Air Spares is a wholesaler that stocks engine components and test equipment for

Question

Air Spares is a wholesaler that stocks engine components and test equipment for the commercial aircraft industry. A new customer has placed an order for eight high-bypass turbine engines, which increase fuel economy. The variable cost is $1.6 million per unit, and the credit price is $2.035 million each. Credit is extended for one period, and based on historical experience, payment for about 1 out of every 100 such orders is never collected. The required return is 1.9 percent per period.

Assuming that this is a one-time order, should it be filled? The customer will not buy if credit is not extended.

What is the break-even probability of default in part (a)? (Round your answer to 2 decimal places. (e.g., 32.16))

Suppose that customers who don’t default become repeat customers and place the same order every period forever. Further assume that repeat customers never default. What is the NPV per engine purchased on credit?

Assuming the customer becomes a repeat customer, what is the break-even probability of default? (Round your answer to 2 decimal places. (e.g., 32.16))

Explanation / Answer

a1)NPV is the present value of future cash flow . Here the outflow is the variable cost and inflow is the present value sales price multiplied by (1-default prob)
=(-1.6*10^6)+((1-0.01)*2.035*10^6))/(1+1.9%)
=377,085

a2)Since the NPV is positive they should fill the order

b)Break even happens when we equate the NPV to zero. let the default probability be "x%" then
(-1.6*10^6)+((1-x)*2.035*10^6))/(1+1.9%)=0
x=19.88%

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