1
.
Nast Stores - Consumer credit scoring model.
Y = (a x EMPLOYMENT) + (b x HOMEOWNER) + (c x CARDS)
where:
a=
0.2
b=
0.4
c=
0.3
EMPLOYMENT = 1 if full-time, 0.5 part-time, 0 if unemployed
HOMEOWNER = 1 if homeowner, 0 otherwise
CARDS = 1 if presently have 1-5 credit cards, 0 otherwise
Minimum score =
0.7
a.
)
Consumer credit scoring model.
Value of Janice's
variables:
EMPLOYMENT=
HOMEOWNER =
CARDS =
Y=
b.
)
0.5
0.50
1.00
0.00
: reject credit application
Consumer credit scoring model.
Value of Janice's
variables
EMPLOYMENT=
HOMEOWNER =
CARDS =
Y=
0.9
1.00
1.00
1.00
: accept credit application because she now meets the
minimum cutoff score
c.) Adding a new variable to a consumer credit scoring model.
0 stands for less than one year, 0.5 stands for 1-2 years, 1 stands for > 2 years.
d.
)
Suggesting other variables for a consumer credit scoring model.
- How long employed in current job
0 for < one year, 0.5 for 1-5 years, 1 for > than 5 years.
- Dollar amount annual income
0 < than $20,000, 0.5 for $20-$50,000, 1 > than $50,000.
- Phone number
0 for no phone number, 1 for phone number.
2
.
Certainty NPV and Uncertainty NPV for Credit Decision.
a.
)
The certainty case.
ASSUMPTIONS:
Credit terms, CP
Opportunity cost of funds, k
Daily rate
Dollar amount of invoice, S
45
12.00%
0.0329%
$30,000
Variable costs, VCR
65.00%
Credit administration and collection
1.00%
days
APR
of
sales
of
sales
costs, EXP
ILLUSTRATION OF CASHFLOW TIMELINE
Day 0
Day 45
---|----------------------------------------|------------------->
0.65 x $30,000 =
$19,500.00
PV of variable costs
$30,000 invoice
($300) EXP
$29,700 x 1 / (1 + (0.12 / 365) x
45))
$29,267.01
PV of collections
= -(VCR x S) + S / (1 + iCP)) (EXP x S) / (1+ iCP)
= NPV of credit extension under certainty. Karen should approve the order since NPV > 0.
$29,267.01 - $19,500 = $9,767.01
b.
)
The uncertainty case.
Payment
Timing
< 45 days
45-60 days
60-90 days
Probabilit
y
0.50
0.30
0.15
> 90 days
0.05
1.00
Collection agency
charge
Collection agency
collects
Addditional time agency takes
After 45 and before 90 additional
cost
of
invoice
of
65%
invoice
30 days
30%
$125 every 15 days
The impact here is that the firm will spend the variable costs associated with the sale upfront, but
will only receive the expected value of the invoice over time. So we need to find the expected
present value of the invoice.
Expecte
d
Additional
Collect-
Payment
Collect-
Payment
ion
Prob-
ion Costs
Date
Period
ability
(> $300)
(1)
(2)
(3)
(4)
< 45
22.5
0.50
$0
45-60
52.5
0.30
$125
60-90
75
0.15
$250
> 90
120
*
0.05
$9,250
**
Net
Collect
ion
Flow
=S(EXP*S)
-(4)
(5)
$29,70
0
$29,57
5
$29,45
0
$9,950
***
*Note: 22.5 is 1/2 of 45, 52.5 is 1/2 of the 45-60 day range, 75 is 1/2 of the 60-90 day range, and the
120 is the best point estimate for the over 90 day range.
**Note: There are no collection costs for payment in 45 days or less; for 52.5 days, however, the
additional collection costs (beyond the 1% * $30,000) are $125; for 75 days the additional collection
costs (beyond the $300) double to $250; after 90 days, the additional collection costs cumulate to
the $250 plus the 30% of the referred amount of $30,000 (= $9,000) for a total of $9,250 in
additional charges beyond the original $300 !
***Note: the $9,950 = 0.65 * $30,000 (the percent of the referred amount collected by the agency =
$19,500) less the agency's charge of 30% (=$9,000 !), less the $250 accrued additional collection
costs, less the 1% EXP * S of $300.
Net
NPV of
Collection Flow
PV
Credit
Sale
Expecte
d
Present
Value
= S - (EXP*S) (4)
Factor
=(5) * (6) - S * VCR
= (7) * (3)
(8)
$4,991
$2,872
$1,386
($496.38
)
(5)
$29,700
$29,575
$29,450
(6)
0.9927
0.9830
0.9759
(7)
$9,982
$9,573
$9,241
$9,950
0.9620
($9,928)
Total NPV =
$8,753
While not as large as the NPV for the certainty case
$9,767 , the NPV of
$8,752.73
from the credit sale from the risk analysis is positive, and so credit should
be extended.
3
.
Collection float including invoicing float and the cash consequences.
Order & Invoice Preparation:
Order Entry and Shipping
Invoice Preparation & Sending ("Invoicing Float")
Credit
Period:
Credit Terms
Added Delay (customers payables)
Payment Preparation
Payment Collection & Application:
Mail, Processing, Availability Delays
Cash Application
5
3
30
2
1
6
0
Total Delay from Purchase Communication
to Cash Application:
a.
)
Calculate the total delay from purchase communication to cash application.
Total delay = 5 + 3 + 30 + 2 + 1 + 6 + 0 =
b.
)
47
=====
days
What part of the total delay represents cash tied up from the seller's
perspective?
100%
47
days
b.
)
Why should the seller be concerned about the order and invoice preparation delays?
Because, as we saw in part b, order and invoice preparation delays slow incoming
cash from sales. It is also directly controllable by the seller.
c.) What fraction of the total delay in your answer to (a) is made up of the credit terms?
Based on your answer, comment on the importance of managing all parts of the cash
flow timeline.
Credit Terms =
Total Delay =
30
47
days
days
Therefore,
64%
of the total delay is made up of credit terms.
This leaves
36%
of the delay to be managed, some of which is
directly under the control of the
seller.