HM9 - c A paying customer now represents a perpetuity of...

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HM9 Chapter 19. 13. Month 3: $18,000 + (0.5 × $90,000) + (0.3 × $120,000) + (0.2 × $100,000) = $119,000 Month 4: $14,000 + (0.5   ×   $70,000) + (0.3 × $90,000) + (0.2 × $120,000) = $100,000 Chapter 20. 13. PV(COST) = 96 PV(REV) = 101/1.01 = 100 a.The expected profit from a sale is: [0.93 × ($100 – $96)] – (0.07 × $96) = –$3 The firm should not extend credit. b.At the break-even probability, expected profit equals zero: [p × ($100 – $96)] – [(1 – p) × $96] = 0 p = 0.96 So if the firm is to break even, 96% of its customers must pay their bills.
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Unformatted text preview: c. A paying customer now represents a perpetuity of profits equal to: $100 – $96 = $4 per month The present value is: $4/0.01 = $400 So the present value of a sale, given a 7% default rate, is: (0.93 × $400) – (0.07 × $96) = $365.28 It clearly pays to extend credit. d.(p × $400) – [(1 – p) × $96] = 0 ⇒ p = 0.194 = 19.4% So the probability of payment must be greater than 19.4% to justify extending credit....
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