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 $90, and the cost per carton is $60. The unit sales will increase from 1,040 cartons to 1,100 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.)

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.)

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.)

Answer 1

Solution :-

(a) change in the firm's total monthly profits when ROI=1%

                              Price per carton =$90.

                              Cost per carton=$60.

                              Profit per carton=$90-$60

                                                          =$30.

                Increase in sales due to credit facility =(1100-1040)cartons.

                                                                             =60 cartons

Hence Increase in profit due to credit facility =$30*60 cartons

                                                                        =$1,800

Sales Value of the entire sales =price per carton*number of carton                                                                    sold

                                                     =$90*1100 cartons

                                                     =$99,000.

This amount will be received at the month end . Hence the present value of receivable can be calculated as follows .

Present value factor @1% per month.=0.990099

Therefore present value of collections =$99,000*0.990099

                                                                =$98,019.801

Decrease in cash net cash inflow due to credit facility in PV terms

                              =Total value of sales- present value of collections

                              =$99,000-$98019.801

                              =$980.199

Net change in the firm's total monthly profits

                         =Extra profit due to this decision-loss of    cash inflow in PV terms

                         =$1,800 - $980.199

                              =$819.801

Part( b):- When ROI-1.5%

                              Present value factor @1.5% per month.=0.985222.

Therefore present value of collections =$99,000*0.985222

                                                              =$97,536.978

Decrease in cash net cash inflow due to credit facility in PV terms

                              =Total value of sales- present value of collections

                              =$99,000-$97,536.978      

                              =$1463.022

Net change in the firm's total monthly profits

                         =Extra profit due to this decision-loss of    cash inflow in PV terms

                         =$1,800 - $1463.022

                              =$336.978

Part (c):-

In case only new customers are offered credit, then the additional profit earned is as follows:

Increase in sales =60 cartons.

Increase in profit =$30*60 cartons

                              =$1,800.

Collections from new customers

                              =60 carton*$90 per carton

                              =$5,400

Present value of collections from new customers

                              =0.985222* $5,400

                              =$5320.1988.

Increase in profit due to new customers only

                              =$1,800 - ($5,400-$5320.1988.)

                              =$1,800 - $79.8012

                              =$1720.20

Hence monthly profits on a present value basis will increase by $1720.20.