Air Spares is a wholesaler that stocks engine components and test equipment for

Question

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 $3.2 million per unit, and the credit price is $3.505 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 3.8 percent per period.

Assuming that this is a one-time order, should it be filled? The customer will not buy if credit is not extended.

What is the break-even probability of default in part (a)? (Round your answer to 2 decimal places. (e.g., 32.16))

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. What is the NPV per engine purchased on credit?

Assuming the customer becomes a repeat customer, what is the break-even probability of default?(Round your answer to 2 decimal places. (e.g., 32.16))

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 $3.2 million per unit, and the credit price is $3.505 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 3.8 percent per period.

Explanation / Answer

NPV a-1 Details Amount Credit Price 38,05,000.00 Required return 4.10% DF for 1 Period @4.10%                   0.96 Present Value of credit price A 36,55,139.29 Variable Cost 35,00,000.00 Probability of Collection risk =1/125 0.8% 0.80% PV of collection Risk        29,241.11 Present Value of total Cash outflow B 35,29,241.11 NPV A-B     1,25,898.17 a-2 Should be accepted .since it gives a postive contribution and assuming that the firm has excess capacity for undertaking the order.( No additional Fixed cost will be incurred to facilitate the order) Break Even Probability b NPV before considering the collection Risk 125,898.17+29,241.11     1,55,139.28 NPV as a % on Present value of credit sales price 155139.28/3655139.29 4.24% Break Even Probability NPV/PV of sales Price 4.24% c-1 NPV before Collection Risk     1,55,139.28 Total No of customers current period 125 Defaulting Customer current Period 1 Non-Defaulting Customer current Period 124 Total No of customer based on the assumption of repeated customer 125+124 249 Defaulting Customer 1 Probability 0.40% Present Value of collection Risk Present value of Credit Price * Probability        14,679.27 Revised NPV per Engine     1,40,460.01 c-2 Break Even Probability of Default NPV before considering the collection Risk 140,460.01+14,679.27     1,55,139.28 NPV as a % on Present value of credit sales price 155139.28/3655139.29 4.24% Break Even Probability NPV/PV of sales Price 4.24%

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