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.
Under the current policy, the default rate is 2.1 percent, so the average daily defaults will be:
Average daily defaults = .021($113,000,000/365)
Average daily defaults = $6,501.37
The current policy has administrative costs equal to 1.6 percent of sales, so the average daily
administrative costs are:
Under Option 1, the average daily sales are:
Average daily sales = $129,000,000/365
Average daily sales = $353,424.66
The average daily variable costs will be:
Average daily variable costs = .45($129,000,000/365)
Interest rate = (1 + .0001597)41 – 1
Interest rate = .00657, or .657%
Since the credit policy will exist into perpetuity, the NPV is:
NPV = –$159,041.10 + ($353,424.66 – 159,041.10 – 9,189.04 – 8,482.19)/.00657
NPV = $26,751,158.21
Option 2
Under Option 2, the average daily sales are:
Average daily sales = $127,000,000/365
Average daily sales = $347,945.21
The average daily variable costs will be:
Option 2 has administrative costs equal to 1.9 percent of sales, so the average daily administrative costs
are:
Average daily administrative costs = .019($127,000,000/365)
Average daily administrative costs = $6,610.96
Option 3
Under Option 3, the average daily sales are:
Average daily sales = $130,000,000/365
Average daily sales = $356,164.38
The average daily variable costs will be:
Average daily variable costs = .45($130,000,000/365)
Average daily variable costs = $160,273.97
Under Option 3, the default rate is 2.5 percent, so the average daily defaults will be:
Average daily defaults = .025($130,000,000/365)
NPV = –$160,273.97 + ($356,164.38 – 160,273.97 – 8,904.11 – 7,479.45/.00785
NPV = $22,697,882.88
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. The