CHAPTER 20
CREDIT POLICY AT HOWLETT
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:
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 1.6 percent, so the average daily defaults will be:
The current policy has administrative costs equal to 2.2 percent of sales, so the average daily
administrative costs are:
We also need the appropriate interest rate for the collection period. With a 6 percent annual interest rate,
the periodic rate for the 37-day collection period is:
Since the credit policy will exist into perpetuity, the NPV is:
CHAPTER 20 C-2
Option 1
Under Option 1, the average daily sales are:
The average daily variable costs will be:
Under Option 1, the default rate is 2.5 percent, so the average daily defaults will be:
Option 1 has administrative costs equal to 3.2 percent of sales, so the average daily administrative costs
are:
We also need the appropriate interest rate for the collection period. With a 6 percent annual interest rate,
the periodic rate for the 40 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:
The average daily variable costs will be:
Under Option 2, the default rate is 1.8 percent, so the average daily defaults will be:
CHAPTER 20 C-3
Option 2 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 6 percent annual interest rate,
the periodic rate for the 50 day collection period is:
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 Option 3, the default rate is 2.2 percent, so the average daily defaults will be:
Option 3 has administrative costs equal to 3.0 percent of sales, so the average daily administrative costs
are:
We also need the appropriate interest rate for the collection period. With a 6 percent annual interest rate,
the periodic rate for the 48 day collection period is:
Since the credit policy will exist into perpetuity, the NPV is:
CHAPTER 20 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.
