Which of the following credit decisions appears correct for a customer who 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 use the formula: 
Expected profit = (1 - probability of default) * (Revenue - Cost) - (Probability of default * Cost)

Revenue = $1,000
Cost = $800 (profit margin of 20%)
Probability of default = 20%
Discount rate = 10%

Expected profit = (1 - 0.2) * ($1,000 - $800) - (0.2 * $1,000) * (1 + 0.1) = $1,440

Therefore, option C is the correct decision as it results in a positive expected profit.

Which of the Following Credit Decisions Appears Correct for a Customer