# 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.

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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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