Question

The Branding Iron Company sells its irons for $80 apiece wholesale. Production cost is $70 per iron. There is a 35% chance that a prospective customer will go bankrupt within the next half-year. The customer orders 1,000 irons and asks for 6 months' credit. Assume the discount rate is 8% per year, there is no chance of a repeat order, and the customer will either pay in full or not pay at all. Calculate the expected profit for the order. (A negative amount should be indicated by a minus sign. Do not round intermediate calculations. Round your answer to 2 decimal places.)

Answer 1

Selling price per piece of Iron = $80

Production Cost per piece of Iron = $70

Profit per Iron = 80-70 = $10

.

No. of Irons ordered by Customer = 1,000 Irons.

Probability that the customer will go bankrupt within the next half-year = 35%

Therefore, Probability that the customer will not go bankrupt within the next half-year = (100%-35%) = 65%

.

Expected Profit from the Customer’s Order = 1,000*10*65%

= 6,500

.

.

Discount percentage per year = 8%

Therefore, discount percentage for 6 months period = 8%/2 = 4%

.

Therefore, the expected profit for the order = Present Value of Profit realization from the customer

= 6,500*(1.04^1)

= 6,500/1.04

= 6,250