Concept explainers
Evaluating Credit Policy [LO2] Air Spares is a wholesaler that stocks engine components and test equipment for the commercial aircraft industry. A new customer has placed an order for eight high-bypass turbine engines, which increase fuel economy. The variable cost is $1.6 million per unit, and the credit price is $1.725 million each. Credit is extended for one period, and based on historical experience, payment for about 1 out of every 200 such orders is never collected. The required return is 1.8 percent per period.
a. Assuming that this is a one-time order, should it be filled? The customer will not buy if credit is not extended.
b. What is the break-even probability of default in part (a)?
c. Suppose that customers who don’t default become repeat customers and place the same order every period forever. Further assume that repeat customers never default. Should the order be filled? What is the break-even probability of default?
d. Describe in general terms why credit terms will be more liberal when repeat orders are a possibility.
Want to see the full answer?
Check out a sample textbook solutionChapter 20 Solutions
Fundamentals of Corporate Finance
- Exercise 14-3 (Algo) Internal Rate of Return [LO14-3] Wendell’s Donut Shoppe is investigating the purchase of a new $42,800 donut-making machine. The new machine would permit the company to reduce the amount of part-time help needed, at a cost savings of $5,700 per year. In addition, the new machine would allow the company to produce one new style of donut, resulting in the sale of 2,500 dozen more donuts each year. The company realizes a contribution margin of $1.50 per dozen donuts sold. The new machine would have a six-year useful life. Click here to view Exhibit 14B-1 and Exhibit 14B-2, to determine the appropriate discount factor(s) using tables. Required: 1. What would be the total annual cash inflows associated with the new machine for capital budgeting purposes? 2. What discount factor should be used to compute the new machine’s internal rate of return? (Round your answers to 3 decimal places.) 3. What is the new machine’s internal rate of return? (Round your final answer…arrow_forwardCompute the Break-Even Point [LO5–5] Mauro Products distributes a single product, a woven basket whose selling price is $15 and whose variable expense is $12 per unit. The company’s monthly fixed expense is $4,200. Required: 1. Solve for the company’s break-even point in unit sales using the equation method. 2 . Solve for the company’s break-even point in dollar sales using the equation method and the CM ratio. 3. Solve for the company’s break-even point in unit sales using the formula method. 4 . Solve for the company’s break-even point in dollar sales using the formula method and the CM ratio.arrow_forwardProblem 7-20 (Algo) Credit policy decision with changing variables [LO7-4] Slow Roll Drum Company is evaluating the extension of credit to a new group of customers. Although these customers will provide $432,000 in additional credit sales, 9 percent are likely to be uncollectible. The company will also incur $17,500 in additional collection expense. Production and marketing costs represent 77 percent of sales. The firm is in a 35 percent tax bracket. No other asset buildup will be required to service the new customers. The firm has a 12 percent desired return. Assume the average collection period is 180 days. a. Compute the return on incremental investment. Note: Input your answer as a percent rounded to 2 decimal places. Use a 360-day year. Return on incremental investment %arrow_forward
- 10 Question View Policies Current Attempt in Progress It costs Concord Company $26 per unit ($18 variable and $8 fixed) to produce its product, which normally sells for $38 per unit. A foreign wholesaler offers to purchase 6400 units at $21 each. Concord would incur special shipping costs of $2 per unit if the order were accepted. Concord has sufficient unused capacity to produce the 6400 units. If the special order is accepted, what will be the effect on net income? O $6400 decrease O $19200 increase O $115200 increase O $6400 increasearrow_forwardExercise 11-10 (Algo) Make or Buy Decision [LO11-3] Futura Company purchases the 75,000 starters that it installs in its standard line of farm tractors from a supplier for the price of $11.80 per unit. Due to a reduction in output, the company now has idle capacity that could be used to produce the starters rather than buying them from an outside supplier. However, the company's chief engineer is opposed to making the starters because the production cost per unit is $12.60 as shown below: Direct materials Direct labor Supervision Depreciation Variable manufacturing overhead. Rent Total product cost Per Unit $6.00 2.50 1.60 1.20 0.80 0.50 $ 12.60 Total $ 120,000 $ 90,000 $:37,500 If Futura decides to make the starters, a supervisor would have to be hired (at a salary of $120,000) to oversee production. However, the company has sufficient idle tools and machinery such that no new equipment would have to be purchased. The rent charge above. is based on space utilized in the plant. The…arrow_forwardProblem 12-25 (Algo) Net Present Value Analysis of a Lease or Buy Decision [LO12-2] The Riteway Ad Agency provides cars for its sales staff. In the past, the company has always purchased its cars from a dealer and then sold the cars after three years of use. The company's present fleet of cars is three years old and will be sold very shortly. To provide a replacement fleet, the company is considering two alternatives: Purchase alternative: The company can purchase the cars, as in the past, and sell the cars after three years of use. Ten cars will be needed, which can be purchased at a discounted price of $15,000 each. If this alternative is accepted, the following costs will be Incurred on the fleet as a whole: Annual cost of servicing, taxes, and licensing Repairs, first year Repairs, second year Repairs, third year At the end of three years, the fleet could be sold for one-half of the original purchase price. Lease alternative: The company can lease the cars under a three-year lease…arrow_forward
- 5. Individual Problems 19-1 In the late 1990s, car leasing was very popular in the United States. A customer would lease a car from the manufadurer for a set term, y tws years, and then have the option of keeping the car IF the customer decided to keep the car, the customer would pay a price to the mandfacturer, the "residual value," computed as 60% of the new car price. The manufacturer would then sell the returned cers at Puction. In 1999, manuacturers lo an average of $480 on each returned car (the auction price was, on average, s480 less than the residual value). Suppose two customers have leased cars from a manufacturer. Their lease agreements are ud, and they are considering whether to e (and purchase at 60% of the new car price) their cars or return their Cars. Two years ago, Mara leased a car valued new at s17,500. 7 he returne the ca the manufacturer could likely get s12,250 at auction for the car Simone also leased a cac valued new at $17,500, two years age f she returns the…arrow_forwardExercise 14-3 (Algo) Internal Rate of Return [LO14-3] Wendell's Donut Shoppe is investigating the purchase of an $34,600 donut-making machine with a six-year useful life. The new machine would reduce labor costs by $6,500 per year. In addition, it would allow the company to produce one new style of donut, resulting in the sale of 2,500 dozen more donuts each year. The company realizes a contribution margin of $1.60 per dozen donuts sold. Click here to view Exhibit 14B-1 and Exhibit 14B-2, to determine the appropriate discount factor(s) using tables. Required: 1. What are the new machine's total annual cash inflows? 2. What discount factor should be used to compute the new machine's internal rate of return? Note: Round your answer to 3 decimal places. 3. What is the new machine's internal rate of return? Note: Round your final answer to the nearest whole percentage. 4. In addition to the data given previously, assume the machine will have a $13,755 salvage value at the end of six years.…arrow_forwardCurrent Attempt in Progress - Your answer is partially correct. At Sheridan Electronics, it costs $33 per unit ($18 variable and $15 fixed) to make an MP3 player that normally sells for $42. A foreign wholesaler offers to buy 4,260 units at $29 each. Sheridan Electronics will incur special shipping costs of $1 per unit. Assuming that Sheridan Electronics has excess operating capacity, indicate the net income (loss) Sheridan Electronics would realize by accepting the special order. (Enter negative amounts using either a negative sign preceding the number e.g. -45 or parentheses e.g. (45).) Revenues Costs-Variable manufacturing Shipping Net income $ The special order should be accepted Reject Order 0 0 0 0 Accept Order 123,540 76,680 i 4,260 i 42,600 $ Net Income Increase (Decrease) 123,540 76,680 4,260 42,600arrow_forward
- 35 Rapterz Renewal Inc.. is considering a change in its cash-only sales policy. The new terms of sale would be net 30 days. You have been provided with the following: Current Credit Policy Sales price per unit Variable cost per unit Unit sales per month Required monthly return Calculate the NPV of Switching. Show all calculations. $165 132 1,260 1.5% Proposed Credit Policy $168 132 Should the company switch policies? Explain your answer. 1,290 1.5%arrow_forwardTroy Engines, Limited, manufactures a variety of engines for use in heavy equipment. The company has always produced all of the necessary parts for its engines, including all of the carburetors. An outside supplier has offered to sell one type of carburetor to Troy Engines, Limited, for a cost of $30 per unit. To evaluate this offer, Troy Engines, Limited, has gathered the following information relating to its own cost of producing the carburetor internally: Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead, traceable Fixed manufacturing overhead, allocated Total cost $34 *One-third supervisory salaries; two-thirds depreciation of special equipment (no resale value). Required 1 Required 2 Per Unit Required 3 Required: 1. Assuming the company has no alternative use for the facilities that are now being used to produce the carburetors, what would be the financial advantage (disadvantage) of buying 13,000 carburetors from the outside supplier? 2.…arrow_forwardExercise 13-10 (Algo) Make or Buy Decision [LO13-3] Futura Company purchases the 70,000 starters that it installs in its standard line of farm tractors from a supplier for the price of $11.50 per unit. Due to a reduction in output, the company now has idle capacity that could be used to produce the starters rather than buying them from an outside supplier. However, the company’s chief engineer is opposed to making the starters because the production cost per unit is $12.70 as shown below: Per Unit Total Direct materials $ 6.00 Direct labor 2.20 Supervision 1.80 $ 126,000 Depreciation 1.50 $ 105,000 Variable manufacturing overhead 0.80 Rent 0.40 $ 28,000 Total product cost $ 12.70 If Futura decides to make the starters, a supervisor would have to be hired (at a salary of $126,000) to oversee production. However, the company has sufficient idle tools and machinery such that no new equipment would have to be purchased. The rent charge above is based…arrow_forward
- Essentials Of InvestmentsFinanceISBN:9781260013924Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.Publisher:Mcgraw-hill Education,
- Foundations Of FinanceFinanceISBN:9780134897264Author:KEOWN, Arthur J., Martin, John D., PETTY, J. WilliamPublisher:Pearson,Fundamentals of Financial Management (MindTap Cou...FinanceISBN:9781337395250Author:Eugene F. Brigham, Joel F. HoustonPublisher:Cengage LearningCorporate Finance (The Mcgraw-hill/Irwin Series i...FinanceISBN:9780077861759Author:Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan ProfessorPublisher:McGraw-Hill Education