Dickson City Company has annua
Dickson City Company has annual sales of $5 million, while thecost of goods sold is $3.2 million. All sales are made on a cashbasis. The owner of Dickson has come up with the plan of givingcredit to the customers. He believes that this will increase thesales by 25% without increasing any of the fixed costs. He thinksthat 20% of the customers will pay within 30 days, 40% within 60days, 37% within 90 days, and 3% of the customers will default onthe sales. The cost of capital to Dickson is 12%.
(A) Should Dickson City introduce the policy of creditsales?
Answers: NPV(cash) = $1.8 million, NPV(credit) = 1.941million, yes. ♥
(B) The manager of the firm doubts whether the sales willactually increase by 25% as a result of this strategy. Find theminimum increase in sales to justify introduction of the new creditpolicy.
Answer: 15.29%
Answer:
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Answer:
1.
Calculation of NPV of cash sales:-
Annual sales is $5 million
Cost of goods sold is $3.2 million
Net Present Value=Present value of cash flows−Initialinvestment=$5 million−3.2 million=$1.8 million
Therefore, the NPV of cash sales is $1.8million.
Calculation of NPV of credit sales:-
Annual sales=Cash sales×(1+increase)=$5 million×(1 + 25\%)=$6.25 million
a. 20% customer pay in 30 day:-
Customer pay=$6.25 million×20%=$1.25 million
b. 40% customer pay in 60 day:-
Customer pay=$6.25 million×40%=$2.50 million
c. 37% customer pay in 90 day:-
Customer pay=$6.25 million×37%=$2.31 million
d. 3% customer will default:-
Customer default=$6.25 million×3%=$0.19 million
e. Cost of goods sold:-
Cost of goods sold=$3.2 million×(1+25%)=$4 million
=> 1.25M/(1.12%)30/365+2.5M/(1.12%)60/365+2.3125M/(1.12%)90/365 – 4M
= $1.941Million
Since NPV on credit sales > NPV on cash sales we mustintroduce the option
2)
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