Problem
Question I
One Potato Two Potato Corporation sells potato chips internationally from PEI. Its credit terms are 2/10 net 30. Based on experience, 65% of all customers will take the discount.
Task
i. What is the average collection period for One Potato Two Potato?
ii. If One Potato Two Potato sells 1,300 'orders' every month at a price of $1,750 each, what is its average balance sheet amount in accounts receivable? Assume 365 days per year.
Question II
Covehead Lighthouse Corporation is considering a change in its cash-only policy. The new terms would be net one period. Based on the following information, determine if Covehead Lighthouse should proceed or not. The required rate of return is 2.5% per period.
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Current Policy
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New Policy
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Price per unit
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$73
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$75
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Cost per unit
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$38
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$38
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Unit sales per month
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3,280
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3,390
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Question III
Space Exploration Technology Corporation (Space X), is an aerospace manufacturer that sells stock engine components and tests equipment for commercial space transportation. A new customer has placed an order for eight high-bypass turbine engines, which increase fuel economy. The variable cost is $1.6 million per unit, and the credit price is $1.725 million each. Credit is extended for one period, and based on historical experience, payment for about one out of every 200 such orders is never collected. The required return is 1.8% per period.
Task
i. Assuming that this is a one-time order, should it be filled? The customer will not buy if credit is not extended.
ii. What is the break-even probability of default in part i?
iii. Suppose that customers who don't default become repeat customers and place the same order every period forever. Further assume that repeat customers never default. Should the order be filled? What is the break-even probability of default?