
Case study:
Person SW, thepresident of H industries, has been exploring many ways to increase the financial performance of the company. The sales of H industries were slow. However due to the expansion in the economy, the sales might increase in the future. Person SW has asked Person AP to examine the credit policy of H industries and bring about changes to increase the profitability.
Characters in the case:
- H industries: The manufacturing industry of office equipment
- Person SW: The president of H industries
- Person AP: The company’s treasurer
To discuss: The credit policy of H industries.

Answer to Problem 1M
Company H should select Option 1 because it has the highest
Explanation of Solution
Adequate information:
Credit policy refers to a set of procedures that include terms and conditions for providing goods on credit and principles for making collections. The company has a policy of net 30. The default rate on credit is 1.6%. Person AP came with 3 available options. H industries’ variable cost of production are 45% of sales, the interest rate is 6% of effective annual rate.
Option: 1
To relax the decision of the company to grant credit
Option: 2
To increase the credit period to net 45
Option: 3
Combination of relaxed policy and extension of credit period
Explanation:
The formula to calculate the average daily sales under current policy:
Compute the average daily sales under current policy:
Hence, the average sales under current policy are $328,767.12.
The formula to calculate the average daily variable costs under current policy:
Compute the average daily variable costs under current policy:
Hence, the variable costs under current policy are $147,945.205.
The formula to calculate the average daily default under the current policy:
Compute the average daily default under the current policy:
Hence, the average daily default under current policy is $5,260.27.
The formula to calculate the average daily administrative cost under current policy:
Compute the average daily administrative cost under the current policy:
Hence, the average administrative costs under current policy are $7,232.87.
The formula to calculate the interest rate for the collection period:
Compute the interest rate:
Hence, the interest rate is 0.62%.
The formula to calculate the net
Compute the net present value under the current policy:
Hence, the NPV under current policy is $27,001,857.205.
Option 1:
The formula to calculate the average daily sales under option 1:
Compute the average daily sales under option 1:
Hence, the average daily sale under option 1 is $383,561.64.
The formula to calculate the average daily variable costs under option 1:
Compute the average daily variable costs under option 1:
Hence, the
The formula to calculate average daily default under option 1:
Compute the average daily default under option 1:
Hence, the average daily default under option 1 is $9,589.04.
The formula to calculate the average daily administrative cost under option 1:
Compute the average daily administrative cost under option 1:
Hence, the average daily administrative costs under option 1 are $12,273.97.
The formula to calculate the interest rate for the collection period:
Compute the interest rate for the collection period:
Hence, the interest rate is 0.676%.
The formula to calculate the net present value (NPV) under option 1:
Compute the net present value (NPV) under option 1:
Hence, the NPV under option 1 is $27,800,163.54.
Option 2:
The formula to calculate the average daily sales under option 2:
Compute the average daily sales under option 2:
Hence, the average daily sales under option 2 are $375,342.46.
The formula to calculate the average daily variable costs under option 2:
Compute the average daily variable costs under option 2:
Hence, the average daily variable costs under option 2 are $168,904.10.
The formula to calculate the average daily default under option 2:
Compute the average daily default under option 2:
Hence, the average daily default under option 2 is $6,756.16.
The formula to calculate the average daily administrative cost under option 2:
Compute the average daily administrative cost under option 2:
Hence, the average daily administrative costs under option 2 are$9,008.21.
The formula to calculate the interest rate for the collection period:
Compute the interest rate:
Hence, the interest rate is 0.841%.
The formula to calculate NPV under option 2:
Compute the NPV under option 2:
Hence, the NPV under option 2 is $22,503,389.59.
Option 3:
The formula to calculate the average daily sales under current policy:
Compute the average daily sales under current policy:
Hence, the average daily sales under option 3 are $410,958.90.
The formula to calculate the average daily variable costs under option 3:
Compute the average daily variable costs under option 3:
Hence, the average daily variable costs under option 3 are $184,931.50.
The formula to calculate the average daily default under option 3:
Compute the average daily default under option 3:
Hence, the average daily default under option 3 is $9,041.09.
The formula to calculate the average daily administrative cost under option 3:
Compute the average daily administrative cost under option 3:
Hence, the average daily administrative costs under option 3 are $12,328.76.
The formula to calculate the interest rate for collection period:
Compute the interest rate for collection period:
Hence, the interest rate is 0.808%.
The formula to calculate NPV under option 3:
Compute the net present value under option 3:
Hence, the NPV under option 3 is $25,143,973.202.
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Chapter 20 Solutions
Fundamentals of Corporate Finance Alternate Edition
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