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Berkshire Sports inc

Berkshire Sports, Inc., operates a mail-order running-shoe business. Management is considering dropping its policy of no credit. The credit policy under consideration by Berkshire follows:

No Credit Credit
Price per unit--- $35 $40
Cost per unit--- $25 $32
Quantity sold--- 2000 3000
Probability of payment-- 100% 85%
Credit period--- 0 1
Discount rate---- 0 3%

A. Should Berkshire offer credit to its customers?
B. What must the probability of the payment be before Berkshire would adopt the policy?

Please show work.

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Solution Preview

Profit if there is no credit = (35-25) * 2000 = $20,000.

Profit if it allows credit = (40-32)* 3000 = $ 24,000. However the probability of payment is only 85% which means the expected profit = 0.85*24,000 = $20,400/-. Again, there is credit period of 1 month. So we have to calculate the effective income. The firms annual revenue is $ 20,400/- which means monthly revenue is $20,400/12 = $1,700/-.Assuming everything else remaining same, the firm is going ...

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$2.19