Final answer:
Mahan Corporation should grant credit whenever the expected value, calculated by multiplying the probability of collection by the net profit from a sale (revenue - costs), is greater than zero. In this case, since the expected profit of $240 (4/5 of $300) is positive, they should extend credit.
Step-by-step explanation:
The student's question deals with the decision-making process involved in extending credit to customers based on the probability of collection. The expectation for the Mahan Corporation would be to compare the present value of revenues received from a sale, in this case, $1,500, with the present value of incurred costs, which is $1,200.
Given that the probability of collection is 4/5, we calculate this as an expected value for a sale which would be: (Probability of Collection) × (Revenue - Costs). Substituting the values, it becomes (4/5) × ($1,500 - $1,200) = (4/5) × $300 = $240. Since the expected profit of $240 is positive, Mahan Corporation's policy should be to grant credit as long as the probability of collection multiplied by the net profit from the sale (revenue - costs) is greater than zero.
From a broader perspective, if we apply this logic to a credit card company charging fees for late payments, the principle is the same. The company must evaluate the expected value of fee collection against the costs of extending credit and managing defaults to determine their credit policies.