The Branding Iron Company sells its irons for $50 apiece wholesale. Production c

Question

The Branding Iron Company sells its irons for $50 apiece wholesale. Production cost is $40 per iron. There is a 25% chance that wholesaler Q will go bankrupt within the next year. Q orders 1,000 irons and asks for six months’ credit. Assume that the discount rate is 10% per year, there is no chance of a repeat order, and Q will pay either in full or not at all. a. Calculate the NPV of the order. (Negative amount should be indicated by minus sign. Do not round intermediate calculations. Round your answer to 2 decimal places.) NPV of the order $ per iron b. Should you accept the order? Yes No

Explanation / Answer

Contribution per order = (price – cost) x order size

                                                = (50-40) x 1000

                                                = 10,000

Bad debt expense = cost of order x bad debt %

                                    = 40 x1000 x 25%

                                    = 10,000

Net cash flow per order = 10,000 -10,000

                                                = 0

NPV of the order = cash flow per order / (1+r)^n

                                   = 0/ (1+0.10)^1

                                = 0

This order should be accepted as NPV is zero and if Q does not make any default in payment, NPV would be positive.

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