© 2012 McGraw-Hill Ryerson LimitedChapter 22 -1  Setting a Credit Policy ◦ Credit policy: Standards set to determine the amount and nature of credit to.

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© 2012 McGraw-Hill Ryerson LimitedChapter  Setting a Credit Policy ◦ Credit policy: Standards set to determine the amount and nature of credit to extend to customers  The decision to offer credit depends on the probability of payment  Grant credit if the expected profit from doing so is greater than the profit from refusing LO5

© 2012 McGraw-Hill Ryerson LimitedChapter If credit is refused, there is no profit or loss. If credit is offered, there is a probability (p) that the customer will pay and seller will make (Rev – cost). This also means that there is a probability (1 – p) that the customer will default and the loss will be the cost: LO5

© 2012 McGraw-Hill Ryerson LimitedChapter  The expected profit from the two sources of action are as follows:  The firm should grant credit if the expected profit from doing so is positive Refuse Credit: 0 Grant Credit: p x PV(Rev – Cost) – (1-p) x PV(Cost) LO5

© 2012 McGraw-Hill Ryerson LimitedChapter  Some general principles ◦ Maximize profit ◦ Concentrate on the dangerous accounts ◦ Look beyond the immediate order LO5