Answers to Chapter Review and Self Test Problems

21.1 If the switch is made, an extra 100 units per period will be sold at a gross profit of $175 - 130 = $45 each. The total benefit is thus $45 X 100 = $4,500 per period. At 2.0 percent per period forever, the PV is $4,500/.02 = $225,000.

The cost of the switch is equal to this period's revenue of $175 X 1,000 units = $175,000 plus the cost of producing the extra 100 units, 100 X $130 = $13,000. The total cost is thus $188,000, and the NPV is $225,000 - 188,000 = $37,000. The switch should be made.

21.2 If the customer pays in 30 days, then you will collect $22 X 1,000 = $22,000. There's only an 85 percent chance of collecting this; so you expect to get $22,000 X .85 = $18,700 in 30 days. The present value of this is $18,700/1.03 = $18,155.34. Your cost is $15 X 1,000 = $15,000; so the NPV is $18,155.34 - 15,000 = $3,155.34. Credit should be extended.

Ross et al.: Fundamentals of Corporate Finance, Sixth Edition, Alternate Edition

VII. Short-Term Financial Planning and Management

21. Credit and Inventory Management

© The McGraw-Hill Companies, 2002

CHAPTER 21 Credit and Inventory Management

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