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