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problem: Mississippi Delta Inc. has been selling switching equipment to computer companies on net 30 terms, in which payment is expected by thirty days from the invoice date. Concerned about deteriorating collection patterns, the credit manager has divided customers into two groups for examination purpose; prompt payers and laggards. Prompt payers [80% of Mississippi Delta’s customers] pay, on average, in thirty-five days, versus a 72-day average for the laggards. The manager wonders if the credit terms should be modified to include a two percent cash discount on invoices paid within 10 days. The average invoice is the same for both groups, roughly 4,000 dollars. The manager expects fifty percent of the prompt payers to pay in exactly ten days and the average on the other half to slip to 40 days. He thinks that the twenty percent of the laggards will pay is ten days and the average on the others will slip to 70 days. Given these forecasts, he is not sure that the lost revenue from discount takers (who would then pay only 98 percent of the invoiced dollar amount) justifies the improved collection. The company’s yearly cost of capital is eleven percent.

[A] Sensitivity analysis involves varying the key assumptions, one at a time, and observing the effect on the key decisions criterion-such as profits or net present value. In the net present value analysis above, how could one carry out sensitivity examine? [If you have a financial spreadsheet available, conduct a sensitivity analysis that varies the number of prompt payers who will pay me exactly ten days and report your findings.]

[B] What other factors should be taken into account before Mississippi Delta Inc. makes a switch, assuming such is justifiable on an net present value basis.

Basic Finance, Finance

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