Collegiate Tuxedo rents apparel throughout the year.They have experienced non-payment by about 15% of their customers with an average loss of £200.Collegiate wants to stem their losses by
Using an instant electronic credit check on the customer.These checks will cost them £7 on each of
The 1,000 customers.The opportunity cost is 1.5% for the credit period.Should they pursue the
Credit check?

Question

Quizplus · Accepted Answer

The expected loss due to non-payment is 15% of 1000 customers = 150 customers, which will result in a loss of £200 per customer, resulting in a total loss of £30,000.
If Collegiate Tuxedo uses an instant electronic credit check on all customers, the cost would be £7 per customer, resulting in a total cost of £7,000 (1000 x £7).
The opportunity cost is 1.5% for the credit period, which means that for each £1 not received immediately, Collegiate Tuxedo loses 1.5p per year.
Assuming that the credit period is one year, the net gain from using the credit check is:
Expected gain = (0.85 × 1000 × £200) – £7,000 – ((1000 × £200) × 0.015) = £170,000 – £7,000 - £3,000 = £160,000.
Therefore, the net gain is £160,000, which is higher than the expected loss of £30,000. Thus, Collegiate Tuxedo should pursue the credit check to reduce their losses.

Collegiate Tuxedo Rents Apparel Throughout the Year