Crisps has received an order for 14500 bags of potato chips from BigBag. Crisps

Question

Crisps has received an order for 14500 bags of potato chips from BigBag. Crisps views BigBag to be a long-term customer and believes they will continue to place the same order year after year forever. Crisps sells its large bags of potato chips for $2.15 each, and calculates its internal cost for the product at $1.25 each.

Market research estimates that there is a 37% chance that BigBag will pay in full what it owes. Crisps uses a discount rate of 6.45% for all NPV analysis.

Based on this information, calculate the NPV of this credit decision?
$

Explanation / Answer

Sales=14500*2.15

Cost=14500*1.35

hence, Profit=Sales-Cost=14500*(2.15-1.35)

But as there is only 37% chance of recovering the full amount

So, expected annual cash flows=0.37*14500*(2.15-1.35)=4292

This is a perpetuity with annual cash flows as 4292

NPV of a perpetuity=-Inital Investment+Annual Cash Flows/Discount Rate

Given, Initial investment=0

So, NPV=4292/0.0645=$66542.63566

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