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Credit Policy Evaluation Royal, Inc
Credit Policy Evaluation Royal, Inc., is considering a change in its cash-only sales olicy. The new terms of sale would be net one month. Based on the following information, determine if the company should proceed or not. Describe the buildup of receivables in this case. The required return is .95 percent per month.
Current Policy New Policy Price per unit $680 $680 Cost per unit $455 $455 Unit sales per month 1,070 1,120
Expert Solution
The cost of switching is the lost sales from the existing policy plus the incremental variable costs under the new policy, so:
Cost of switching = $680(1,070) + $455(1,120 - 1,070) = $727,600 + $22,750 = $750,350
The benefit of switching is the new sales price minus the variable costs per unit, times the incremental units sold, so:
Benefit of switching = ($680 - $455)(1,120 - 1,070) = $225 * 50 = $11,250
The benefit of switching is a perpetuity, so the NPV of the decision to switch is:
NPV = -$750,350 + $11,250/0.0095
= -$750,350 + $1184210.53
= $433,860.53
Since NPV is positive. The company should proceed.
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