Which of the following credit decisions appears correct for a customer that intends to order $1,000 of goods annually that have a 20% profit margin if the probability of default is 20% and the discount rate is 10%?
A)Reject because expected loss equals $320
B)Reject because expected profit equals $0
C)Accept because expected profit equals $1,440
D)Accept because expected profit equals $3,200

Question

Quizplus · Accepted Answer

To calculate the expected profit, we need to consider the profit margin of 20% on $1,000 worth of goods, which is $200.

Expected profit = (1 - Probability of default) x Profit margin x Annual order value - (Discount rate x Annual order value)

Therefore, Expected profit = (1 - 0.2) x $200 x $1,000 - (0.1 x $1,000) = $1,440

Since the expected profit is positive, it is advisable to accept the credit application.

Which of the Following Credit Decisions Appears Correct for a Customer