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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.

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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