Surf City sells its network browsing software for $40 per copy to computer software distributors and allows its customers 1 month to pay their bills. The cost of the software is $25 per copy. The industry is very new and unsettled, however, and the probability that a new customer granted credit will go bankrupt within the next month is 15%. The firm is considering switching to a cash-on-delivery credit policy to reduce its exposure to defaults on trade credit. The discount rate is 2% per month.

Required:

a-1.What is the present value of the expected profit under the current credit policy?

a-2.What is the expected profit under the cash-on-delivery policy? If the firm switches policies, sales will fall by 40%.

b-1.What would be the present value of the expected profit if a customer that is granted credit and pays its bills can be expected to generate repeat orders with negligible likelihood of default for each of the next 6 months? Similarly, customers that pay cash also will generate on average 6 months of repeat sales.

b-2.What would be the present value of the expected profits under the cash-on-delivery policy, given the sales information from (b-1)?