Problem: Locust Software sells computer training packages to its business customers at a price of $101. The cost of production (in present value terms) is $96. Locust sells its packages on terms of net 30 and estimates that about 7 percent of all orders will be uncollectible. An order comes in for 20 units. The interest rate is 1 percent per month.
Q1. Should the firm extend credit if this is a one-time order? The sale will not be made unless credit is extended.
Q2. What is the break-even probability of collection?
Q3. Now suppose that if a customer pays this month's bill, it will place an identical order in each month indefinitely and can be safely assumed to pose no risk of default. Should credit be extended?
Q4. What is the break-even probability of collection in the repeat-sales case?