Air Spares is a wholesaler that stocks engine components and test equipment for
ID: 2718212 • Letter: A
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 $2.4 million per unit, and the credit price is $2,725 million each. Credit is extended for one period, and based on historical experience, payment for about 1 out of even 400 such orders is never collected. The required return is 2.7 percent per period. What is the NPV per engine purchased on credit? (Enter your answer in dollars, not millions of dollars, i.e. 1,234,567. Round your answer to 2 decimal places, (e.g., 32.16)) 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 even 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))Explanation / Answer
Answer (a-1)
NPV = $ 246,725.90
Answer (a-2)
Should the company extend credit -- Yes
Answer (b)
Break-even Probability = 90.68%
Answer (c-1)
NPV = $ 253,359.30 per unit
Answer (c-2)
Break-even Probability = 90.45%
Cost of the engine = $ 2.725 Million
probability of loss = 1/400 = 0.0025
Probability the customers will pay = 1-0.0025 = 0.9975
Present Value per engine = $ 2,725,000/ 1.027 = $ 2,653,359.2989
= $ 2,653,359.30 (rounded off)
Revenue from one engine = $ 2,653,359.3 - $ 2,400,000 = $ 253,359.30
NPV from the sale = 0.9975 * NPV of Revenue - 0.0025 * Cost
= 0.9975 * $ 253,359.30 – 0.0025 * $ 2,400,000
= $ 252,725.90 - $ 6,000
= $ 246,725.90
Since expected profit from sale is positive, the company should extend credit to the customer
At break-even probability expected profit equals zero. That is
p *246725.90 – (1-p)* 2,400,000 = 0
246725.90 * p – 2,400,000 * 1 + 2,400,000*p = 0
2,646725.90 * p = 2,400,000
p = 2,400,000 / 2,646,725.90 = 0.906780 or 90.68%
That is if 90.68% of the orders pay, then the company breaks even and expected profit will be zero.
As repeat customers do not default, NPV per engine is
2653359.30 - 2,400,000 = $ 253,359.30
Break-even probability of repeat customers is
P * 253359.30 – (1-p) * 2,400,000 = 0
253359.30 * p - 2,400,000 + 2,400,000 * p = 0
2,653,359.30 * p = 2,400,000
p =2,400,000/2,653,359.30 = 0.904513 or 90.45%
That is the company breaks even if 90.45% of the repeat customers pays for their orders.
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.