6.2. Dickson City Company has annual sales of $5 million, while the cost of good

Question

6.2. Dickson City Company has annual sales of $5 million, while the cost of goods sold is $3.2 million. All sales are made on a cash basis. The owner of Dickson has come up with the plan of giving credit to the customers. He believes that this will increase the sales by 25% without increasing any of the fixed costs. He thinks that 20% of the customers will pay within 30 days, 40% within 60 days, 37% within 90 days, and 3% of the customers will default on the sales. The cost of capital to Dickson is 12%.

(A) Should Dickson City introduce the policy of credit sales?

NPV(cash) = $1.8 million, NPV(credit) = 1.941 million, yes.

(B) The manager of the firm doubts whether the sales will actually increase by 25% as a result of this strategy. Find the minimum increase in sales to justify introduction of the new credit policy.

15.92% Solution provided by instructor. How do you do this problem Parts A&B. Please show all steps

Explanation / Answer

(a)

NPV Cash Sales = -3.2+5=$1.8 Million

NPV Credit Sales= 3.2[-3.2+5(0.2/1.1230/365 + 0.4/1.1260/365+0.37/1.1290/365)]= $1.94Million

The NPV of credit sales is morethan the cash sales, So we go for the Credit Sales

(B) Minimum increase to justify=15.92%

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