Allen Distribution Company Essay

1475 Words Apr 26th, 2011 6 Pages
| Case 1: Allen Distribution Company | Would we extend the \$1,000 credit line to the Morse Photo Company? | | | 11/27/2010 |

Introduction to Case problem and important points to be covered

The core problem for Allen Distribution Company is how to distinguish from the marginal accounts the difference between good creditors and bad creditors. Especially we show how the difference between creditors can be utilized in practice by the credit representatives. For this we provide clear guidelines. The option of extending the Morse Photo Company’s \$ 1000 credit line is used as test case for these purposes.
To distinguish customers we divide the accounts to different categories. There are two important points of views which in
With this we can calculate the expected profit.

* Offer \$ 1000 credit: * Customer pays p = 99,38%, REV – COST = 312,15 \$ (credit departments costs included using 7,64% discount rate) * Customer defaults 1-p = 0,62%, COST = -687,85 \$

Actual revenue calculated for Allen Electricity using its 20% required rate of return : p*PV(REV – COST) – (1-p)*PV(COST) = 99,38%*(312,15\$/1,2) – 0,62%*(687,85\$/1,2) =

This calculation gives us the expected return from Morse for period 1. Because this is positive, the credit could be granted for period one. However the probability to default is unexpectedly low as the return on assets is only 1%. Hence, we add one more factor into our calculations to ensure the creditworthiness.
We give the Morse photo company credit rating according to its financial ratios. According to these figures, Morse’s creditworthiness is determined to on average BBB. EBIT interest cover is in this case excluded from the examination because Morse’s income statement does not provide the figure. In general it will however be included in the calculations. This table is from Standard and Poor’s statistics and it can be updated yearly and used as standard for evaluative purposes.

Now that Morse has been given a credit rating of BBB we can evaluate the company’s long-term probability to default. With BBB it is 3,4% 5 years after issue and 6,9% 10 years after issue.
From the table below we

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