George Stamper, a credit analyst with Micro-Encapsulators Corp. (MEC), needed to respond to an urgent e-mail request from the southeast sales office. The local sales manager reported that she had an opportunity to clinch an order from Miami Spice (MS) for 50 encapsulators at $10,000 each. She added that she was particularly keen to secure this order since MS was likely to have a continuing need for 50 encapsulators a year and could therefore prove a very valuable customer. However, orders of this size to a new customer generally required head office agreement, and it was therefore George's responsibility to make a rapid assessment of MS's creditworthiness and to approve or disapprove the sale.

Mr. Stamper knew that MS was a medium-sized company with a patchy earnings record. After growing rapidly in the 1980s, MS had encountered strong competition in its principal markets and earnings had fallen sharply. Mr. Stamper was not sure exactly to what extent this was a bad omen. New management had been brought in to cut costs, and there were some indications that the worst was over for the company. Investors appeared to agree with this assessment, for the stock price had risen to $5.80 from its low of $4.25 the previous year. Mr. Stamper had in front of him MS's latest financial statements, which are summarized in Table 20.4. He rapidly calculated a few key financial ratios and the company's Z score.

Mr. Stamper also made a number of other checks on MS. The company had a small issue of bonds outstanding, which were rated B by Moody's. Inquiries through MEC's bank indicated that MS had unused lines of credit totaling $5 million but had entered into discussions with its bank for a renewal of a $15 million bank loan that was due to be repaid at the end of the year. Telephone calls to MS's other suppliers suggested that the company had recently been 30 days late in paying its bills.

Mr. Stamper also needed to take into account the profit that the company could make on MS's order. Encapsulators were sold on standard terms of 2/30, net 60. So if MS paid promptly, MEC would receive additional revenues of 50 3 $9,800 5 $490,000. However, given MS's cash position, it was more than likely that it would forgo the cash discount and would not pay until sometime after the 60 days. Since interest rates were about 8%, any such delays in payment could reduce the present value to MEC of the revenues. Mr. Stamper also recognized that there were production and transportation costs in filling MS's order. These worked out at $475,000, or $9,500 a unit. Corporate profits were taxed at 35%.

1. What can you say about Miami Spice's creditworthiness?

2. What is the break-even probability of default? How is it affected by the delay before MS pays its bills?

3. How should George Stamper's decision be affected by the possibility of repeat orders?