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Financing foreign operations - credit risk

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Texas Computers (TC) recently has begun selling overseas. It currently has thirty foreign orders outstanding, with the typical order averaging \$2,500. TC is considering the following three alternatives to protect itself against credit risk on these foreign sales:

Request a letter of credit from each customer. The cost to the customer would be \$75 plus 0.25 percent of the invoice amount. To remain competitive, TC would have to absorb the cost of the letter of credit.

Factor the receivables. The factor would charge a nonrecourse fee of 1.6 percent.
Buy foreign credit insurance. The insurer would charge a 1 percent insurance premium.

a. Which of these alternatives would you recommend to Texas Computers? Why?

b. Suppose that TC's average order size rose to \$250,000. How would that affect
your decision?

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Solution Preview

Let us compare the costs of the three alternatives

1. Order size 2500

Letter of Credit Factor Insurance
Cost 0.25%+75 ...

Solution Summary

The solution explains how to decide between a letter of credit or factoring receivables or buying foreign credit insurance

\$2.49