1. Extension of credit, single order

A potential new customer has submitted an order totaling $650,000 to a company. It has requested the company to extend credit for this order, with payment 30 days after delivery. The company’s contribution margin (price minus variable costs) on this order is 8.5%, and its fixed costs are not affected. The company will pay one third of its costs for the order 15 days after the order is accepted, another third 30 days later, and the balance when the order is delivered, 75 days after acceptance. The company believes there is an 90% chance the customer will make payment on the order (i.e., a 10% chance the account will be uncollectible). If payment is not made when due, the company does not expect to be able to recover any of its costs. The company’s required return for this proposed transaction is 25%.

1. What are the company’s expected cash outflows from this order and when will they occur?

2. What is the company’s expected cash inflow from this order and when will it occur?

3. What is net present value of this order?

4. Should the company accept this order? Explain.

2. Extension of credit, multiple orders

The company from part E expects that if the customer makes payment on the initial order, there is an 75% probability the customer will submit an additional order. It expects the follow-on order will be placed at the time of payment for the first order and be for $1,300,000. The company’s contribution margin on the follow-on order is expected to be 11.5% (some customer specific investments made for the first order will not need to be repeated for the follow-on order and the larger production run will also reduce costs). Timing for the company’s costs will be the same for the follow-on order: one third of the company’s total costs the will be paid 15 days after the order is placed, another third, 30 days later, and the rest 30 days after that, when the order is delivered to the customer. As with the first order, the customer’s payment will be due 30 days after delivery. The company expects there is a 98% probability the customer will make payment on the follow-on order.

1. If payment is made on the first order and the follow-on order is placed, what are the company’s expected cash outflows and when will they occur?

2. If payment is made on the first order and the follow-on order is placed, what is the company’s expected cash inflow and when will it occur?

3. What is the company’s expected net present value on the follow-on order?

4. What is the combined probability of payment on the first order and receipt of the follow-order?

5. Based on the answer to question 3 in case E, and questions 3 and 4 of this case, should the company accept the first order? Explain.