bre44380_ch30_787-812.indd 812 10/06/15 10:57 AM
812 Part Nine Financial Planning and Working Capital Management
By refusing credit to firms with a low credit score (less than 80), Galenic calculates that it
would reduce its bad debt ratio to 60/9,160, or just under .7%. While this may not seem like a
big deal, Galenic’s credit manager reasons that this is equivalent to a decrease of one-third in
the bad debt ratio and would result in a significant improvement in the profit margin.
a. What is Galenic’s current profit margin, allowing for bad debts?
b. Assuming that the firm’s estimates of default rates are right, how would the new credit
scoring system affect profits?
c. Why might you suspect that Galenic’s estimates of default rates will not be realized in
practice? What are the likely consequences of overestimating the accuracy of such a credit
scoring scheme?
d. Suppose that one of the variables in the proposed scoring system is whether the customer
has an existing account with Galenic (new customers are more likely to default). How
would this affect your assessment of the proposal?- The three main credit bureaus maintain useful websites with examples of their business and
consumer reports. Log on to http://www.equifax.com and look at the sample report on a small
business. What information do you think would be most useful if you were considering grant-
ing credit to the firm? - Log on to the Federal Reserve site at http://www.federalreserve.gov and look up current money-
market interest rates. Suppose your business has $7 million set aside for an expenditure in
three months. How would you choose to invest it in the meantime? Would your decision be
different if there were some chance that you might need the money earlier?
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