Michael Dell, the founder of Dell Inc, has been exploring ways of improving the company's financial performance. Dell manufactures and sells computers to retailers. The company's growth has been relatively slow in recent years, but with an expansion in the economy, it appears that sales may increase more rapidly in the future. Michael has asked Kevin Rollins, the company's treasurer, to examine Dell's credit policy to see if a change can help increase profitability. The company currently has a policy of net 40. As with any credit sales, default rates are always of concern. Because of Dell's screening and collection process, the default rate on credit is currently only 1.7 percent. Kevin has examined the company's credit policy in relation to other vendors, and he has found three available options. The first option is to relax the company's decision on when to grant credit. The second option is to increase the credit period to net 50, and the third option is a combination of the relaxed credit policy and the extension of the credit period to net 50. On the positive side, each of the three policies under consideration would increase sales. The three policies have the drawbacks that default rates would increase, the administrative costs of managing the firm's receivables would increase, and the receivables period would increase. The effect of the credit policy change would impact all four of these variables to different degrees. Kevin has prepared the following table outlining the effect on each of these variables: Annual Sales Default Rates Administrative cost Receivables (Millions) (% Sales) (% Sales) period Current Policy 146 1.7 2.3 39 days Option 1 169 2.6 3.3 42 days Option 2 166 1.9 2.5 52 days Option 3 182 2.3 3.1 50 days Dell's variable costs of production are 45 percent of sales, and the relevant interest rate is a 6 percent effective annual rate. Dell's variable costs of production are 45 percent of sales, and the relevant interest rate is a 6 percent effective annual rate. QUESTIONS 1. Which credit policy should the company use? 2. Notice that in option 3, the default rate and administrative costs are above those in option Is this plausible? Why or why not? Michael Dell, the founder of Dell Inc, has been exploring ways of improving the company's financial performance. Dell manufactures and sells computers to retailers. The company's growth has been relatively slow in recent years, but with an expansion in the economy, it appears that sales may increase more rapidly in the future. Michael has asked Kevin Rollins, the company's treasurer, to examine Dell's credit policy to see if a change can help increase profitability. The company currently has a policy of net 40. As with any credit sales, default rates are always of concern. Because of Dell's screening and collection process, the default rate on credit is currently only 1.7 percent. Kevin has examined the company's credit policy in relation to other vendors, and he has found three available options. The first option is to relax the company's decision on when to grant credit. The second option is to increase the credit period to net 50, and the third option is a combination of the relaxed credit policy and the extension of the credit period to net 50. On the positive side, each of the three policies under consideration would increase sales. The three policies have the drawbacks that default rates would increase, the administrative costs of managing the firm's receivables would increase, and the receivables period would increase. The effect of the credit policy change would impact all four of these variables to different degrees. Kevin has prepared the following table outlining the effect on each of these variables: Annual Sales Default Rates Administrative cost Receivables (Millions) (% Sales) (% Sales) period Current Policy 146 1.7 2.3 39 days Option 1 169 2.6 3.3 42 days Option 2 166 1.9 2.5 52 days Option 3 182 2.3 3.1 50 days Dell's variable costs of production are 45 percent of sales, and the relevant interest rate is a 6 percent effective annual rate. Dell's variable costs of production are 45 percent of sales, and the relevant interest rate is a 6 percent effective annual rate. QUESTIONS 1. Which credit policy should the company use? 2. Notice that in option 3, the default rate and administrative costs are above those in option Is this plausible? Why or why not