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Jim Khana, the credit manager of Velcro Saddles, is reappraising the company’s credit policy. Velcro sells on terms of net 30. Cost of goods sold is 85% of sales, and fixed costs are a further 5% of sales. Velcro classifies customers on a scale of 1 to 4. During the past five years, the collection experience was as follows. Assume the average annual interest rate was 2%. Assume away from the effect of repeat orders.
Classification Defaults as Percent of Sales Average Collection Period in Days for Non-defaulting Accounts
1 0% 45
2 2% 42
3 10% 40
4 20% 80
a) Which of the above groups should the company sell to? (Hint: Calculate per $100
of sales)
b) Now suppose that it costs $95 to classify each new credit applicant and that an
equal proportion of new applicants falls into each of the four categories. For what
value of the sales should Mr. Khana not bother to undertake a credit check?
Classification Defaults as Percent of Sales Average Collection Period in Days for Non-defaulting Accounts
1 0% 45
2 2% 42
3 10% 40
4 20% 80
a) Which of the above groups should the company sell to? (Hint: Calculate per $100
of sales)
b) Now suppose that it costs $95 to classify each new credit applicant and that an
equal proportion of new applicants falls into each of the four categories. For what
value of the sales should Mr. Khana not bother to undertake a credit check?
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