Question

7. Curtis Cortman, a local entrepreneur, is attempting to establish credit with your firm. He would like to buy some equipment today at a cost of $1,495. Your variable cost for that equipment is $1,875 and your monthly interest rate is 1.3 percent. You believe he could become a regular customer if you grant him 30 days credit. You also believe that the probability of default is only 3 percent. What is the net present value of this decision?

Answer 1

Sale price to customer received after 30 days   1495  
      
probability of default is 3%. So in default amount paid =   0  
Probability of non default = 1-3% = 97%. Amount received in case=   1495  
Monthly interest rate=   1.30%  
You give him 30 days credit. so Amount will be received after 30 days or 1 month      
Present value of amount received = Future value/(1+monthly rate)^no of months      
1495/(1+1.3%)^1      
1475.814413      
      
Expected amount received = (Probability of non default*Amount received)+(Probability of default*0)      
(97%*1475.814413)+(3%*0)      
1431.53998      
Variable cost of equipment sold=   1875  
      
NPV = Present Value of Cash received - Cash paid for Variable cost      
1431.53998   -1875  
-443.4600197      
NPV is    -$443.46  
      
So he should not sell the equipment to Courtis courtman