Final answer:
A company extends credit expecting the increase in sales revenue will outweigh the cost of extending credit, considering the principles of financial capital and the demand and supply in financial markets. By offering credit, firms aim to boost sales and customer base, which should compensate for the risks and costs associated with credit extension.
Step-by-step explanation:
A company typically extends credit to customers because it expects the rise in sales revenue to be greater than the rise in the cost of extending credit. The assumption is that by offering credit, the company can increase its customer base or the amount of sales to existing customers, leading to a higher overall sales revenue. This strategy can be advantageous for the company as long as the additional costs associated with extending credit, such as potential bad debts expense and administrative costs, are less than the additional revenue generated.
Firms need to raise financial capital to fund their growth and operations. Such capital can be raised through various means, including borrowing from banks or issuing bonds. Companies make strategic choices about which type of financial capital to use based on their expected ability to generate future profits and repay these financial obligations.
Understanding the concepts of demand and supply in financial markets is crucial. Higher interest rates typically lead to reduced borrowing, as the cost to the borrower increases. Conversely, when interest rates are low, both individuals and businesses are more inclined to borrow, leading to an increase in the quantity demanded of financial capital. This is because consumers, including college students, and businesses are more confident about their ability to repay loans in the future when the interest is lower.