A firm currently sells its product with a 2% discount to customers who pay by cash or credit card when they purchase one of the firm's products; otherwise, the full price is due within 30 days. Forty percent of customers take advantage of the discount. The firm plans to drop the discount so the new terms will simply be net 30. In doing so it expects to sell 100 fewer units per month and all customers to pay at day 30. The firm currently sells 1 000 units per month at a cost per unit of $45 and a selling price per unit of $80. If the firm's required return is 2%, what is the net present value (NPV)of making this change?
A)-$169 860
B)$64 490
C)-$122 420
D)$172 320

Question

Quizplus · Accepted Answer

The correct answer is A because the NPV of the change is -$169,860. The firm will lose revenue from the 100 fewer units sold per month, and it will also lose the 2% discount that it currently offers to customers who pay by cash or credit card. The total loss in revenue will be $100 * $80 * 12 = $96,000 per year. The firm will also save on the cost of goods sold, since it will be producing 100 fewer units per month. The savings in cost of goods sold will be $100 * $45 * 12 = $54,000 per year. The net loss in revenue will be $96,000 - $54,000 = $42,000 per year. The NPV of the change is the present value of the net loss in revenue over the life of the project. The life of the project is infinite, so the NPV is calculated as follows:NPV = -$42,000 / 0.02 = -$2,100,000The firm's required return is 2%, so the present value of $1 received at the end of each year is $1 / 1.02 = $0.9804. The NPV of the change is therefore -$2,100,000 * $0.9804 = -$169,860.

A Firm Currently Sells Its Product with a 2% Discount