Question

Solar Engines manufactures solar engines for tractor-trailers. Given the fuel savings available, new orders for 195 units have been made by customers requesting credit. The variable cost is $12,000 per unit, and the credit price is $14,750 each. Credit is extended for one period. The required return is 2.1 percent per period. If Solar Engines extends credit, it expects that 20 percent of the customers will be repeat customers and place the same order every period forever and the remaining customers will be one-time orders. Calculate the NPV of the decision to grant credit.

Answer 1

Present value factor @ 2.10%

Period	2.10%
1	0.979432
2	0.959287
3	0.939556

A. Calculation of Discounted Cash InFlow (DCF) for collection from customers:

Since the collection is not received immediately, we have to calculate the present value of the collection. It is calculated as $14,750 x 0.979432 = $.14,447.

B.Calculation of NPV

NPV = DCF calculated as above (-) Variable Cost = $.14,447 - $.12,000 = $.2,447 per unit

For 195 units, the NPV will be $.2,447 x 195 = $.477,091. Since the NPV >0, Solar engine can grant credit.

It is assumed that the variable cost is paid in period 0 itself. Hence discounting the same is not required.