Surf City sells its network browsing software for $15 per copy to computer software distributors and allows its customers 1 month to pay their bills. The cost of the software is $10 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 25%. 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 1% per month.

a. Should the firm switch to a cash-on-delivery policy? If it does so, its sales will fall by 40%.

b. How would your answer change 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.

Transcribed Image Text:

Selling price Cost price $15.00 per copy S10.00 per copy Probability of a customer going bankrupt 25.00% Sales in cash-on-delivery policy will fall by 40.00% Discount rate 1.00% per month