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Algebra Ltd is selling inventory managment software for small to mid-size firms. Currently the computer program is sold only for cash. In order to increase its revenues, the company is considering the alternative of offering a credit for one month to all its customers. However, by providing customer credit, the company expects that it will incur the risk of attracting high risk customers that could default on their payments. The two strategies are outlined below:
Cash based sales Credit sales
Unit Sale Price $100 $100
Quantity Sold 100 130
Cost per Unit $50 $55*
Probability of customer defaulting 0% 10%
*The $5 difference in unit cost reflects the cost of managing the credit policy
Algebra Ltd cost of capital is 1% per month. Show computations if applicable.
a. What is the net present value (NPV) of selling the computer program for cash?
b. What is the NPV of selling the computer program on credit?
c. What should Algebra Ltd do?
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