978-1259709685 Chapter 28 Case

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CHAPTER 28 CASE C-1

CHAPTER 28

CREDIT POLICY AT BRAAM

INDUSTRIES

To decide on the optimal credit policy, we need to calculate the NPV of each policy. We will begin with

the calculation of the NPV of the current policy.

Current Policy

First, we need to calculate the average daily sales which are:

Now, we need to calculate the daily interest rate:

Next, we need the average daily costs. We will begin with the average daily variable costs, which are 45

percent of sales. So, the average daily variable costs are:

Under the current policy, the default rate is 2.1 percent, so the average daily defaults will be:

The current policy has administrative costs equal to 1.6 percent of sales, so the average daily

administrative costs are:

We also need the appropriate interest rate for the collection period. With a .01597 percent daily interest

rate, the periodic rate for the 38 day collection period is:

Since the credit policy will exist into perpetuity, the NPV is:

CHAPTER 28 CASE C-2

Option 1

Under Option 1, the average daily sales are:

Under the Option 1, the default rate is 2.6 percent, so the average daily defaults will be:

Option 1 has administrative costs equal to 2.4 percent of sales, so the average daily administrative costs

are:

We also need the appropriate interest rate for the collection period. With a .01597 percent daily interest

rate, the periodic rate for the 41 day collection period is:

Since the credit policy will exist into perpetuity, the NPV is:

Option 2

Under Option 2, the average daily sales are:

Under the Option 2, the default rate is 2.2 percent, so the average daily defaults will be:

Average daily defaults = .022($129,000,000/365)

Average daily defaults = $7,775.34

CHAPTER 28 CASE C-3

Option 2 has administrative costs equal to 1.9 percent of sales, so the average daily administrative costs

are:

Since the credit policy will exist into perpetuity, the NPV is:

Option 3

Under Option 3, the average daily sales are:

The average daily variable costs will be:

Under the Option 3, the default rate is 2.5 percent, so the average daily defaults will be:

Option 3 has administrative costs equal to 2.1 percent of sales, so the average daily administrative costs

are:

We also need the appropriate interest rate for the collection period. With a .01597 percent daily interest

rate, the periodic rate for the 49 day collection period is:

Since the credit policy will exist into perpetuity, the NPV is:

CHAPTER 28 CASE C-4

The company should choose Option 1 since it has the highest NPV.

The default rate and administrative costs of Option 2 are below those of Option 3. This is plausible.

Option 2 extends the credit period, while Option 3 extends the credit period and relaxes the credit policy.