 2 decimal places. Negative amount should be indicated by a minus sign.)

Change in total monthly profit=

c. Assume the interest rate is 1.5% per month but the firm can offer the credit only as a special deal to new customers, while existing customers will continue to pay cash on delivery. What will be the change in the firm's total monthly profits on a present value basis under these conditions? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Change in total monthly profit=

Answer 1

a) currently selling without credit nets the company the following amount -

Current profit = ($140 - $85) x 1090 = $59,950

Now, if the company gives one month credit, then it will receive the sales after one month. So -

New profit = (Present value of sales - cost) x new units sold

or, New profit = {$140/ (1 + 0.01)¹ - $85} x 1150 = $61655.94

Change in profit = $61655.94 - $59,950 = $1705.94

b) New profit = {$140/ (1 + 0.015) - $85} x 1150 = $60870.69

Change in profit = $60870.69 - $59950 = $920.69

c) Since only new customers will get the credit, only sales for new units will be converted to present value -

New Profit = [($140 - $85) x 1090] + [($140/ (1 + 0.015) - $85] x 60 = $63125.86

Change in profit = $63125.86 - $59950 = $3175.86