Decision tree project, Risk Management

Assignment Help:

You work for a company that sells expensive equipment to other companies. The marketing director has closed on a substantial sale (for your company) but the customer has requested that the sale be done on a credit basis instead of being paid in full on delivery. In order to evaluate this request, you make the following assumptions:

  • If we deny the credit request, there is a 20% chance the customer will buy the machine with cash anyway.
  • If we grant the credit request, there is a 70% chance that the customer will be a good credit risk.
  • If we grant credit and the customer is a good credit risk, then the bill will be paid in full.

The issue that requires some analysis comes if we grant the credit request and the customer turns out to be a bad credit risk. In this case, your company has two options. First, we could continue to send the customer a bill and hope eventually to be paid. Under this option, we would receive all of the money with a probability of 10%, we would get only half the money with a probability of 20%, and we would get nothing with a probability of 70%. The second option would be to more actively pursue the collection of the amount owed. To take the necessary actions would cost the company about 20% of the amount the customer owes, regardless of what amount is eventually collected, as a payment to the company pursuing the collection. As before, the customer might pay all, half or nothing. The probabilities of these three outcomes are 30%, 50% and 20%, respectively. The machine the customer is considering sells for $80,000 and costs us $45,000 to make. Note that this means that the collection cost of the second option would be $20,000.

1.) Create a decision tree representation for this problem in Excel. What are the decision nodes, what are the chance nodes.

2.) What is the expected value of this customer order? What decisions lead to this value?

3.) Suppose that the probability that the customer will buy without being offered credit changes. Create a data table to show what decisions should be made for different probabilities.

4.) Suppose that the cost of the credit collection process changes. Create a data table to show what decisions should be made for different costs.

5.) Consider the first option for collections. Suppose that the probability for the customer paying in full ranges from 0% to 40%, and that the probability that they pay half ranges from 0% to 50%. Create a two-way data table and determine the value of the potential sale under the various possible conditions.

Part Two

In order to make a more informed decision, you decide to collect some sample information by talking to local CPA that knows a little about your potential customer. They can tell you that they think the customer is "strong" or "weak." They also tell you that out of the companies that were good risks, they rated 75% of them as strong. Of the companies that were bad risks, they rated only 15% as strong.

Assume that the collection probabilities of the two options are not affected by the sample information about the customer.

1.) Calculate the probability that the CPA will rate the customer strong. The probability of a weak rating.

2.) If the CPA gives you a strong rating, what are the probabilities about whether the customer is a good or bad credit risk. What are the probabilities if the CPA rates the customer as weak.

3.) Create a decision tree that incorporates the sample information. What are the best decisions to make? What is the expected value of the potential customer.

4.) What would you be willing to pay the CPA for the information about the customer?


Related Discussions:- Decision tree project

Discretionary access control and mandatory access control, Question: (a...

Question: (a) (i) Explain what is meant by Discretionary Access Control and Mandatory Access Control. (ii) What is the difference between the two types of access contro

Explain the equilibrium rate of return, Portfolio theory tries to the expla...

Portfolio theory tries to the explain the equilibrium rate of return or the price fixation in capital market through the two important relationship these include: 1) capital mar

Risks associated with cyclone and storm activity, Part A Glenda has ta...

Part A Glenda has taken a household insurance on her classic Queenslander home in North Queensland.  At the time of application, the insurer "URINSURED" asked numerous questio

Informal sector, explain importance of informal sector in economy

explain importance of informal sector in economy

Explain basic organisational structures, Question : (a) Every company h...

Question : (a) Every company has its own idea about how to organise itself and its work. Different companies doing the same work may have different organisation structures and

Differentiate between speculation and arbitraging, Question: a) Using i...

Question: a) Using illustrative and numerical example, differentiate between speculation and arbitraging in the context of foreign exchange market. b) One year borrowing and

Differentiate between interest and currency swaps, a) Differentiate betwee...

a) Differentiate between interest and currency swaps. b) Suppose a Swiss firm, ACER Com Ltd, wants to invest in the U.S. The Swiss firm needs US dollars with a term to maturit

Forward-forward and forward spot swaps in managing risks, Question: You...

Question: You have been appointed as the treasurer of Manchester International, an electronic firm with many subsidiaries abroad. The management of Manchester International is

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd