Question

A company is assessing granting credit to a new customer. The variable cost per unit is $59, the current price is $120, the probability of default is 31% and the monthly required return is 1.0%. Calculate the NPV if we are looking at repeat business.

Answer 1

To calculate the NPV for repeat business, subtract the variable cost per unit from the current price to get the expected profit per unit. Multiply the expected profit per unit by the probability of default to account for default risk. Discount the expected profit per unit at the monthly required return rate to calculate the NPV per unit.

Step-by-step explanation:

In order to calculate the Net Present Value (NPV) for repeat business, we need to consider the variable cost per unit, the current price, the probability of default, and the monthly required return.

First, we need to calculate the expected profit per unit. This can be done by subtracting the variable cost per unit from the current price: $120 - $59 = $61.

Next, we multiply the expected profit per unit by the probability of default to get the expected profit per unit after considering default risk: $61 * (1 - 0.31) = $42.09.

Finally, we calculate the NPV per unit by discounting the expected profit per unit at the monthly required return rate: $42.09 / (1 + 0.01) = $41.67.