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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