From: Finance Manager

To: Credit Control Manager, V plc.
Date: 15 May 2019
Subject: Order from New Customer

As required, I have looked into the above subject matter. After analyzing the financial implications, I have identified three possible outcomes for the transaction with the new customer. Below are the details of each scenario:

Possible Outcomes:

1. Outcome (i): If all things go as expected, we will receive the balance due from the customer (probability: 60%).
2. Outcome (ii): We have to pay a ₦500,000 collection fee, but the balance is eventually received (probability: 20%).
3. Outcome (iii): We pay the ₦500,000, but the balance is not forthcoming (probability: 20%).

The expected value being positive, the order is financially viable

(b)

1. Risk Aversion and Negative Outcome Size:
   Although the expected value is positive, we must recognize that there are only three possible outcomes: one positive (₦4,640,000), another positive (₦4,210,000), and one substantial negative (₦15,186,000). Depending on the company’s risk tolerance and aversion to large negative outcomes, the size of the potential loss may influence the decision to proceed with the order. If we are highly risk-averse, this large potential loss may dissuade us from accepting the order.
2. Cost of Insuring Against Default:
   Another consideration is the possibility of insuring against default. While insurance against customer default can provide peace of mind, it would come at an additional cost, which could further affect the overall financial viability of the order. This cost should be factored into the decision-making process.
3. Alternative Payment Methods:
   We could explore other payment options, such as bills of exchange or different terms, like offering a discount for early payment. These alternatives could help reduce the likelihood of late payments or defaults, and may be attractive to the customer, enhancing the chances of prompt payment.
4. Potential for Repeat Business:
   There is the potential for securing further orders or gaining a recommendation if we accept this order and deliver as expected. A successful transaction could lead to repeat business or positive referrals, which would add long-term value to the company, even if there are some risks involved in the short term.
5. Possibility of Recovering Some Balance Later:
   In the event that the customer defaults and the debt is written off, there may still be a chance to recover some of the outstanding balance later, particularly if the buyer goes into insolvency. It would be important to assess the likelihood of this recovery and factor it into the overall risk assessment.
6. Opportunity Cost:
   If the order is not accepted, there may be opportunity costs, such as potential penalties or layoffs due to a lack of orders. If this customer order is significant for our business operations and can sustain employment levels, declining the order could have broader implications beyond just the financial figures.
7. Risk Premium in the Opportunity Cost of Capital:
   Finally, we should consider whether the 16% opportunity cost of capital already includes a component to reflect uncertainty or risk aversion. If it does, this factor might mitigate the need to worry too much about the potential negative outcome, as the expected return is already adjusted for the perceived risks.

Please let me know if you would like me to elaborate on any of these points or take any particular aspect further for a more detailed analysis. I look forward to your feedback on the matter.

Signed:
Finance Manager
V Plc.