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

The price per carton is $ 90 and the cost per carton is $ 60.

Profit per carton = Selling Price - Cost per carton = 90 - 60 = $ 30 per carton.

The unit sales will increase from 1040 units to 1100 units per month if credit is granted.

Original Sales = 1040 cartons * $ 90 per carton = $ 93,600.

Original Profit = Sales - Cost = 93,600 - ( 1040 units * $ 60 per unit) = 93,600 - 62,400 = $ 31,200.

Total Sales if credit is granted = 1100 cartons * $ 90 per carton = $ 99,000.

a. If credit is granted to all customers, the new total sales amount will be received after 1 month and not immediately.

The formula for Future Value is as follows :-

were, r = Rate of interest and n = number of time periods

Thus, in this example,

99,000 = Present Value * (1 + 0.01)¹

99,000 = Present Value * 1.01

Present Value = $ 98,019.80.

Present Value of credit sales is $ 98,019.80. Thus, the present value profit is :-

Present Value Profit = Present Value of Sales - Cost = 98,019.80 - ( 1100 units * $ 60 per carton)

Present Value Profit = 98,019.80 - 66,000 = $ 32,019.80.

Thus,

Change in profit = New present value profit - Original Profit

                          = 32,019.80 - 31,200

Change in profit = 819.80.

Thus, there is increase in profit by $ 819.80 by giving credit of 1 month to all customers.

b. If interest rate is 1.5 % , then,

99,000 = Present Value * (1 + 0.015)¹

99,000 = Present Value * 1.015

Present Value = $ 97,536.95.

Present Value of credit sales is $ 97,536.95. Thus, the present value profit is :-

Present Value Profit = Present Value of Sales - Cost = 97,536.95 - 66,000 = $ 31,536.95.

Thus,

Change in profit = New present value profit - Original Profit

                          = 31,536.95 - 31,200

Change in profit = 336.95.

Thus, there is increase in profit by $ 336.95 by giving credit of 1 month to all customers.

c Interest rate is 1.5% per month and credit is given only to new customers.

Out of total sales of 1100 units, amount for 1040 units from existing customers is received in cash today and amount for 60 units (1100-1040) will be received after 1 month. i.e, 60 units * $ 90 per unit = $ 5,400.

5,400 = Present Value * (1 + 0.015)¹

5,400 = Present Value * 1.015

Present Value = $ 5,320.20.

Present Value of credit sales is $ 5,320.20.

Thus, the total present value of sales = Cash Sales + Present Value of credit sales

= (1040 units * $ 90 per unit ) + $ 5,320.20 = 93,600 + 5,320.20 = $ 98,920.20

Present Value Profit = Present Value of Sales - Cost = 98,920.20 - 66,000 = $ 32,920.20

Thus,

Change in profit = New present value profit - Original Profit

                          = 32,920.20 - 31,200

Change in profit = $ 1,720.20

Thus, there is increase in profit by $ 1,720.20 by giving credit of 1 month to new customers.