A firm is considering two alternative credit strategies: All Cash Credit Price p
ID: 2788708 • Letter: A
Question
A firm is considering two alternative credit strategies:
All Cash
Credit
Price per unit
$50
$55
Cost per unit
$25
$27
Quantity Sold
6,000
6,700
Payment Probability
100%
92%
If the firm decides to grant credit to customers the Days to Collect will be 60 days. During that time the firm will have to borrow $100,000 on average, at a rate of 1% per month.
a). Should the firm grant credit? (Use calculations to support your answer).
b). The firm is considering using a credit agency to identify customer that will not pay and will drop the quantity sold to 6,500 units. The credit agency will charge an initial $1,500 fee and then $2.00 for every credit check after that. If the agency can identify all customers that will not pay should the firm use the credit agency?
All Cash
Credit
Price per unit
$50
$55
Cost per unit
$25
$27
Quantity Sold
6,000
6,700
Payment Probability
100%
92%
Explanation / Answer
The net profit from All Cash = (50-25)*6000 = 150000
The net profit from credit = (55-27)*6700 - 55*6700*0.08 - 0.01*100000*2
= 156120
Since, the net income from selling on credit is more, it should be preferred.
B) Now, the net income = (55-27-2)*6500 - 0.01*2*100000-1500
= 165500
Since the net income increases, the credit agency should be used.
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