Question

A company is assessing granting credit to a new customer. The variable cost per unit is $52, the current price is $120, the probability of default is 22% and the monthly required return is 2.0%. Calculate the NPV of the switch. Assume the customer will purchase once. Round your answer to 2 Decimals (e.g. 2222.05) and the unit is $.

Answer 1

The NPV of granting credit to a new customer when taking into account the variable cost, selling price, probability of default, and monthly required return is $40.78.

Step-by-step explanation:

To calculate the net present value (NPV) of granting credit to a new customer, we need to evaluate the cash flows considering the variable cost, selling price, probability of default, and the required return. We use the formula:

NPV = Selling Price - Variable Cost - (Probability of Default × Selling Price) / (1 + Monthly Required Return)

First, we calculate the expected revenue after accounting for the probability of default:

Expected Revenue = Selling Price × (1 - Probability of Default)

Expected Revenue = $120 × (1 - 0.22) = $93.60

Then we adjust this for the cost and required return to get NPV:

NPV = ($93.60 - $52) / (1 + 0.02)

NPV = $41.60 / 1.02

NPV = $40.78

Therefore, the NPV of the switch is $40.78, rounded to two decimals.