chapter21 - CHAPTER 21 CREDIT AND INVENTORY MANAGEMENT...

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CHAPTER 21 CREDIT AND INVENTORY MANAGEMENT Answers to Concepts Review and Critical Thinking Questions 1. a. A sight draft is a commercial draft that is payable immediately. b. A time draft is a commercial draft that does not require immediate payment. c. A bankers acceptance is when a bank guarantees the future payment of a commercial draft. d. A promissory note is an IOU that the customer signs. e. A trade acceptance is when the buyer accepts the commercial draft and promises to pay it in the future. 2. Trade credit is usually granted on open account. The invoice is the credit instrument. 3. Credit costs: cost of debt, probability of default, and the cash discount No-credit costs: lost sales The sum of these are the carrying costs. 4. 1. Character: determines if a customer is willing to pay his or her debts. 2. Capacity: determines if a customer is able to pay debts out of operating cash flow. 3. Capital: determines the customer’s financial reserves in case problems occur with opera- ting cash flow. 4. Collateral: assets that can be liquidated to pay off the loan in case of default. 5. Conditions: customer’s ability to weather an economic downturn and whether such a down- turn is likely. 5. 1. Perishability and collateral value 2. Consumer demand 3. Cost, profitability, and standardization 4. Credit risk 5. The size of the account 6. Competition 7. Customer type If the credit period exceeds a customer’s operating cycle, then the firm is financing the receivables and other aspects of the customer’s business that go beyond the purchase of the selling firm’s merchandise. 6. a. B: A is likely to sell for cash only, unless the product really works. If it does, then they might grant longer credit periods to entice buyers. b. A: Landlords have significantly greater collateral, and that collateral is not mobile. c. A: Since A’s customers turn over inventory less frequently, they have a longer inventory period, and thus, will most likely have a longer credit period as well. d. B: Since A’s merchandise is perishable and B’s is not, B will probably have a longer credit period.
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CHAPTER 21 B-337 e. A: Rugs are fairly standardized and they are transportable, while carpets are custom fit and are not particularly transportable. 7. The three main categories of inventory are: raw material (initial inputs to the firm’s production process), work-in-progress (partially completed products), and finished goods (products ready for sale). From the firm’s perspective, the demand for finished goods is independent from the demand for the other types of inventory. The demand for raw material and work-in-progress is derived from, or dependent on, the firm’s needs for these inventory types in order to achieve the desired levels of finished goods. 8. JIT systems reduce inventory amounts. Assuming no adverse effects on sales, inventory turnover will increase. Since assets will decrease, total asset turnover will also increase. Recalling the DuPont equation, an increase in total asset turnover, all else being equal, has a positive effect on ROE.
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