Suppose a corporation currently sells Q units per month for a cash-only price of P. Under a new credit policy that allows one
QUESTION:
Suppose a corporation currently sells Q units per month for a cash-only price of P. Under a new credit policy that allows one month’s credit, the quantity sold will be Q 9 and the price per unit will be P 9. Defaults will be p percent of credit sales. The variable cost is n per unit and is not expected to change. The percentage of customers who will take the credit is a, and the required return is R per month. What is the NPV of the decision to switch? Interpret the various parts of your answer.
ANSWER:
We can express the old cash flow as:
Old cash flow = (P – v)Q
And the new cash flow1 will be:
New cash flow = (P – v) (1 – α) Q’ + αQ’ [(1 – π)P’ – v]
So, the incremental cash flow is:
Incremental cash flow = –(P – v)Q + (P – v)(1 – α)Q’ + αQ’ [(1 – π)P’ – v]
Incremental cash flow = (P – v)(Q’ – Q) + αQ’ [(1 – π)P’ – P]
Thus:
NPV = (P – v)(Q’ – Q) – αPQ’ +
