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Consider the case of the Cast Iron Company
Consider the case of the Cast Iron Company. On each nondelinquent sale, Cast Iron receives revenues with a present value of $1,350 and incurs costs with a present value of $1,000. Cast Iron's costs have increased from $1,000 to $1,200. Assuming that there is no possibility of repeat orders and that the probability of successful collection from the customer is p= 0.95, answer the following.
a-1. What is the expected profit of granting credit? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations. Round your answer to 2 decimal places.)
a-2. Should Cast Iron grant or refuse credit?
0 Grant 0 Refuse
b. What is the break-even probability of collection? (Enter your answer as a percent rounded to 1 decimal place.)
Break-even probability
Expert Solution
a-1) Expected profit of granting credit = Present value of revenue of each sale * Probabilitycollection - Present value of total costs
Expected profit of granting credit = $1,350 * 0.95 - $1,200
= $82.50
a-2) The firm should grant credit as profit is positive.
b) Break - even probability would be the probability of collection which makes the expected revenue equal to the total costs of each sale -
Revenue each sale x Probabilitycollection = Total Costs
$1,350 * Probabilitycollection = $1,200
Probabilitycollection = $1,200 / $1,350 = 88.9%
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