2. As the bad-debt loss ratio for the high-risk category exceeds the profit margin of 22 percent, it would be desirable to reject orders from this risk class if such orders could be identified. However, the cost of credit information, as a percentage of the average order, is $4/$50 = $%, and this cost is applicable to all new orders. As the high-risk category is one-fifth of sales, the comparison would be 5 x 8% = 40% relative to the bad-debt loss of 24%. Therefore, the company should not undertake credit analysis of new orders.

An example can better illustrate the solution. Suppose new orders were

$100,000. The following would then hold:

Order Cafegoy LOW MEDIUM HIGH RISK RISK RISK Total orders $30,000 $50,000 $20,000 Baddebt loss 300 2,000 4,800