Question

Problem 6

a) Zoey Enterprises manufactures solar engines for helicopters. Given the fuel savings available, new orders for 125 units have been made by customers requesting credit. The variable cost is $11,400 per unit, and the credit price is $13,000 each. Credit is extended for one period. The required return is 1.9 percent per period. If Zoey Enterprises extends credit, it expects that 30 percent of the customers will be repeat customers and place the same order every period forever, and the remaining customers will place one-time orders. Should credit be extended?

b) Now, assume that the probability of default is 15 percent. Should the orders be filled now? Assume the number of repeat customers is affected by the defaults. In other words, 30 percent of the customers who do not default are expected to be repeat customers.

Answer 1

• Variable Cost = 11,400
• Credit Price =13000
• Contribution= 13,000-11,400=1600
• Repeat coustomer = 125*30%= 37.5 =38(round off)

1. Additional profit arising out of Repeat sale = Repeat customer *contribution

Additional profit arising out of Repeat sale = 38*1600=60,800 .........(a)

2. Increase in receviables= 125 +38=163*13000=$2,119,000

3. Cost of additional Receivables= $2,119,000*1.9%=$40,261.......(b)

4. Net additional Profit = Additional profit due to Repeat sale - additional cost due to increase in receviable

=a-b

=$60,800-$40,261 =$20,539

credit be extended because it increase profit by $20,539

b) 15% of customer Default

Cost of bad debt=$2,119,000 *15% =$317850

Net Profit/Net Loss=$20,539-$317,850=-$297,311

Due to default Firm will suffer from loss $297,311 so credit should not extend.

Repeat customer Now =163*85%*30%=42

1. Additional profit arising out of Repeat sale = Repeat customer *contribution

Additional profit arising out of Repeat sale = 42*1600=67,200 .........(a)

2. Increase in receviables= 163 +42=205*13000=$2,665,000

3. Cost of additional Receivables= $2,665,000*1.9%=$50,635.......(b)

4. Net additional Profit = Additional profit due to Repeat sale - additional cost due to increase in receviable

=a-b

=$67,200-$50,635 =$16,565

credit be extended because it increase profit by $16,565