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Mini Case 4

Credit Policy at Braam Industries

In order to formulate which out of the four policies (including the current policy) will be the most optimal for Braam industries, an NPV analysis must be done of all four policies (Kong, et al, 2016).

Current Policy

Daily sales of Braam Industries = Annual salesnumber of days in a year

Daily sales of Braam Industries = 113000000365

Daily sales of Braam Industries = $309589

Average daily cost:

Average daily variable costs = 113000000365*0.45

Average daily variable costs = $139315

Administrative costs per day = 113000000365*0.0160

Administrative costs per day = $4953

Average daily defaults = 113000000365*0.0210

Average daily defaults = $6501

Interest rate = 1*0.0636538-1

Interest rate = 0.00609 => 0.609%

Net Present Value = 139315+(309589-139315- 6501- 953)/0.00609

Net Present Value = $49611659

Option 1

Daily sales of Braam Industries = Annual salesnumber of days in a year

Daily sales of Braam Industries = 129000000365

Daily sales of Braam Industries = $353425

Average daily cost:

Average daily variable costs = 129000000365*0.45

Average daily variable costs = $159041

Administrative costs per day = 129000000365*0.0240

Administrative costs per day = $8482

Average daily defaults = 129000000365*0.0260

Average daily defaults = $9189

Interest rate = 1*0.0636541-1

Interest rate = 0.00657 => 0.657%

Net Present Value = 159041+(353425-159041- 8482- 9189)0.00657

Net Present Value = $51104110

Option 2

Daily sales of Braam Industries = Annual salesnumber of days in a year

Daily sales of Braam Industries = 127000000365

Daily sales of Braam Industries = $347945

Average daily cost:

Average daily variable costs = 127000000365*0.45

Average daily variable costs = $156575

Administrative costs per day = 127000000365*0.0190

Administrative costs per day = $6610

Average daily defaults = 127000000365*0.0220

Average daily defaults = $7655

Interest rate = 1*0.0636551-1

Interest rate = 0.00818 => 0.818%

Net Present Value = 156575+(347945-156575- 7655- 6610)0.00818

Net Present Value = $40792176

Option 3

Daily sales of Braam Industries = Annual salesnumber of days in a year

Daily sales of Braam Industries = 130000000365

Daily sales of Braam Industries = $356164

Average daily cost:

Average daily variable costs = 130000000365*0.45

Average daily variable costs = $160274

Administrative costs per day = 130000000365*0.0210

Administrative costs per day = $7480

Average daily defaults = 130000000365*0.0250

Average daily defaults = $8904

Interest rate = 1*0.0636549-1

Interest rate = 0.00785 => 0.785%

Net Present Value = 160274+(356164-160274- 7480- 8904)0.00785

Net Present Value = $43284076

Conclusion

After analyzing all the calculations done above and it can be summarized that the best option would be the option 1 as it has the highest NPV. There is high plausibility in the default rate and administrative cost of option being lower than option 3. There are several reasons for this, primarily, the credit period is extended in both Option 2 and Option 3 but the credit policy is relaxed in Option 3. By relaxing the credit policy in Option 3, the default rate will automatically increase (Morais, et al, 2019). This is because there will companies that are less likely to pay and also have a lower credit rating would be added into the policy. The effect of this would be carried onto the administrative costs which will be higher to manage the increased number of delinquent accounts (Prina, 2015).

References

Kong, J., Zhou, Y., Lai, H., Zhang, F., & Zhou, Z. (2016). Analysis of Credit Sale Risk of Emerging Market Product. Procedia Computer Science, 91, 362-371.

Morais, B., Peydró, J. L., Roldán‐Peña, J., & Ruiz‐Ortega, C. (2019). The International Bank Lending Channel of Monetary Policy Rates and QE: Credit Supply, Reach‐for‐Yield, and Real Effects. The Journal of Finance, 74(1), 55-90.

Prina, S. (2015). Banking the poor via savings accounts: Evidence from a field experiment. Journal of Development Economics, 115, 16-31.