Question 6 (15 marks)

Credit Management

Air Spares is a wholesaler that stocks engine components and test equipment for the commercial aircraft industry. A new customer has placed an order for eight high-bypass turbine engines, which increase fuel economy. The variable cost is $2.5 million per unit and the credit price is $2.815 million each. Credit is extended for one period and based on historical experience, payment for about 1 out of every 100 such orders is never collected. The required return is 3.1 percent per period.

Required:

1. What is the NPV per engine purchased on credit?
2. What is the break-even probability of default in Question (a)?
3. Suppose that customers who dont default become repeat customers and place the same order every period forever. Further assume that repeat customers never default. What is the NPV per engine purchased on credit? And what is the break-even probability of default?