5. Credit Scoring (20 pts.) A lender provides seed financing to help local entre

Question

5. Credit Scoring (20 pts.) A lender provides seed financing to help local entrepreneurs. Loan decisions are based on 3 measures - repayment ability, business experience, and character - using a credit score system. Repayment Ability: Annual Income Experience: Years of business experience or >75,000 60,000-75,000 2 45,000-59,9993 30,000-44,999 4 15,000-29,999 5 3-4 less than 1 4 15,000 Character (subjective based on interview) Excellent Average Poor Credit Score Calculation: Score 0.3*(Repayment Score) +0.4* (Experience Score) + 0.3*(Character Score) Loan Decision: 1. Score must be less than 3 2. Interest rate is: r= 5% + Score (example: if score was 2.5, then r-5 + 2.5-7.5%) 3. Annual loan payments must be less than 15% of annual income Note: All standards/hurdles above must be met for a loan to be approve For each of the three applicants in the table below, determine if their loan application would be d. accepted. If the loan application is rejected, briefly describe why. Applicant Information: John Doe S48,000 6 months Excellent S25,000 5 years Jane Smith S39,000 3 years Average S25,000 5 years Applicant Name Income Experience ears Character Cate Loan Amount Requested Loan Term Requested

Explanation / Answer

For John Doe

Score allotted

Weight

Repayment

3

0.3

Experience

4

0.4

Character

1

0.3

Score = sum of weight x score allotted

           = 3 x .30 + 4 x.40 + 1 x 0.30

           = 2.80

Interest rate = 5%+ score

                        = 5% + 2.8%

                        = 7.80%

Loan payment = Loan amount x R/ (1-(1+R)^-n)

                            = $25,000 x 0.078 / (1- (1+0.078)^-5)

                            = 1950 / 0.3130799

                            = $6228.44

Loan payment / Income = $6228.44 / 48000

                                                = 12.98%

Since Loan payment / Income is less than 15%, the decision is accepted.

For Jane Smith

Score allotted

Weight

Repayment

4

0.3

Experience

2

0.4

Character

3

0.3

Score = sum of weight x score allotted

           = 4 x .30 + 2 x.40 + 3 x 0.30

           = 2.90

Interest rate = 5%+ score

                        = 5% + 2.9%

                        = 7.90%

Loan payment = Loan amount x R/ (1-(1+R)^-n)

                            = $25,000 x 0.079 / (1- (1+0.079)^-5)

                            = 1975 / 0.316257

                          = $6244.92

Loan payment / Income = $6244.92 / 39000

                                                = 16.01%

Since Loan payment / Income is greater than 16.01%, the decision is rejected.

Score allotted

Weight

Repayment

3

0.3

Experience

4

0.4

Character

1

0.3

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