06
06
06
1. The faster a firm's growth in sales, the more likely it is that an increasing percentage of financing will be
internally generated.
True False
2. Supply chain management has little impact on financial performance and is primarily a marketing and
management concept.
True False
3. Many companies such as McDonalds have embraced supply chain management using web-based
procedures.
True False
True False
5. The financial manager generally needs to devote little time to management of working capital.
True False
6. Liquidating current assets are really fixed assets since they have lives greater than one year.
True False
7. The key to current asset planning is the ability of management to forecast sales accurately and then match
production schedules with the sales forecast.
True False
8. One of the big benefits of implementing supply chain management, is a reduction in inventory on hand.
True False
9. Permanent current assets are not similar to fixed assets because they are fully liquidated within the year.
True False
1
10. Wal-Mart requires manufacturers to ship goods with RFID tags so that it can better track inventory and
reduce the need for supply chain management.
True False
11. When using level production, inventory will peak in the month where unit sales trend above the production
level.
True False
12. Cash, accounts receivables, and inventory all move monthly in the same direction under level production.
True False
13. Level production methods smooth production schedules and utilize manpower and equipment more
efficiently than seasonal production methods.
True False
14. The use of point-of-sale terminals has made it easier for many retail store managers to manage their
inventory.
True False
15. The cash budget combines the cash receipts and cash payments schedules in determining cash flow.
True False
16. Ideally, permanent current assets should be financed with short-term borrowings.
True False
17. As a general rule, it is desirable to finance the permanent assets, including "permanent current assets", with
long-term debt and equity.
True False
18. Increased use of long-term financing is generally a more conservative approach to current asset financing.
True False
2
19. A risky financial plan will use long-term financing for fixed assets, permanent current assets, and a portion
of temporary current assets.
True False
20. Short-term financing is risky because of the possibility of rising short-term rates and the inability of always
being able to refund short-term debt.
True False
21. Short-term interest rates are generally lower than long-term interest rates.
True False
22. By using long-term capital to cover short-term needs, the firm is virtually assured of becoming technically
insolvent.
True False
23. Heavy use of long-term financing generally leads to lower financing costs.
True False
24. During an economic "boom" period, a shortage of low-cost financing alternatives exists.
True False
25. The "term structure of interest rates" refers to the relationship between yields on debt and their maturities.
True False
26. The "term structure of interest rates" depicts the competitive cost of funds for the various short-term
sources of funds such as Treasury bills, commercial paper, and bank CDs.
True False
27. The "term structure of interest rates" is a schedule that tells when a company's bonds mature and shows
how many dollars a firm must pay in interest payments.
True False
28. Yield curves change very little in the short run (3 months).
True False
3
29. If the liquidity premium theory was the only correct theory, yield curves would always be upward-sloping.
True False
30. The ratio of long-term financing to short-term financing at any given time will be greatly influenced by the
term structure of interest rates.
True False
31. It is not necessary to understand interest rate movements when deciding the structure of short-term debt
relative to long-term debt.
True False
32. The behavior of various kinds of financial institutions determines the shape of the yield curve, according to
the market segmentation theory.
True False
33. Only the market segmentation theory has any significant impact on interest rates.
True False
34. According to the expectations hypothesis, when long-term interest rates are higher than short-term interest
rates, long-term rates are expected to decline.
True False
35. According to the expectations hypothesis, when long-term interest rates are higher than short-term interest
rates, short-term rates are expected to rise.
True False
36. Short-term interest rates have historically been more volatile than long-term rates.
True False
37. The successful financial manager is very interested in the term structure of interest rates but is not
concerned with the relative volatility or historical level of interest rates.
True False
4
38. Short-term interest rates are more dependent upon inflation than on current demand for money.
True False
True False
40. During tight money periods, short-term financing may be difficult to find.
True False
41. The expected value is the sum of the probabilities of all expected events.
True False
42. Expected value techniques allow consideration of more than one possible outcome.
True False
43. In periods of tight money, long-term rates are often higher than short-term rates.
True False
44. If we examine the ratio of working capital to sales, we can see that for the last several decades, firms'
liquidity has been increasing.
True False
45. Heavy risk exposure due to short-term borrowing can be compensated for by carrying illiquid assets.
True False
46. Heavy use of long-term financing can generate more profit for the company during a tight money period.
True False
47. Use of long-term financing and the carrying of highly liquid assets is a high-risk combination.
True False
48. Firms with predictable cash-flow patterns should assume relatively low levels of risk.
True False
5
49. Firms with highly volatile and perishable inventory should assume relatively low levels of risk.
True False
50. The more short-term financing relative to long-term financing, the more risky the financial structure.
True False
True False
True False
53. The aggressive financing plan involves utilizing long-term financing for permanent and temporary current
assets.
True False
54. Expected value analysis requires taking the difference between the actual projected outcome and the
historic outcome times its' probability and summing these totals.
True False
55. Long-term financing is usually less expensive than short-term financing because it is not as advantageous
to the corporation as short-term financing.
True False
56. The three most important factors when selecting a financing plan are risk, asset liquidity, and timing.
True False
57. Generally a downward sloping yield curve indicates an eminent economic boom.
True False
6
58. Pressure to increase current asset buildup often results from
59. Working capital management is primarily concerned with the management and financing of
A. Long-range planning.
B. Capital budgeting.
C. Short-term financing.
D. Working capital management.
A. the working capital associated with a product will be liquidated within a one year period.
B. all the product will be sold, receivables collected and bills paid over the time period specified.
C. assets associated with the production of a product will be liquidated over the depreciable life of the
assets.
D. self-liquidating assets be financed by long-term sources of capital.
7
63. Well implemented web-based supply chain management has all of the following benefits except
64. Permanent current assets are not a factor in a manager's decision making process when all current assets
will be
A. track livestock.
B. track marathon runner's time.
C. track inventory at retailers.
D. all of these.
66. Frisch Fish Corp expects net income next year to be $750,000. Inventory and accounts receivable will have
to be increased by $650,000 to accommodate this sales level. Frisch will pay dividends of $300,000. How
much external financing will Frisch Fish need assuming no organically generated increase in liabilities?
8
67. Tinbergen Cans expects sales next year to be $50,000,000. Inventory and accounts receivable (combined)
will increase $8,000,000 to accommodate this sales level. The company has a profit margin of 6 percent
and a 30 percent dividend payout. How much external financing will the firm have to seek? Assume there
is no increase in liabilities other than that which will occur with the external financing.
68. Samuelson will produce 20,000 units in January using level production. If each unit costs $500 to
manufacture, what is the dollar value of ending inventory in January if beginning inventory is 10,000 units
and January sales are 15,000?.
9
71. If a firm uses level production with seasonal sales
72. Retail companies like Target and The Limited exhibit sales patterns that are mostly influenced by
73. Retail companies like Target and Limited Brands are more likely to have
A. helps the firm plan its current asset levels for a given production plan.
B. makes managing inventory easier under seasonal production.
C. illustrates fluctuating levels of current assets for a given production plan.
D. all of these are correct.
75. Assuming level production throughout the year, and assuming receivables are collected in two equal
installments over the two months subsequent to the sales period, developing the cash budget requires the
following steps:
10
76. When actual sales are greater than forecasted sales
A. long-term funds.
B. short-term funds.
C. borrowed funds.
D. internally generated funds.
78. Ideally, which of the following type of assets should be financed with long-term financing?
A. use long-term financing for all fixed assets and short-term financing for all other assets.
B. finance a portion of permanent assets and short-term assets with short-term debt.
C. use equity to finance fixed assets, long-term debt to finance permanent assets, and short-term debt to
finance fluctuating current assets.
D. use long-term financing for permanent current assets and fixed assets and a portion of the short-term
fluctuating assets and use short-term financing for all other short-term assets.
A. short-term interest rates are generally lower than long-term interest rates.
B. most firms do not have Basic access to the capital markets.
C. short-term financing is usually more predictable than long-term financing.
D. a and b above.
11
81. The term structure of interest rates
A. changes daily to reflect current competitive conditions in the money and capital markets.
B. plots returns for securities of different risk.
C. shows the relative interest spread between bonds with different risk ratings such as AAA, AA, A, BBB,
etc.
D. depicts interest rates for T-bills over the last year.
A. inflation.
B. money supply.
C. Federal Reserve activities.
D. all of these are true
12
86. The belief that investors require a higher return to entice them into holding long-term securities is the
viewpoint of the
89. U.S. government securities are used to construct yield curves because
90. As the economy moves through a business cycle, which of the following term structure of interest rate
theories dominate the shape of the yield curve.
13
91. Some analysts believe that the term structure of interest rates is determined by the behavior of various types
of financial institutions. This theory is called the
A. expectations hypothesis.
B. market segmentation theory.
C. liquidity premium theory.
D. theory of industry supply and demand for bonds.
92. The theory of the term structure of interest rates which suggests that long-term rates are determined by the
average of short-term rates expected over the time that a long-term bond is outstanding is the
A. expectations hypothesis.
B. segmentation theory.
C. liquidity premium theory.
D. market average rate theory.
94. A firm will usually increase the ratio of short-term debt to long-term debt when
95. Which of the following yield curves would be characteristic during a period of high economic growth?
A. Upward sloping
B. Downward sloping
C. Horizontal
D. Humped
14
96. An inverted yield curve would suggest that
97. When the term structure of interest rates is downward sloping and interest rates are expected to decline, the
99. Which of the following techniques allows explicit consideration of more than one possible outcome?
A. Operating leverage
B. Present value
C. Least-squares regression
D. Expected value
100. Under normal conditions (60% probability), Financing Plan A will produce $30,000 higher return than Plan
B. Under tight money conditions (40% probability), Plan A will produce $40,000 less than Plan B. What is
the expected value of returns?
A. $2800
B. $4,000
C. $4800
D. $2,000
15
101. Under normal conditions (70% probability), Plan A will produce $20,000 higher return than Plan B. Under
tight money conditions (30% probability), Plan A will produce $100,000 less than Plan B. What is the
expected value of returns?
A. $28,000
B. ($16,000)
C. $58,000
D. ($2,000)
102. Which of the following is a reason for diminishing liquidity in modern corporations?
103. Kuznets Rental Center requires $500,000 in financing over the next two years. Kuznets can borrow long-
term at 8 percent interest per year for two years. Alternatively, Kuznets can borrow short-term and pay 6
percent interest in the first year. Then, Kuznets projects paying 9 percent interest in the second year.
Assuming Kuznets pays off the accrued interest at the end of each year, which of the following statements
is true?
A. Kuznets will definitely end up paying more under the long-term financing plan.
B. Kuznets will definitely end up paying less under the long-term financing plan.
C. Kuznets will probably pay more under the short-term financing plan.
D. Kuznets will probably pay less under the short-term financing plan.
104. Hicks Health Clubs, Inc., expects to generate an annual EBIT of $750,000 and needs to obtain financing for
$1,200,000 of assets. Their tax bracket is 40%. If the firm goes with a short-term financing plan, their rate
will be 7.5 percent, and with a long-term financing plan their rate will be 9 percent. By how much will their
earnings after tax change if they choose the more conservative financing plan instead of the more
aggressive plan?
A. $10,000
B. ($10,800)
C. ($6,000)
D. $6,000
16
105. Hicks Health Clubs, Inc., expects to generate an annual EBIT of $750,000 and needs to obtain financing for
$1,200,000 of assets. Their tax bracket is 40%. If the firm goes with a short-term financing plan, their rate
will be 7.5 percent, and with a long-term financing plan their rate will be 9 percent. By how much will their
earnings after tax change if they choose the more aggressive financing plan instead of the more
conservative?
A. $10,800
B. ($10,000)
C. ($6,000)
D. $6,000
107. Which of the following is not a condition under which a prudent manager would accept some risk in
financing?
108. Risk exposure due to heavy short-term borrowing can be compensated for by
17
109. Which of the following combinations of asset structures and financing patterns is likely to create the least
volatile earnings?
110. Which of the following combinations of asset structures and financing patterns is likely to create the most
volatile earnings?
111. An aggressive working capital policy would have which of following characteristics?
112. The following are the expected 1 year T-bill rates for the next 4 years: 3%, 4%, 5%, and 6%. What would
you expect the rate for 3 year securities would be?
A. 4%
B. 4.5%
C. 6%
D. 3.75%
18
113. Riley Co. is considering a short-term or long-term financing plan for $4,000,000 in assets. They expect the
following 1 year rates over the next 3 years: 6.5%, 7.75%, and 9%. Their long-term interest rate will be
7.5% for the 3 years. Assuming the rates follow their expectations, what will be the difference in interest
costs over the 3 years?
114. Genetech has $4,000,000 in assets, have decided to finance 30% with long-term financing (9% rate) and
70% with short-term financing (7%) rate. What will be their annual interest costs?
A. $78,000
B. $126,000
C. $440,000
D. $304,000
115. When the yield curve is upward sloping, generally a financial manager should:
116. When the yield curve is downward sloping, generally a financial manager should
19
117. Match the following with the items below:
20
118. King, Inc., a successful Midwest firm, is considering opening a branch office on the west coast. Under
normal economic conditions, with a 45% probability of occurring, King can expect to earn a net income of
$70,000 per year. In a mini-recession, at 25% probability, King will earn $20,000. In a severe recession, at
a 20% probability, King will lose $15,000. There is also a slight probability (10%) that King will lose
$300,000 if the expansion fails and the branch office must be closed. Should King open a branch office in
California based on these assumptions?
119. Using the expectations hypothesis for the term structure of interest rates, calculate the expected yields for
securities with maturities of two and three years on the basis of the following data:
21
120. Christensen & Assoc. is developing an asset financing plan. Christensen has $1,000,000 in current assets,
of which 15% are permanent, and $700,000 in fixed assets. The current long-term rate is 9%, and the
current short-term rate is 6.5%. Christensen's tax rate is 30%.
a) Construct two financing plans-one conservative, with 80% of assets financed by long-term sources, and
the other aggressive, with only 60% of assets financed by long-term sources. If Christensen's earnings
before interest and taxes are $525,000, calculate net income under each alternative.
b) What are some of the risks associated with each plan?
c) If the yield curve is steeply inverted, which financing plan should Christensen choose?
121. McKinsee Inc. is developing a plan to finance its asset base. The firm has $3,000,000 in current assets, of
which 20% are permanent, and $10,000,000 in fixed assets. Long-term rates are currently 8%, while short-
term rates are at 6%. McKinsee's tax rate is 30%.
a) Construct a conservative financing plan with 80% of assets financed by long-term sources. If McKinsee's
earnings before interest and taxes are $4,500,000, what will their net income be?
b) An alternative and more aggressive plan would be to finance 60% of total assets with long-term
financing. Assuming that EBIT was again $4,500,000, what will net income be under this alternative?
c) If the yield curve was steeply upward sloping, which plan would you recommend? Why?
22
06 Key
1. The faster a firm's growth in sales, the more likely it is that an increasing percentage of financing will be
internally generated.
FALSE
Block - Chapter 06 #1
Blooms: Understand
Difficulty: Intermediate
Learning Objective: 06-01 Working capital management involves financing and controlling the current assets of the firm.
2. Supply chain management has little impact on financial performance and is primarily a marketing and
management concept.
FALSE
Block - Chapter 06 #2
Blooms: Remember
Difficulty: Basic
Learning Objective: 06-01 Working capital management involves financing and controlling the current assets of the firm.
3. Many companies such as McDonalds have embraced supply chain management using web-based
procedures.
TRUE
Block - Chapter 06 #3
Blooms: Remember
Difficulty: Basic
Learning Objective: 06-01 Working capital management involves financing and controlling the current assets of the firm.
FALSE
Block - Chapter 06 #4
Blooms: Understand
Difficulty: Basic
Learning Objective: 06-01 Working capital management involves financing and controlling the current assets of the firm.
5. The financial manager generally needs to devote little time to management of working capital.
FALSE
Block - Chapter 06 #5
Blooms: Understand
Difficulty: Intermediate
Learning Objective: 06-01 Working capital management involves financing and controlling the current assets of the firm.
23
6. Liquidating current assets are really fixed assets since they have lives greater than one year.
FALSE
Block - Chapter 06 #6
Difficulty: Basic
Learning Objective: 06-02 Management must distinguish between those current assets that are easily converted to cash and those that are more permanent. Blooms:
Understand
7. The key to current asset planning is the ability of management to forecast sales accurately and then
match production schedules with the sales forecast.
TRUE
Block - Chapter 06 #7
Blooms: Understand
Difficulty: Intermediate
Learning Objective: 06-01 Working capital management involves financing and controlling the current assets of the firm.
8. One of the big benefits of implementing supply chain management, is a reduction in inventory on hand.
TRUE
Block - Chapter 06 #8
Blooms: Understand
Difficulty: Basic
Learning Objective: 06-01 Working capital management involves financing and controlling the current assets of the firm.
9. Permanent current assets are not similar to fixed assets because they are fully liquidated within the
year.
FALSE
Block - Chapter 06 #9
Blooms: Understand
Difficulty: Intermediate
Learning Objective: 06-02 Management must distinguish between those current assets that are easily converted to cash and those that are more permanent.
10. Wal-Mart requires manufacturers to ship goods with RFID tags so that it can better track inventory and
reduce the need for supply chain management.
FALSE
24
11. When using level production, inventory will peak in the month where unit sales trend above the
production level.
FALSE
Block - Chapter 06 #11
Blooms: Understand
Difficulty: Intermediate
Learning Objective: 06-01 Working capital management involves financing and controlling the current assets of the firm.
12. Cash, accounts receivables, and inventory all move monthly in the same direction under level
production.
FALSE
Block - Chapter 06 #12
Blooms: Understand
Difficulty: Intermediate
Learning Objective: 06-01 Working capital management involves financing and controlling the current assets of the firm.
13. Level production methods smooth production schedules and utilize manpower and equipment more
efficiently than seasonal production methods.
TRUE
Block - Chapter 06 #13
Blooms: Understand
Difficulty: Intermediate
Learning Objective: 06-01 Working capital management involves financing and controlling the current assets of the firm.
14. The use of point-of-sale terminals has made it easier for many retail store managers to manage their
inventory.
TRUE
AACSB: Analytic
Block - Chapter 06 #14
Blooms: Evaluate
Difficulty: Basic
Learning Objective: 06-01 Working capital management involves financing and controlling the current assets of the firm.
15. The cash budget combines the cash receipts and cash payments schedules in determining cash flow.
TRUE
25
16. Ideally, permanent current assets should be financed with short-term borrowings.
FALSE
17. As a general rule, it is desirable to finance the permanent assets, including "permanent current assets",
with long-term debt and equity.
TRUE
18. Increased use of long-term financing is generally a more conservative approach to current asset
financing.
TRUE
19. A risky financial plan will use long-term financing for fixed assets, permanent current assets, and a
portion of temporary current assets.
FALSE
20. Short-term financing is risky because of the possibility of rising short-term rates and the inability of
always being able to refund short-term debt.
TRUE
26
21. Short-term interest rates are generally lower than long-term interest rates.
TRUE
22. By using long-term capital to cover short-term needs, the firm is virtually assured of becoming
technically insolvent.
FALSE
23. Heavy use of long-term financing generally leads to lower financing costs.
FALSE
Block - Chapter 06 #23
Blooms: Understand
Difficulty: Basic
Learning Objective: 06-04 Long-term financing is usually more expensive than short-term financing based on the theory of the term structure of interest rates.
24. During an economic "boom" period, a shortage of low-cost financing alternatives exists.
TRUE
Block - Chapter 06 #24
Blooms: Understand
Difficulty: Intermediate
Learning Objective: 06-04 Long-term financing is usually more expensive than short-term financing based on the theory of the term structure of interest rates.
25. The "term structure of interest rates" refers to the relationship between yields on debt and their
maturities.
TRUE
Block - Chapter 06 #25
Blooms: Understand
Difficulty: Basic
Learning Objective: 06-04 Long-term financing is usually more expensive than short-term financing based on the theory of the term structure of interest rates.
27
26. The "term structure of interest rates" depicts the competitive cost of funds for the various short-term
sources of funds such as Treasury bills, commercial paper, and bank CDs.
FALSE
Block - Chapter 06 #26
Blooms: Understand
Difficulty: Intermediate
Learning Objective: 06-04 Long-term financing is usually more expensive than short-term financing based on the theory of the term structure of interest rates.
27. The "term structure of interest rates" is a schedule that tells when a company's bonds mature and shows
how many dollars a firm must pay in interest payments.
FALSE
Block - Chapter 06 #27
Blooms: Remember
Difficulty: Basic
Learning Objective: 06-04 Long-term financing is usually more expensive than short-term financing based on the theory of the term structure of interest rates.
28. Yield curves change very little in the short run (3 months).
FALSE
29. If the liquidity premium theory was the only correct theory, yield curves would always be upward-
sloping.
TRUE
30. The ratio of long-term financing to short-term financing at any given time will be greatly influenced by
the term structure of interest rates.
TRUE
28
31. It is not necessary to understand interest rate movements when deciding the structure of short-term debt
relative to long-term debt.
FALSE
Block - Chapter 06 #31
Blooms: Understand
Difficulty: Intermediate
Learning Objective: 06-04 Long-term financing is usually more expensive than short-term financing based on the theory of the term structure of interest rates.
32. The behavior of various kinds of financial institutions determines the shape of the yield curve,
according to the market segmentation theory.
TRUE
Block - Chapter 06 #32
Blooms: Understand
Difficulty: Intermediate
Learning Objective: 06-04 Long-term financing is usually more expensive than short-term financing based on the theory of the term structure of interest rates.
33. Only the market segmentation theory has any significant impact on interest rates.
FALSE
34. According to the expectations hypothesis, when long-term interest rates are higher than short-term
interest rates, long-term rates are expected to decline.
FALSE
AACSB: Analytic
Block - Chapter 06 #34
Blooms: Evaluate
Difficulty: Challenge
Learning Objective: 06-04 Long-term financing is usually more expensive than short-term financing based on the theory of the term structure of interest rates.
35. According to the expectations hypothesis, when long-term interest rates are higher than short-term
interest rates, short-term rates are expected to rise.
TRUE
AACSB: Analytic
Block - Chapter 06 #35
Blooms: Evaluate
Difficulty: Intermediate
Learning Objective: 06-04 Long-term financing is usually more expensive than short-term financing based on the theory of the term structure of interest rates.
29
36. Short-term interest rates have historically been more volatile than long-term rates.
TRUE
37. The successful financial manager is very interested in the term structure of interest rates but is not
concerned with the relative volatility or historical level of interest rates.
FALSE
38. Short-term interest rates are more dependent upon inflation than on current demand for money.
FALSE
AACSB: Analytic
Block - Chapter 06 #38
Blooms: Evaluate
Difficulty: Challenge
Learning Objective: 06-04 Long-term financing is usually more expensive than short-term financing based on the theory of the term structure of interest rates.
FALSE
Block - Chapter 06 #39
Blooms: Understand
Difficulty: Intermediate
Learning Objective: 06-04 Long-term financing is usually more expensive than short-term financing based on the theory of the term structure of interest rates.
40. During tight money periods, short-term financing may be difficult to find.
TRUE
Block - Chapter 06 #40
Blooms: Understand
Difficulty: Intermediate
Learning Objective: 06-05 Risk; as well as profitability; determines the financing plan for current assets.
41. The expected value is the sum of the probabilities of all expected events.
FALSE
Block - Chapter 06 #41
Blooms: Understand
30
Difficulty: Intermediate
Learning Objective: 06-06 Expected value analysis may sometimes be employed in working capital management.
42. Expected value techniques allow consideration of more than one possible outcome.
TRUE
Block - Chapter 06 #42
Blooms: Understand
Difficulty: Basic
Learning Objective: 06-06 Expected value analysis may sometimes be employed in working capital management.
43. In periods of tight money, long-term rates are often higher than short-term rates.
FALSE
AACSB: Analytic
Block - Chapter 06 #43
Blooms: Evaluate
Difficulty: Challenge
Learning Objective: 06-04 Long-term financing is usually more expensive than short-term financing based on the theory of the term structure of interest rates.
44. If we examine the ratio of working capital to sales, we can see that for the last several decades, firms'
liquidity has been increasing.
FALSE
Block - Chapter 06 #44
Blooms: Remember
Difficulty: Basic
Learning Objective: 06-03 The financing of an asset should be tied to how long the asset is likely to be on the balance sheet.
45. Heavy risk exposure due to short-term borrowing can be compensated for by carrying illiquid assets.
FALSE
Block - Chapter 06 #45
Blooms: Understand
Difficulty: Intermediate
Learning Objective: 06-05 Risk; as well as profitability; determines the financing plan for current assets.
46. Heavy use of long-term financing can generate more profit for the company during a tight money
period.
TRUE
AACSB: Analytic
Block - Chapter 06 #46
Blooms: Evaluate
Difficulty: Intermediate
Learning Objective: 06-05 Risk; as well as profitability; determines the financing plan for current assets.
31
47. Use of long-term financing and the carrying of highly liquid assets is a high-risk combination.
FALSE
48. Firms with predictable cash-flow patterns should assume relatively low levels of risk.
FALSE
49. Firms with highly volatile and perishable inventory should assume relatively low levels of risk.
TRUE
Block - Chapter 06 #49
Blooms: Understand
Difficulty: Challenge
Learning Objective: 06-05 Risk; as well as profitability; determines the financing plan for current assets.
50. The more short-term financing relative to long-term financing, the more risky the financial structure.
TRUE
Block - Chapter 06 #50
Blooms: Understand
Difficulty: Intermediate
Learning Objective: 06-05 Risk; as well as profitability; determines the financing plan for current assets.
TRUE
FALSE
Block - Chapter 06 #52
Blooms: Understand
Difficulty: Intermediate
Learning Objective: 06-01 Working capital management involves financing and controlling the current assets of the firm.
32
53. The aggressive financing plan involves utilizing long-term financing for permanent and temporary
current assets.
FALSE
Block - Chapter 06 #53
Blooms: Understand
Difficulty: Intermediate
Learning Objective: 06-05 Risk; as well as profitability; determines the financing plan for current assets.
54. Expected value analysis requires taking the difference between the actual projected outcome and the
historic outcome times its' probability and summing these totals.
FALSE
Block - Chapter 06 #54
Blooms: Understand
Difficulty: Intermediate
Learning Objective: 06-06 Expected value analysis may sometimes be employed in working capital management.
55. Long-term financing is usually less expensive than short-term financing because it is not as
advantageous to the corporation as short-term financing.
FALSE
Block - Chapter 06 #55
Blooms: Understand
Difficulty: Intermediate
Learning Objective: 06-04 Long-term financing is usually more expensive than short-term financing based on the theory of the term structure of interest rates.
56. The three most important factors when selecting a financing plan are risk, asset liquidity, and timing.
TRUE
Block - Chapter 06 #56
Blooms: Understand
Difficulty: Intermediate
Learning Objective: 06-05 Risk; as well as profitability; determines the financing plan for current assets.
57. Generally a downward sloping yield curve indicates an eminent economic boom.
FALSE
AACSB: Analytic
Block - Chapter 06 #57
Blooms: Evaluate
Difficulty: Intermediate
Learning Objective: 06-04 Long-term financing is usually more expensive than short-term financing based on the theory of the term structure of interest rates.
33
58. Pressure to increase current asset buildup often results from
59. Working capital management is primarily concerned with the management and financing of
A. Long-range planning.
B. Capital budgeting.
C. Short-term financing.
D. Working capital management.
34
61. The term "permanent current assets" implies
A. the working capital associated with a product will be liquidated within a one year period.
B. all the product will be sold, receivables collected and bills paid over the time period specified.
C. assets associated with the production of a product will be liquidated over the depreciable life of the
assets.
D. self-liquidating assets be financed by long-term sources of capital.
63. Well implemented web-based supply chain management has all of the following benefits except
35
64. Permanent current assets are not a factor in a manager's decision making process when all current assets
will be
A. track livestock.
B. track marathon runner's time.
C. track inventory at retailers.
D. all of these.
36
66. Frisch Fish Corp expects net income next year to be $750,000. Inventory and accounts receivable will
have to be increased by $650,000 to accommodate this sales level. Frisch will pay dividends of
$300,000. How much external financing will Frisch Fish need assuming no organically generated
increase in liabilities?
AACSB: Analytic
Block - Chapter 06 #66
Blooms: Apply
Difficulty: Intermediate
Learning Objective: 06-03 The financing of an asset should be tied to how long the asset is likely to be on the balance sheet.
67. Tinbergen Cans expects sales next year to be $50,000,000. Inventory and accounts receivable
(combined) will increase $8,000,000 to accommodate this sales level. The company has a profit margin
of 6 percent and a 30 percent dividend payout. How much external financing will the firm have to seek?
Assume there is no increase in liabilities other than that which will occur with the external financing.
AACSB: Analytic
Block - Chapter 06 #67
37
Blooms: Apply
Difficulty: Challenge
Learning Objective: 06-03 The financing of an asset should be tied to how long the asset is likely to be on the balance sheet.
68. Samuelson will produce 20,000 units in January using level production. If each unit costs $500 to
manufacture, what is the dollar value of ending inventory in January if beginning inventory is 10,000
units and January sales are 15,000?.
AACSB: Analytic
Block - Chapter 06 #68
Blooms: Apply
Difficulty: Challenge
Learning Objective: 06-03 The financing of an asset should be tied to how long the asset is likely to be on the balance sheet.
AACSB: Analytic
Block - Chapter 06 #70
Blooms: Evaluate
38
Difficulty: Intermediate
Learning Objective: 06-02 Management must distinguish between those current assets that are easily converted to cash and those that are more permanent. Blooms:
Understand
AACSB: Analytic
Block - Chapter 06 #71
Blooms: Evaluate
Difficulty: Intermediate
Learning Objective: 06-02 Management must distinguish between those current assets that are easily converted to cash and those that are more permanent. Blooms:
Understand
72. Retail companies like Target and The Limited exhibit sales patterns that are mostly influenced by
73. Retail companies like Target and Limited Brands are more likely to have
39
74. The use of cash budgeting procedures
A. helps the firm plan its current asset levels for a given production plan.
B. makes managing inventory easier under seasonal production.
C. illustrates fluctuating levels of current assets for a given production plan.
D. all of these are correct.
75. Assuming level production throughout the year, and assuming receivables are collected in two equal
installments over the two months subsequent to the sales period, developing the cash budget requires the
following steps:
AACSB: Analytic
Block - Chapter 06 #75
Blooms: Evaluate
Difficulty: Challenge
Learning Objective: 06-03 The financing of an asset should be tied to how long the asset is likely to be on the balance sheet.
AACSB: Analytic
Block - Chapter 06 #76
Blooms: Evaluate
Difficulty: Intermediate
Learning Objective: 06-03 The financing of an asset should be tied to how long the asset is likely to be on the balance sheet.
40
77. Normally, permanent current assets should be financed by
A. long-term funds.
B. short-term funds.
C. borrowed funds.
D. internally generated funds.
78. Ideally, which of the following type of assets should be financed with long-term financing?
A. use long-term financing for all fixed assets and short-term financing for all other assets.
B. finance a portion of permanent assets and short-term assets with short-term debt.
C. use equity to finance fixed assets, long-term debt to finance permanent assets, and short-term debt to
finance fluctuating current assets.
D. use long-term financing for permanent current assets and fixed assets and a portion of the short-term
fluctuating assets and use short-term financing for all other short-term assets.
AACSB: Analytic
Block - Chapter 06 #79
Blooms: Evaluate
Difficulty: Intermediate
Learning Objective: 06-05 Risk; as well as profitability; determines the financing plan for current assets.
41
80. Generally, more use is made of short-term financing because
A. short-term interest rates are generally lower than long-term interest rates.
B. most firms do not have Basic access to the capital markets.
C. short-term financing is usually more predictable than long-term financing.
D. a and b above.
A. changes daily to reflect current competitive conditions in the money and capital markets.
B. plots returns for securities of different risk.
C. shows the relative interest spread between bonds with different risk ratings such as AAA, AA, A,
BBB, etc.
D. depicts interest rates for T-bills over the last year.
42
83. The term structure of interest rates is influenced by
A. inflation.
B. money supply.
C. Federal Reserve activities.
D. all of these are true
AACSB: Analytic
Block - Chapter 06 #84
Blooms: Analyze
Difficulty: Intermediate
Learning Objective: 06-04 Long-term financing is usually more expensive than short-term financing based on the theory of the term structure of interest rates.
AACSB: Analytic
Block - Chapter 06 #85
Blooms: Understand
Difficulty: Intermediate
Learning Objective: 06-04 Long-term financing is usually more expensive than short-term financing based on the theory of the term structure of interest rates.
43
86. The belief that investors require a higher return to entice them into holding long-term securities is the
viewpoint of the
44
89. U.S. government securities are used to construct yield curves because
90. As the economy moves through a business cycle, which of the following term structure of interest rate
theories dominate the shape of the yield curve.
AACSB: Analytic
Block - Chapter 06 #90
Blooms: Evaluate
Difficulty: Intermediate
Learning Objective: 06-04 Long-term financing is usually more expensive than short-term financing based on the theory of the term structure of interest rates.
91. Some analysts believe that the term structure of interest rates is determined by the behavior of various
types of financial institutions. This theory is called the
A. expectations hypothesis.
B. market segmentation theory.
C. liquidity premium theory.
D. theory of industry supply and demand for bonds.
45
92. The theory of the term structure of interest rates which suggests that long-term rates are determined by
the average of short-term rates expected over the time that a long-term bond is outstanding is the
A. expectations hypothesis.
B. segmentation theory.
C. liquidity premium theory.
D. market average rate theory.
94. A firm will usually increase the ratio of short-term debt to long-term debt when
AACSB: Analytic
Block - Chapter 06 #94
Blooms: Evaluate
Difficulty: Challenge
Learning Objective: 06-04 Long-term financing is usually more expensive than short-term financing based on the theory of the term structure of interest rates.
46
95. Which of the following yield curves would be characteristic during a period of high economic growth?
A. Upward sloping
B. Downward sloping
C. Horizontal
D. Humped
AACSB: Analytic
Block - Chapter 06 #95
Blooms: Evaluate
Difficulty: Challenge
Learning Objective: 06-04 Long-term financing is usually more expensive than short-term financing based on the theory of the term structure of interest rates.
AACSB: Analytic
Block - Chapter 06 #96
Blooms: Evaluate
Difficulty: Intermediate
Learning Objective: 06-04 Long-term financing is usually more expensive than short-term financing based on the theory of the term structure of interest rates.
97. When the term structure of interest rates is downward sloping and interest rates are expected to decline,
the
AACSB: Analytic
Block - Chapter 06 #97
Blooms: Evaluate
Difficulty: Challenge
Learning Objective: 06-04 Long-term financing is usually more expensive than short-term financing based on the theory of the term structure of interest rates.
47
98. During tight money periods
AACSB: Analytic
Block - Chapter 06 #98
Blooms: Evaluate
Difficulty: Intermediate
Learning Objective: 06-04 Long-term financing is usually more expensive than short-term financing based on the theory of the term structure of interest rates.
99. Which of the following techniques allows explicit consideration of more than one possible outcome?
A. Operating leverage
B. Present value
C. Least-squares regression
D. Expected value
100. Under normal conditions (60% probability), Financing Plan A will produce $30,000 higher return than
Plan B. Under tight money conditions (40% probability), Plan A will produce $40,000 less than Plan B.
What is the expected value of returns?
A. $2800
B. $4,000
C. $4800
D. $2,000
AACSB: Analytic
Block - Chapter 06 #100
Blooms: Apply
Difficulty: Challenge
Learning Objective: 06-06 Expected value analysis may sometimes be employed in working capital management.
48
101. Under normal conditions (70% probability), Plan A will produce $20,000 higher return than Plan B.
Under tight money conditions (30% probability), Plan A will produce $100,000 less than Plan B. What
is the expected value of returns?
A. $28,000
B. ($16,000)
C. $58,000
D. ($2,000)
AACSB: Analytic
Block - Chapter 06 #101
Blooms: Apply
Difficulty: Challenge
Learning Objective: 06-06 Expected value analysis may sometimes be employed in working capital management.
102. Which of the following is a reason for diminishing liquidity in modern corporations?
49
103. Kuznets Rental Center requires $500,000 in financing over the next two years. Kuznets can borrow
long-term at 8 percent interest per year for two years. Alternatively, Kuznets can borrow short-term and
pay 6 percent interest in the first year. Then, Kuznets projects paying 9 percent interest in the second
year. Assuming Kuznets pays off the accrued interest at the end of each year, which of the following
statements is true?
A. Kuznets will definitely end up paying more under the long-term financing plan.
B. Kuznets will definitely end up paying less under the long-term financing plan.
C. Kuznets will probably pay more under the short-term financing plan.
D. Kuznets will probably pay less under the short-term financing plan.
AACSB: Analytic
Block - Chapter 06 #103
Blooms: Analyze
Difficulty: Intermediate
Learning Objective: 06-04 Long-term financing is usually more expensive than short-term financing based on the theory of the term structure of interest rates.
50
104. Hicks Health Clubs, Inc., expects to generate an annual EBIT of $750,000 and needs to obtain financing
for $1,200,000 of assets. Their tax bracket is 40%. If the firm goes with a short-term financing plan,
their rate will be 7.5 percent, and with a long-term financing plan their rate will be 9 percent. By how
much will their earnings after tax change if they choose the more conservative financing plan instead of
the more aggressive plan?
A. $10,000
B. ($10,800)
C. ($6,000)
D. $6,000
AACSB: Analytic
Block - Chapter 06 #104
Blooms: Apply
Difficulty: Challenge
Learning Objective: 06-06 Expected value analysis may sometimes be employed in working capital management.
105. Hicks Health Clubs, Inc., expects to generate an annual EBIT of $750,000 and needs to obtain financing
for $1,200,000 of assets. Their tax bracket is 40%. If the firm goes with a short-term financing plan,
their rate will be 7.5 percent, and with a long-term financing plan their rate will be 9 percent. By how
much will their earnings after tax change if they choose the more aggressive financing plan instead of
the more conservative?
A. $10,800
B. ($10,000)
C. ($6,000)
D. $6,000
AACSB: Analytic
Block - Chapter 06 #105
Blooms: Apply
Difficulty: Challenge
Learning Objective: 06-06 Expected value analysis may sometimes be employed in working capital management.
51
106. An aggressive, risk-oriented firm will likely
AACSB: Analytic
Block - Chapter 06 #106
Blooms: Analyze
Difficulty: Intermediate
Learning Objective: 06-05 Risk; as well as profitability; determines the financing plan for current assets.
107. Which of the following is not a condition under which a prudent manager would accept some risk in
financing?
AACSB: Analytic
Block - Chapter 06 #107
Blooms: Analyze
Difficulty: Intermediate
Learning Objective: 06-05 Risk; as well as profitability; determines the financing plan for current assets.
108. Risk exposure due to heavy short-term borrowing can be compensated for by
AACSB: Analytic
Block - Chapter 06 #108
Blooms: Analyze
Difficulty: Intermediate
Learning Objective: 06-05 Risk; as well as profitability; determines the financing plan for current assets.
52
109. Which of the following combinations of asset structures and financing patterns is likely to create the
least volatile earnings?
AACSB: Analytic
Block - Chapter 06 #109
Blooms: Analyze
Difficulty: Intermediate
Learning Objective: 06-05 Risk; as well as profitability; determines the financing plan for current assets.
110. Which of the following combinations of asset structures and financing patterns is likely to create the
most volatile earnings?
AACSB: Analytic
Block - Chapter 06 #110
Blooms: Analyze
Difficulty: Intermediate
Learning Objective: 06-05 Risk; as well as profitability; determines the financing plan for current assets.
111. An aggressive working capital policy would have which of following characteristics?
AACSB: Analytic
Block - Chapter 06 #111
Blooms: Analyze
Difficulty: Intermediate
Learning Objective: 06-05 Risk; as well as profitability; determines the financing plan for current assets.
53
112. The following are the expected 1 year T-bill rates for the next 4 years: 3%, 4%, 5%, and 6%. What
would you expect the rate for 3 year securities would be?
A. 4%
B. 4.5%
C. 6%
D. 3.75%
AACSB: Analytic
Block - Chapter 06 #112
Blooms: Apply
Difficulty: Intermediate
Learning Objective: 06-04 Long-term financing is usually more expensive than short-term financing based on the theory of the term structure of interest rates.
113. Riley Co. is considering a short-term or long-term financing plan for $4,000,000 in assets. They expect
the following 1 year rates over the next 3 years: 6.5%, 7.75%, and 9%. Their long-term interest rate will
be 7.5% for the 3 years. Assuming the rates follow their expectations, what will be the difference in
interest costs over the 3 years?
AACSB: Analytic
Block - Chapter 06 #113
Blooms: Apply
Difficulty: Intermediate
Learning Objective: 06-04 Long-term financing is usually more expensive than short-term financing based on the theory of the term structure of interest rates.
54
114. Genetech has $4,000,000 in assets, have decided to finance 30% with long-term financing (9% rate) and
70% with short-term financing (7%) rate. What will be their annual interest costs?
A. $78,000
B. $126,000
C. $440,000
D. $304,000
AACSB: Analytic
Block - Chapter 06 #114
Blooms: Apply
Difficulty: Intermediate
Learning Objective: 06-04 Long-term financing is usually more expensive than short-term financing based on the theory of the term structure of interest rates.
115. When the yield curve is upward sloping, generally a financial manager should:
AACSB: Analytic
Block - Chapter 06 #115
Blooms: Evaluate
Difficulty: Intermediate
Learning Objective: 06-04 Long-term financing is usually more expensive than short-term financing based on the theory of the term structure of interest rates.
116. When the yield curve is downward sloping, generally a financial manager should
AACSB: Analytic
Block - Chapter 06 #116
Blooms: Evaluate
Difficulty: Intermediate
Learning Objective: 06-04 Long-term financing is usually more expensive than short-term financing based on the theory of the term structure of interest rates.
55
117. Match the following with the items below:
56
Blooms: Understand
Difficulty: Intermediate
Learning Objective: 06-01 Working capital management involves financing and controlling the current assets of the firm.
Learning Objective: 06-02 Management must distinguish between those current assets that are easily converted to cash and those that are more permanent.
Learning Objective: 06-03 The financing of an asset should be tied to how long the asset is likely to be on the balance sheet.
Learning Objective: 06-04 Long-term financing is usually more expensive than short-term financing based on the theory of the term structure of interest rates.
Learning Objective: 06-05 Risk; as well as profitability; determines the financing plan for current assets.
Learning Objective: 06-06 Expected value analysis may sometimes be employed in working capital management.
118. King, Inc., a successful Midwest firm, is considering opening a branch office on the west coast. Under
normal economic conditions, with a 45% probability of occurring, King can expect to earn a net income
of $70,000 per year. In a mini-recession, at 25% probability, King will earn $20,000. In a severe
recession, at a 20% probability, King will lose $15,000. There is also a slight probability (10%) that
King will lose $300,000 if the expansion fails and the branch office must be closed. Should King open a
branch office in California based on these assumptions?
AACSB: Analytic
Block - Chapter 06 #118
Blooms: Apply and Evaluation
Difficulty: Intermediate
Learning Objective: 06-06 Expected value analysis may sometimes be employed in working capital management.
57
119. Using the expectations hypothesis for the term structure of interest rates, calculate the expected yields
for securities with maturities of two and three years on the basis of the following data:
AACSB: Analytic
Block - Chapter 06 #119
Blooms: Apply
Difficulty: Intermediate
Learning Objective: 06-04 Long-term financing is usually more expensive than short-term financing based on the theory of the term structure of interest rates.
58
120. Christensen & Assoc. is developing an asset financing plan. Christensen has $1,000,000 in current
assets, of which 15% are permanent, and $700,000 in fixed assets. The current long-term rate is 9%, and
the current short-term rate is 6.5%. Christensen's tax rate is 30%.
a) Construct two financing plans-one conservative, with 80% of assets financed by long-term sources,
and the other aggressive, with only 60% of assets financed by long-term sources. If Christensen's
earnings before interest and taxes are $525,000, calculate net income under each alternative.
b) What are some of the risks associated with each plan?
c) If the yield curve is steeply inverted, which financing plan should Christensen choose?
AACSB: Analytic
Block - Chapter 06 #120
Blooms: Apply, Analysis, and Evaluation
Difficulty: Challenge
Learning Objective: 06-04 Long-term financing is usually more expensive than short-term financing based on the theory of the term structure of interest rates.
Learning Objective: 06-05 Risk; as well as profitability; determines the financing plan for current assets.
Learning Objective: 06-06 Expected value analysis may sometimes be employed in working capital management.
59
121. McKinsee Inc. is developing a plan to finance its asset base. The firm has $3,000,000 in current assets,
of which 20% are permanent, and $10,000,000 in fixed assets. Long-term rates are currently 8%, while
short-term rates are at 6%. McKinsee's tax rate is 30%.
a) Construct a conservative financing plan with 80% of assets financed by long-term sources. If
McKinsee's earnings before interest and taxes are $4,500,000, what will their net income be?
b) An alternative and more aggressive plan would be to finance 60% of total assets with long-term
financing. Assuming that EBIT was again $4,500,000, what will net income be under this alternative?
c) If the yield curve was steeply upward sloping, which plan would you recommend? Why?
c) Plan B produces slightly higher net income. However, since short-term rates are more
volatile, a general increase in interest rates would probably raise the relative cost of short-
term financing significantly and possibly make short-term credit difficult to obtain. The
firm's net income could be significantly reduced. Lock into long-term financing before
rates increase and funds become difficult to obtain.
AACSB: Analytic
Block - Chapter 06 #121
Blooms: Apply, Analysis, and Evaluation
Difficulty: Challenge
Learning Objective: 06-04 Long-term financing is usually more expensive than short-term financing based on the theory of the term structure of interest rates.
Learning Objective: 06-05
60
06 Summary
Category # of Questio
ns
AACSB: Analytic 43
Block - Chapter 06 121
Blooms: Analyze 8
Blooms: Apply 11
Blooms: Apply and Evaluation 1
Blooms: Apply, Analysis, and Evaluation 2
Blooms: Evaluate 20
Blooms: Remember 8
Blooms: Understand 70
Difficulty: Basic 28
Difficulty: Challenge 17
Difficulty: Intermediate 76
Learning Objective: 06-01 Working capital management involves financing and controlling the current assets of the firm. 20
Learning Objective: 06- 2
02 Management must distinguish between those current assets that are easily converted to cash and those that are more permanent.
Learning Objective: 06- 10
02 Management must distinguish between those current assets that are easily converted to cash and those that are more permanent. Blo
oms: Understand
Learning Objective: 06-03 The financing of an asset should be tied to how long the asset is likely to be on the balance sheet. 15
Learning Objective: 06-04 Long-term financing is usually more expensive than short- 49
term financing based on the theory of the term structure of interest rates.
Learning Objective: 06-05 1
Learning Objective: 06-05 Risk; as well as profitability; determines the financing plan for current assets. 22
Learning Objective: 06-06 Expected value analysis may sometimes be employed in working capital management. 11
61