Look back at Example 3.

Cast Iron’s costs have increased from $1,000 to

$1,050. Assuming there is no possibility of repeat orders, and that the probability of successful collection from the customer is p = .9, answer the following:

a. Should Cast Iron grant or refuse credit?

b. What is the break-even probability of collection?

Data from in Example 3

 

Transcribed Image Text:

EXAMPLE 3 The Credit Decision Consider the case of the Cast Iron Company. On each nondelinquent sale Cast Iron re- ceives revenues with a present value of $1,200 and incurs costs with a present value of $1,000. Therefore, the company's expected profit if it offers credit is PxPV(REV-COST)-(1-p) x PV(COST) = px 200 - (1 - p) 1,000 If the probability of collection is 5/6, Cast Iron can expect to break even: Expected profit = 5/6 200 - (1 - 5/6) 1,000 = 0 Thus Cast Iron's policy should be to grant credit whenever the chances of collection are better than 5 out of 6.