Question

Read each question carefully, make sure to answer all questions are answered and show your work:

5. Nast stores has derived the following consumer credit-scoring model after years of data collect Y=(0.20 x Employment) + (0.4 x Homeowner) + (0.3 x Cards)

Employment = 1 if employed part-time, and 0 if unemployed Cards= 1 if presently has 1-5 credit cards, 0 otherwise

Nast determines that a score of at least 0.70 indicates a very good credit risk, and it extends credit to these individuals. (each letter below is a separate question, answer a-d)

a. If Janice is employed part-time, is a homeowner, and has six credit cards at present, does the model indicate she should receive credit?

b. Janice just got a full-time job and closed two of her credit card accounts. Should she receive credit? Has her credit worthiness increased or decreased, according to model?

c. Your boss mentions that he just returned from a trade-association conference, at which one of the speakers recommended that length of time at present residence (regardless of homeownership status) be include in credit-scoring models. If the weight turns out to be 0.25, how do you think the variable would be coded (i.e., 0 stands for what, 1 stands for what, etc)?

d. Suggest other variables that associated might have left out of the model, and tell how you would code them (i.e., 0,1,2 are assigned to what conditions or variables?).

6. Firm X is evaluating a proposal to extend credit to a group of new customers. The new customers will generate an average of $30,000 per day in new sales. On average, they will pay in 60 days. The variable cost ratio (i.e., COGS) is 98% of sales, collection expenses are 1% of sales, and the discount rate is 5%. Assume that the variable costs occur upfront, while the collection costs occur on the date in which the customer’s payment is received. What is the NPV of one day's sales if Firm J grants credit? Assume that there is no bad debt loss.

A. $57.88 B. $1,043.56 C. -$239.67 D. -$319.57

Answer 1

5.

a) Janice credit score according to the model is

Y=(0.20 x Employment) + (0.4 x Homeowner) + (0.3 x Cards)

Janice is employed part-time, so employment score is 1

Janice is a homeowner, so homeownership status is 1

and has six credit cards so Cards score is 0

Y=(0.20 x 1) + (0.4 x 1) + (0.3 x 0) = 0.60

Since the score is less than 0.7, Janice shall not receive the Credit

b) Janice just got a full-time job and closed two of her credit card accounts

Fulltime job and part time job score is same but closing her credit cards below 5 has an impact

Y=(0.20 x 1) + (0.4 x 1) + (0.3 x 1) = 0.90

Janice creditworthiness improves and eligible for Credit now

c) Homesownership status can be reviewed in terms of mortgage status

0 stands for not owning home

, 1 stands for owning home with debt

2 stands for owning debt free home

d) Other variables that could be included includes

- Age of the individual to determine the number of years of employment available ( Above 60 years should be "0", below 60 shall be "1")

- Percentage of credit limit utilised in the credit card ( More than 90% of credit limit utilised shall be "0" and less than that shall be "1")

6. NPV of one day's sales

Given information

Average Sales per day = $30,000

COGS ( 98% of Sales) = $29,400

Collection cost (1% of Sales) = $ 300

Discount Rate = 5%

Credit period = 60 days

Solution

The Sales shall be realised after 60 days and the collection cost shall also be incurred after 60 days.

Lets find out the Present value of Sales Collection and the Collection Cost

In order to find the present value

First step - Find out the periodic rate, that shall be applied to calculate the present value

Periodic rate =

no of months refers to credit period

credit period is 2 months

Thus periodic rate = ((1+0.05)2/12)-1 = (((1+0.05)^0.166)-1

=0.81%

Second Step - Find out the present value of Sales

Sales value per day - $30,000

Present value of Sales to be collected after 60 days = 30000/(1+0.0081)= $29759

Third Step - Find out the Collection cost

Collection cost = 1% of Sales = $300

Present value of Collection cost to be incurred after 60 days = 300/(1+0.0081)= $297.59

Fourth Step - NPV of one day's sales

NPV of One Day's Sales = Present Value of Sales - (COGS + Collection Cost)

= 29759 - ( 29400 + 297.59)

NPV of One Day's Sales = $ 61.41

The Closest match is $57.88, so we shall select OPTION A