| Abstract: | This paper analyzes the dealership credit limit problem in terms of the valuation of a Markov process of cash flows with sequential credit decisions over an infinite planning horizon. The formulation distinguishes between the upper bound on credit applicable at the account formation stage and the upper bound applicable to periodic reorders. The result is a closed form solution to the problem which serves as a criterion function for approving or denying credit on a customer-by-customer basis. Data for a sample of manufacturing firms are employed to estimate typical ranges for criterion function parameters. Upper bounds on credit limits are then calculated and graphically presented for median parameter values as well as for values at the 5th and 95th percentiles for the sample data. Finally, an empirical study is conducted of actual trade credit extended by firms. The results support the hypothesis that the variables in the decision model are important determinants of the amount of trade credit outstanding. |
