Gallant Sdn. Bhd., offers a credit period of 4 weeks. The price and cost per unit of its product are, respectively, RM26 and RM22. The firm’s required return (EAR) on receivables is 1% for the period of 4 weeks. (a) If the probability of default of a particular one-time customer is 20%, should the firm sell on credit to this customer? (b) What is the maximum probability of default of a one-time customer that Gallant Sdn. Bhd., should sell to on credit? Justify your decision. (c) If the probability of default of another customer is also 20%, but it is likely that the customer will be a repeat customer who buys from the firm every 4 weeks, should the firm sell on credit to this customer?
Gallant Sdn. Bhd., offers a credit period of 4 weeks. The price and cost per unit of its product are, respectively, RM26 and RM22. The firm’s required return (EAR) on receivables is 1% for the period of 4 weeks.
(a) If the probability of default of a particular one-time customer is 20%, should the firm sell on credit to this customer?
(b) What is the maximum probability of default of a one-time customer that Gallant Sdn. Bhd., should sell to on credit? Justify your decision.
(c) If the probability of default of another customer is also 20%, but it is likely that the customer will be a repeat customer who buys from the firm every 4 weeks, should the firm sell on credit to this customer?
(d) What is the maximum probability of default of a customer that Gallant Sdn. Bhd., should sell to on credit, if the customer is likely to be repeat customer who buys from the firm every 4 weeks? Justify your decision.
(e) Now, if the firm’s required return on receivables is 11% based on EAR (and not 1% for the period of 4 weeks as stated above), what is the equivalent effective required return on receivables on a 4-week period? Given this required return, should the company sell on credit to a one-time customer with the probability of default of 20%?
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