Book Title
Fundamentals of Corporate Finance Standard Edition 9th Edition

978-0073382395 Chapter 20 Concepts Review and Critical Thinking Questions

April 3, 2019
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
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
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 operating
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 downturn is
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
6. a. B: A is likely to sell for cash only, unless the product really works. If it does, then they might
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,
d. B: Since A’s merchandise is perishable and B’s is not, B will probably have a longer credit
CHAPTER 20 B-331
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
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
9. Carrying costs should be equal to order costs. Since the carrying costs are low relative to the order costs,
the firm should increase the inventory level.
10. Since the price of components can decline quickly, Dell does not have inventory which is purchased and
then declines quickly in value before it is sold. If this happens, the inventory may be sold at a loss.
Solutions to Questions and Problems
NOTE: All end of chapter problems were solved using a spreadsheet. Many problems require multiple steps.
Due to space and readability constraints, when these intermediate steps are included in this solutions
manual, rounding may appear to have occurred. However, the final answer for each problem is found
without rounding during any step in the problem.
1. a. There are 30 days until account is overdue. If you take the full period, you must remit:
Remittance = 400($125)
Remittance = $50,000
b. There is a 1 percent discount offered, with a 10 day discount period. If you take the discount, you
will only have to remit:
Remittance = (1 – .01)($50,000)
Remittance = $49,500
c. The implicit interest is the difference between the two remittance amounts, or:
Implicit interest = $50,000 – 49,500
Implicit interest = $500