Question

Microbiotics currently sells all of its frozen dinners cash-on-delivery but believes it can increase sales by offering supermarkets 1 month of free credit. The price per carton is $160, and the cost per carton is $95. The unit sales will increase from 1,110 cartons to 1,170 per month if credit is granted. Assume all customers pay their bills and take full advantage of any credit period offered.

Required:
If the interest rate is 1% per month, what will be the change in the firm's total monthly profits on a present value basis if credit is offered to all customers?

Answer 1

The change in Microbiotics' total monthly profits on a present value basis if credit is offered to all customers is $2,386.61 positive.

What is the present value?

The calculation of the present value involves the discounting of the interest rate from the future cash flows.

The present value can be computed using the present value table or an online financial calculator.

Data and Calculations:

Price per carton = $160

Cost per carton = $95

Profit per carton = $65 ($160 - $95)

Total profit for 1,110 cartons = $72,150 ($65 x 1,110)

Total profit for 1,170 cartons = $76,050 ($65 x 1,170)

Cost of credit = $760.50 ($76,050 x 1%)

Change in profit = $75,289.50 ($76,050 - $760.50)

Discount factor of 1% = 0.990

Present value of $75,289.50 at 1% in a month's time = $74,536.61 ($75,289.50 x 0.990)

Thus, the change in Microbiotics' total monthly profits on a present value basis if credit is offered to all customers is $2,386.61 positive ($74,536.61 - $72,150).

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