Test Planning Table For Chapter 18: Learning Objective Knows Basic Understands Applies Principles

Chapter 18 - Financial Management
TEST PLANNING TABLE FOR CHAPTER 18
LL:1 LL:2 LL:3

Knows Basic Understands Applies Principles
Learning Objective
Terms and Facts Concepts and
Principles
1. Explain the role and 1,2,3,4,5,6,7,8,9,10,11,12, 21,22,23,24,25,26,27, 31,32,33,

responsibilities of 13,14,15,16,17,18,19,20, 28,29,30, 184,185,186,187,188,1
financial managers. 171,172,173,174,175,176,1 181,182,183, 89,
77, 192,
178,179,180, 288
2. Outline the financial 34,35,36,37,38,39,40,41, 55,56,57,58,59, 60,61,62,63,64,65,

planning process, and 42,43,44,45,46,47,48,49, 200,201 202,203,204,205,206,
explain the three key 50,51,52,53,54, 207,
budgets in the financial 190,191,193,194,195,196, 289,290,
plan. 197,198,199 295*
3. Explain why firms 66,67,68,69,70,71,72,73, 84,85,86,87,88,89,90, 96,9798,99,100,101,

need operating funds. 74,75,76,77,78,79,80,81, 91,92,93,94,95, 222,223,224,225,226,
82,83, 219,220,221~ 227,228,229,230,231,
208,209,210,211,212,213, 232,
214,215,216,217,218 296*,297*
4. Identify and describe 102,103,104,105,106,107, 125,126,127,128,129~, 130,131,132,133,134,

different sources of short- 108,109,110,111,112,113, 248,249 250,251,252,253,254,
term financing. 114,115,116,117,118,119, 255,256,257,
120,121,122,123,124, 291,
233,234,235,236,237,238, 298*,299*
239,240,241,242,243,244,
245,246,247
5. Identify and describe 135,136,137,138,139,140, 159,160,161,162,163, 166,167,168,169,170,

different sources of long- 141,142,143,144,145,146, 164~,165~, 280,281,282,283,284,
term financing. 147,148,149,150,151,152, 273,274,275,276,277, 285,286,287,
153,154,155,156,157,158, 278,279 292,293,294,
258,259,260,261,262,263, 300*
264,265,266,267,268,269,
270,271,272
Total number of test items: 300
True/false questions are in plain text.

Multiple choice questions are in bold text.
Questions on boxed material are in bold text with a tilde~.
Essay questions are in bold underlined text.
Minicase questions are in bold with an asterisk*.
18-1
Chapter 18
Financial Management Answer Key
True / False Questions
1. Finance is the function in a business that acquires funds for the firm and manages those
funds within the firm.
Answer: True
AACSB: Reflective Thinking
Bloom’s: Remember
Learning Objective: 18-01 Explain the role and responsibilities of financial managers
Level of Difficulty: 1 Easy
Topic: Financial Management
2. Managing a firm's resources so that it can meet its goals and objectives is the goal of
financial accounting.
Answer: False
Bloom’s: Remember
3. A financial manager makes recommendations to top executives regarding strategies for

improving the financial strength of a firm.
Answer: True
Bloom’s: Remember
4. The duties and responsibilities of a financial manager are virtually identical to the duties
and responsibilities of an accountant.
Answer: False
Bloom’s: Remember
18-2
5. Financial managers use data prepared by accountants to develop strategies for improving
the financial performance of the firm.
Answer: True
Bloom’s: Remember
6. There is actually a stronger relationship between finance and marketing than there is
between finance and accounting.
Answer: False
Bloom’s: Remember
7. Financial managers examine the data prepared by accountants and make

recommendations to top management regarding strategies for improving the financial
performance of the company.
Answer: True
Bloom’s: Remember
8. Financial management is more important for a large firm than it is for a small firm.
Answer: False
Bloom’s: Remember
9. The chief financial officer (CFO) is responsible for accounting and financial functions.
Answer: True
Bloom’s: Remember
18-3
10. The chief financial officer of a company is responsible for managing cash, accounts
receivable, and inventory.
Answer: True
Bloom’s: Remember
11. While finance is a critical activity for profit-seeking organizations, by definition

nonprofit organizations are not required to fulfill the finance function.
Answer: False
Bloom’s: Remember
12. A comptroller is responsible for the acquiring and managing of funds for an
organization.
Answer: False
Bloom’s: Remember
13. Inability to attract and retain qualified employees is one of the most common ways for a
firm to fail financially.
Answer: False
Bloom’s: Remember
14. Financial managers are responsible for controlling cash flows.
Answer: True
Bloom’s: Remember
15. Undercapitalization refers to the problem of insufficient start-up funds.
Answer: True
18-4
Bloom’s: Remember
16. Investors and entrepreneurs should have an understanding of financial issues.
Answer: True
Bloom’s: Remember
17. Financial managers are responsible for budgeting, auditing, and advising top
management on financial matters.
Answer: True
Bloom’s: Remember
18. One of the most common ways for a firm to fail financially is poor control over cash
flow.
Answer: True
Bloom’s: Remember
19. Inadequate control of expenses represents a common financial problem that contributes
to business failure.
Answer: True
Bloom’s: Remember
20. A comptroller is the chief accounting officer of an organization.
Answer: True
Bloom’s: Remember
18-5
21. Tax payments are important to the finance manager because they represent a cash inflow
to a firm.
Feedback: Tax payments are a disbursement. Taxes represent a cash outflow for the firm.
Finance managers must stay abreast of changes in tax laws in order to minimize the tax
obligations of their firms.
Answer: False
Bloom’s: Understand
Level of Difficulty: 2 Medium
22. An internal auditor is responsible for paying the company's bills and collecting overdue
payments from customers.
Feedback: The auditing function involves reviewing the company books to make certain they
are in compliance with GAAP, Generally Accepted Accounting Principles. The finance team
is responsible for bill collection and for making timely payments to suppliers and creditors.
Answer: False
23. Financial managers are responsible for buying merchandise on credit and collecting
payment from accounts receivable.
Feedback: In order to maintain adequate cash flows, the finance team makes decisions on
purchasing inventory and other goods on credit, and also for the timely collections of credit
sales.
Answer: True
18-6
24. Accountants truly represent the financial managers of a business.
Feedback: Accountants perform the technical aspects of gathering, organizing, classifying,

and summarizing events and transactions, and prepare technical documents such as financial
statements and reports. Finance managers interpret the results of these reports and create
financial strategy for the firm.
Answer: False
25. Inadequate expense control typically occurs as a result of undercapitalization.
Feedback: Undercapitalization refers to a problem many beginning business ventures have—

insufficient start-up funds. Expense control problems can occur even in firms that do not start
out undercapitalized, and is an area of concern to all businesses, not just new firms. Constant
attention is needed to ensure expenses increase only when necessary.
Answer: False
26. The importance of financial managers to firms with large cash inflows is greater than for
firms with smaller cash flows.
Feedback: Finance professionals are greatly needed in small firms. Small and medium-sized
firms have smaller cash or credit cushions than large firms, which increases the need for
monitoring cash flows.
Answer: False
18-7
27. Financial managers are responsible for the management of accounts receivable and
accounts payable.
Feedback: The finance functions of buying merchandise on credit (accounts payable) and
collecting payment from customers (accounts receivable) are the responsibilities of financial
managers.
Answer: True
28. Tax management by financial managers involves the development of strategies to evade
tax liabilities.
Feedback: The goal is not to evade tax liabilities. The goal is to minimize a firm's tax
consequences. Tax management is the analysis of tax implications of various managerial
decisions in an attempt to minimize the taxes paid by the business.
Answer: False
29. Generally accepted accounting principles require that any assessment of a firm's
financial statements be performed by independent outside auditors.
Feedback: A firm can use internal auditors to evaluate whether the firm is in compliance with
GAAP, Generally Accepted Accounting Principles.
Answer: False
30. To be effective, an internal auditor must be critical of any improprieties or deficiencies

found in the financial activities of the firm.
Feedback: An organization's accounting statements would be less reliable if an internal

auditor was biased and subjective in the evaluation of the firm's accounting procedures.
Answer: True
Bloom’s: Apply
18-8
31. As a financial manager, Sabrina's responsibilities include the interpretation of financial

statements provided by the firm's accountants and the preparation of recommendations
to top management.
Feedback: Financial managers interpret accounting data in order to develop suggestions for
improving the company's financial health.
Answer: True
AACSB: Knowledge Application
Bloom’s: Apply
Level of Difficulty: 3 Hard
32. Mark manages credit and collections at Polly Parrot Pet Supplies, Inc. He is responsible
for accounts receivable and accounts payable. These activities suggest that his job is in
financial management.
Feedback: Determining the customers that qualify for credit and making collection of overdue
accounts are important responsibilities of financial managers.
Answer: True
Bloom’s: Apply
33. Is there something in a name? April Gardner was told that she would grow up to be a
master gardener. She didn't really believe that stuff, but now she finds herself in charge
at a large city-owned botanical garden. She is requiring her staff to pursue continuing
education. To put her money where her mouth is, she will enroll in a couple of
accounting and finance courses at the local community college because this is an area
where she is weak. This is a good plan, especially since she is the boss.
Feedback: Although you do not have to be an expert in finance to be the boss, it is important
that you have an understanding of how money flows in and out of your company. Financial
understanding is important to anyone who wants to run a business, whether for-profit or
nonprofit.
Answer: True
Bloom’s: Apply
18-9
34. The overall objective of financial planning is to optimize the firm's profitability and
make the best use of its money.
Answer: True
Bloom’s: Remember
Learning Objective: 18-02 Outline the financial planning process, and explain the three key budgets in the financial plan
35. The first step in financial planning is to develop a budget to better control costs.
Answer: False
Bloom’s: Remember
36. One step in the financial planning process is to establish financial control procedures
that allow managers to monitor the organization's performance.
Answer: True
Bloom’s: Remember
37. The timing of a short-term forecast is more important than the forecast's accuracy.
Answer: False
Bloom’s: Remember
38. A firm's short-term financial forecast provides a projected sales estimate.
Answer: True
Bloom’s: Remember
39. The primary focus of a cash flow forecast is the firm's revenue and costs for the current
operating period.
Answer: False
18-10
Bloom’s: Remember
40. A firm's most recent financial statements often serve as the basis for predicting future
sales, costs and expenses.
Answer: True
Bloom’s: Remember
41. The long-term financial forecast plays a crucial part in the company's long-term strategic
plan.
Answer: True
Bloom’s: Remember
42. The long-term financial forecast gives top management some sense of the profit
potential of various strategic decisions.
Answer: True
Bloom’s: Remember
43. A budget reflects management's expectations for revenues and allocates the use of
specific resources throughout the firm.
Answer: True
Bloom’s: Remember
Topic: Budgeting
44. Budgets are prepared after the financial forecasts are developed.
Answer: True
Bloom’s: Remember
Topic: Budgeting
18-11
45. To be effective, budgets are prepared independently of organizational forecasts.
Answer: False
Bloom’s: Remember
Topic: Budgeting
46. A capital budget highlights the expected funds provided by owner investments.
Answer: False
Bloom’s: Remember
Topic: Budgeting
47. An operating budget analyzes the firm's spending plans for long-lasting assets that
require large sums of money.
Answer: False
Bloom’s: Remember
Topic: Budgeting
48. A capital budget highlights a firm's spending plans for major assets, such as property,
buildings, and equipment.
Answer: True
Bloom’s: Remember
Topic: Budgeting
49. A capital budget combines all of the other budgets into one detailed plan for monitoring
the operations of the firm.
Answer: False
Bloom’s: Remember
Topic: Budgeting
50. The operating (master) budget identifies the funds (and the allocation of those funds)
required to operate a business at a projected level of revenue.
Answer: True
18-12
Bloom’s: Remember
Topic: Budgeting
51. A cash budget helps managers anticipate borrowing, debt repayment, operating
expenses, and short-term investment opportunities.
Answer: True
Bloom’s: Remember
Topic: Budgeting
52. The main objective of financial control is to establish priorities for the purchase of plant
and equipment.
Answer: False
Bloom’s: Remember
Topic: Budgeting
53. By identifying variances from the financial plan, managers are able to focus on those
departments that require corrective action.
Answer: True
Bloom’s: Remember
Topic: Budgeting
54. Financial control is a process where firms compare actual revenues and costs with
budgeted revenues and costs.
Answer: True
Bloom’s: Remember
Topic: Budgeting
18-13
55. Since short-term financial forecasts predict expected future events, they should not be
influenced by recent financial statements.
Feedback: Past financial statements are often used as the basis for making projections about
future sales revenues, costs and expenses used in the short-term forecast.
Answer: False
56. A budget's primary purpose is to provide managers with a financial summary of past
operations.
Feedback: A budget is a future plan, not a summary of past operations. When properly
constructed, a budget becomes the primary basis and guide for the firm's financial operations.
Answer: False
Topic: Budgeting
57. Forecasting means determining how closely the actual revenue and expense results
matched up with the predicted revenues and expenses.
Feedback: Forecasting means looking out into the future and estimating the firm's revenue
opportunities and expenses.
Answer: False
Bloom’s: Remember
58. Budgets assist managers in performing the functions of planning and control.
Feedback: A budget should reflect the plans of the organization, as well as the resources
devoted to achieve those plans. Financial control can be exercised by comparing the budgeted
plans to the actual operations of the firm.
Answer: True
Topic: Budgeting
18-14
59. A company's capital budget helps management plan for cash shortages or surpluses.
Feedback: A capital budget highlights the firm's planned spending on fixed assets such as
buildings and equipment. It is the cash budget that provides managers with information
regarding projected cash balances.
Answer: False
Topic: Budgeting
60. Preferred Pet Care, Inc., plans to purchase a second mobile unit next year that will cost
an estimated $55,000. The finance manager will include this projected purchase in the
company's capital budget.
Feedback: A capital budget highlights the firm's spending plans for major assets that usually
require large sums of money.
Answer: True
Bloom’s: Apply
Topic: Budgeting
61. As a financial manager of a small firm, Jerry needs to determine how much his company
will have to borrow in the coming months, and when the borrowed funds will be needed.
The preparation of the cash budget will help.
Feedback: The cash budget shows projected revenues, expenses, and cash balance for a
specific period of time, usually one month or one quarter. It provides insight as to whether the
firm needs to borrow in the short term in order to pay for expenses for the same period.
Answer: True
Bloom’s: Apply
Topic: Budgeting
18-15
62. Karen, a financial manager with Bigbux Incorporated, regularly compares actual
revenues and expenses against their projected values. After identifying areas with
significant deviations from planned values, she investigates to find the cause of these
variances. Karen's activities represent the steps involved in the preparation of Bigbux's
capital budget.
Feedback: Karen is involved in financial control, which is the process of comparing actual
revenues, costs, and expenses against their projected values. The control process helps
financial managers identify deviations and take corrective action when necessary. The Capital
Budget is a projected statement of the number and types of fixed assets required to run the
operation over a specified period of time.
Answer: False
Bloom’s: Apply
63. Preferred Pet Care, Inc., a mobile pet care company, is planning for the future. The
company owners (two seasoned veterinarians) have brought together the vice president
of marketing and the director of information systems to talk about their expansion
campaign, "We come to you!" The talks are in the preliminary stages, so there is no need
to concern the finance team at this time because cash flow is currently not a problem.
Feedback: Forecasting for the future is an important part of any firm's strategic plan. If a firm
is planning to expand, it is important to begin creating long-term forecasts, where the firm
predicts revenues and expenses for periods longer than one year, sometimes 5 to 10 years out.
Answer: False
Bloom’s: Apply
64. Big Bear Ski Lodge owners know that the lifts on the north slope will need replacing in
the next two years. Three months prior to replacement, they will include the expenditure
in their cash budget.
Feedback: Chair lifts would be considered a capital budget item—a major capital expenditure
for a ski lodge. A major purchase such as this would be part of the capital budget in the
company's financial plan.
Answer: False
Bloom’s: Apply
Topic: Budgeting
18-16
65. Big Bear Ski Lodge's cash budget for the month of March 2015 shows a negative
amount. Due to the fact that the months of January and February were quite lucrative
and showed positive amounts, the finance manager will not borrow any money in the
short term to cover for March's deficit.
Feedback: The finance manager utilizes the cash budget (see Figure 18.3) to estimate cash
inflows and outflows on a period-by-period basis (usually a month or a quarter). If the month
of March shows a deficit, the cash collected in January and February has already been
dispersed to pay for expenses during those months and the subsequent month of March. The
manager will need to consider short-term financing to cover the shortage.
Answer: False
Bloom’s: Apply
Topic: Budgeting
66. One very important responsibility of the finance department in both large and small
businesses involves acquiring needed funds to operate the business.
Answer: True
Bloom’s: Remember
Learning Objective: 18-03 Explain why firms need operating funds
67. Finance managers need funds for capital purchases, but seldom for the day-to-day
operations.
Answer: False
Bloom’s: Remember
68. The concept of the time value of money is based on the interest-earning power of
money.
Answer: True
Bloom’s: Remember
69. When his firm is owed money, the financial manager tries to collect as early as possible.
Answer: True
18-17
Bloom’s: Remember
70. Financial managers generally oppose credit sales because of the impact on cash flows.
Answer: False
71. Effective financial managers evaluate customers' ability to pay for merchandise
purchased on credit.
Answer: True
72. With added competition, firms prefer not to offer the availability of credit sales to their
customers.
Answer: False
Bloom’s: Remember
73. Accepting credit cards, such as MasterCard or Visa, enables a firm to decrease the
expense of extending credit to customers.
Answer: True
Bloom’s: Remember
74. The cost to a retailer of accepting credit cards is generally greater than the benefits
provided.
Answer: False
18-18
75. Acquiring and storing inventory represents a sizable expenditure for many businesses.
Answer: True
Bloom’s: Remember
76. To improve cash flow and profitability, effective managers attempt to minimize the
firm's investment in inventory.
Answer: True
Bloom’s: Remember
77. Capital expenditures are major investments in long-term assets such as property and
equipment.
Answer: True
Bloom’s: Remember
78. Sound financial management involves determining the most appropriate sources of
funds to meet short-term and long-term needs of an organization.
Answer: True
Bloom’s: Remember
79. While firms finance their long-term needs with debt financing, their short-term needs are
served by equity financing.
Answer: False
Bloom’s: Remember
Topic: Short and Long Term Financing
18-19
80. Short-term financing refers to borrowed funds that must be repaid in a year or less.
Answer: True
Bloom’s: Remember
81. Equity financing must be repaid.
Answer: False
Bloom’s: Remember
Topic: Debt and Equity Financing
82. Equity financing represents funds acquired from within the firm or through the sale of
stock, representing ownership in the company.
Answer: True
Bloom’s: Remember
83. Business organizations always use long-term financing for (both) short-term and long-
term needs, but they never use short-term financing for (both) short-term and long-term
needs.
Answer: False
Bloom’s: Remember
84. Debt financing refers to funds acquired from the profitable operations of a firm or
through the sale of ownership in the firm.
Feedback: Debt financing refers to borrowing money from lending institutions, with the
understanding that these sources of funds will be repaid at a later date.
Answer: False
18-20
85. Expansion into new markets (either domestic or global) is sometimes financed with
long-term funds.
Feedback: Expanding production in order to capture new markets is an endeavor that usually
takes a sizeable investment over a long period of time.
Answer: True
86. Companies raising funds must choose either debt or equity sources, but not both.
Feedback: Firms may utilize several sources and several combinations of financing. These
generally include debt financing (borrowed funds), equity financing (funds acquired through
the sale of company stock), and even internal sources of financing such as companies
retaining their earnings.
Answer: False
87. Financial managers understand the time value of money. They try to maximize cash
expenditures, as opposed to minimizing cash expenditures.
Feedback: Financial managers try to minimize cash expenditures to free up funds for
investment in interest-bearing accounts. The interest received from interest-bearing accounts
contributes to profits.
Answer: False
18-21
88. Based on the time value of money, $100 received a year from today is worth more than
$100 received today.
Feedback: A dollar is worth more today than it is worth a week, a month, or a year from now.
A dollar may be invested today, and grow to a larger value one year from now. If you were
offered $1.00 today, you should expect a little more than a dollar, one year from now, if
everything else is equal.
Answer: False
89. Money has time value due to the fact that if invested, it has the potential to earn more
money at some point in the future.
Feedback: A dollar today is worth more than the same dollar in the distant future, due to time
value of money. If you invest a dollar today, it has the potential to earn interest, which would
make it worth more at some time in the future. Financial managers are aware of this time
value and often try to shift some of their cash on hand into investments in interest-bearing
accounts.
Answer: True
90. Efficient cash management requires firms to pay their bills as quickly as possible, and
delay the collection of accounts receivable.
Feedback: In order to increase cash flow, businesses attempt to collect credit sales from their
customers as soon as possible, and delay payment of outstanding bills.
Answer: False
18-22
91. Successful businesses establish restrictive credit policies encouraging customers to pay
cash.
Feedback: Making credit available helps make current customers happy and attracts new
customers. Although extending credit ties up funds and entails risk, many businesses would
have trouble surviving without making credit available to customers.
Answer: False
92. Offering cash discounts to customers who pay their bills by a certain date represents an
effective technique to manage accounts receivable.
Feedback: Although selling on credit is a necessity for many businesses, a major problem
with offering credit is that it ties up funds that the firm needs for other purposes. Offering cash
or quantity discounts to customers who pay their account early is an effective way of
improving collections and speeding the inflow of cash into the firm.
Answer: True
Bloom’s: Apply
93. An effective strategy to manage cash flows requires retail businesses to eliminate their
inventory.
Feedback: Financial managers face a trade-off when dealing with inventory. Investment in
inventory is costly, but businesses must maintain some inventory in order to provide
customers an adequate selection of available goods. The goal of inventory management is not
to eliminate inventory but rather to minimize the cost of holding inventory.
Answer: False
18-23
94. A firm will choose to seek debt financing only for the purpose of paying for short-term
operating needs.
Feedback: Debt financing is synonymous with borrowing funds. Funds can be borrowed
either short-term or long-term.
Answer: False
95. Equity financing may involve the sale of stock (representing ownership) to new
investors.
Feedback: Equity capital is money raised by retaining profits within the firm or by the sale of
ownership in the firm. There is no requirement to repay these funds.
Answer: True
96. As a financial manager for a large manufacturing firm, Gail evaluates the purchase of
expensive machinery and construction of new facilities. She is analyzing capital
expenditure proposals.
Feedback: Capital expenditures are major investments in long-term assets like buildings,
equipment, and land or intangible assets such as patents, trademarks, and copyrights.
Answer: True
Bloom’s: Apply
18-24
97. Anna operates a florist shop specializing in weddings. While she knows that her
competitors allow customers to buy on credit, she is concerned about the risk and
expense of unpaid customer accounts. One strategy to reduce risk and collect sales
revenue more quickly would be to accept bank-issued credit cards.
Feedback: Not only are credit cards a convenient means of payment for many customers, the
banks that issue the cards have already established the creditworthiness of the cardholders.
Moreover, accepting credit cards is a good way for firms to cut the time and expense involved
in collecting accounts receivable. Firms believe the benefits outweigh the credit card company
fees.
Answer: True
Bloom’s: Apply
98. White Palace operates a chain of restaurants specializing in hamburgers. The corporation
plans to expand to new communities. The acquisition of land and construction of new
restaurants represent major capital expenditures.
Feedback: Capital expenditures are major investments in tangible, long-term assets, such as
land, buildings, and equipment, as well as intangible assets such as patents, trademarks, and
copyrights.
Answer: True
Bloom’s: Apply
99. After thoroughly studying the feasibility for expansion, Preferred Pet Care Inc., a mobile
pet care company that operates in the greater Chicago area, plans to offer a similar
service in the Indianapolis metropolitan area. This endeavor will require a large capital
expenditure. Due to the nature of this project, the firm will consider only equity
financing.
Feedback: Although a project of this nature is considered a capital expenditure, it may be

financed in one of three ways: with debt financing (long-term borrowing); with equity
financing (the sale of private or public offering of stock), or with retained earnings.
Answer: False
Bloom’s: Apply
18-25
100. Allison Robards, owner of Backstreet Books, an eclectic bookstore near a large
university, is seeking additional financing for books and CDs that she plans to buy and
sell in the same fiscal year. Even though it will be a sizeable investment in inventory,
Allison is seeking short-term financing.
Feedback: Inventory that is purchased and sold in the same year is financed with short-term
sources of funds.
Answer: True
Bloom’s: Apply
101. Backstreet Books is seeking financing to fund the opening of two more locations in a
major university town. There is no need to consider debt financing for this project. It
will require a sizeable investment in equity funds.
Feedback: Although an expansion project is a sizeable investment that usually requires long-
term financing, both debt financing and equity financing may be considered for this project.
Long-term loans (debt financing) are repaid in a time period longer than one year, and usually
carry terms of anywhere from 2–10 years. Equity financing, funds from the sale of stock in
the firm, does not need to be repaid.
Answer: False
AACSB: Analytical Thinking
Bloom's: Analyze
102. Financial managers devote the majority of their time obtaining long-term financing to
fund the firm's capital expenditures.
Answer: False
Bloom’s: Remember
Learning Objective: 18-04 Identify and describe different sources of short-term financing
103. Small businesses rely heavily on long-term financing.
Answer: False
Bloom’s: Remember
18-26
104. Much of a financial manager's day-to-day activities involve managing the short-term
financial needs of the firm.
Answer: True
Bloom’s: Remember
105. The most widely used source of short-term funding is trade credit.
Answer: True
Bloom’s: Remember
106. Trade credit represents one of the most expensive forms of short-term financing.
Answer: False
Bloom’s: Remember
107. Trade credit is the practice of buying goods now and paying for them later.
Answer: True
Bloom’s: Remember
108. The terms "2/10, net 30" indicate that the seller is offering a 20% discount for early
payment.
Answer: False
Bloom’s: Remember
109. Trade credit means the seller will sell and deliver products and/or services to the buyer,
with the understanding that the buyer will pay for these products and/or services at a
later date.
Answer: True
18-27
Bloom’s: Remember
110. Suppliers prefer to offer trade credit to customers with poor credit ratings or no credit
history.
Answer: False
Bloom’s: Remember
111. A promissory note is a written contract between a supplier and a business customer,
with a promise that customer will pay supplier a specified amount by a certain date.
Answer: True
Bloom’s: Remember
112. Family and friends represent problem-free sources of financing for most small
businesses.
Answer: False
Bloom’s: Remember
113. A revolving credit agreement is designed to reduce the risk of lending money.
Answer: False
Bloom’s: Remember
114. Inventory financing represents the selling of accounts receivables as collateral for a
loan.
Answer: False
Bloom’s: Remember
18-28
115. A secured loan means the borrower has the security of knowing repayment is not due
for several years.
Answer: False
Bloom’s: Remember
116. An unsecured loan does not require a borrower to provide collateral to secure a loan.
Answer: True
Bloom’s: Remember
117. A line of credit represents a guarantee from a bank to lend a firm a given amount of
money.
Answer: False
Bloom’s: Remember
118. A revolving credit agreement represents a line of credit that is guaranteed.
Answer: True
Bloom’s: Remember
119. Commercial finance companies normally charge lower rates on short-term loans than
those charged by commercial banks.
Answer: False
Bloom’s: Remember
18-29
120. Factoring refers to the process of selling accounts receivable for cash.
Answer: True
Bloom’s: Remember
121. Factoring refers to the process of selling inventory to generate short-term funds.
Answer: False
Bloom’s: Remember
122. Factoring represents the least expensive way for a firm to raise short-term funds.
Answer: False
Bloom’s: Remember
123. A tool that provides lots of convenience, credit cards are a source of a readily available
line of credit for a small business because they provide convenience.
Answer: True
Bloom’s: Remember
124. Commercial paper is unsecured short-term debt.
Answer: True
Bloom’s: Remember
18-30
125. Financially stable firms are able to sell commercial paper to raise short-term funds.
Feedback: Commercial paper consists of unsecured promissory notes in amounts of $100,000

and up that mature in 270 days or less. Since it offers no collateral, only financially stable
firms are able to sell commercial paper.
Answer: True
126. Many sellers offer a 2% discount to a buyer that makes payment 20 days before the due
date, (2/10, net 30). Firms that fail to take advantage of this early payment discount are
giving up approximately 36%.
Feedback: There are about eighteen 20-day periods in a year. The penalty for not taking a
discount is calculated as follows: 18 periods x 2% equals 36%.
Answer: True
127. If a buyer is offered the terms of sale of "3/10, net 30" this means that the buyer can
receive a 10 percent discount by making full payment within 30 days of the billing date.
Feedback: The terms "3/10, net 30" indicate the buyer is offered a 3 percent discount if
payment is made within 10 days of the billing date.
Answer: False
128. A line of credit from a bank guarantees a firm that a specified amount of financing will
be available when it is needed.
Feedback: A line of credit means a bank will lend a business a given amount of short-term
funds provided the bank has funds readily available. In other words, the availability of funds
is not guaranteed.
Answer: True
18-31
129.According to the box, Adapting to Change, it is impossible for small businesses to bring
in venture capital from investors.
Feedback: Small-business owners can gain financing through various channels. In this box,
we learn that James Reinhart of ThredUp received financing for his small business thanks to
family, friends, angel investors and venture capitalists.
Answer: False
130.Bill is a financial manager for Great View Eye Care, a local chain of Milwaukee retail
stores offering glasses and optical health care. The majority of Bill's day likely involves
efforts to locate and secure long-term financing to fund Great View Eye Care's capital
expenditures.
Feedback: The bulk of the job of a financial manager requires handling of short-term
financial needs for his/her company. This includes managing cash, accounts receivables, and
inventory.
Answer: False
Bloom’s: Apply
131.Rod was required to pledge his house and car as collateral for a loan he received from
the First National Bank. The money from the loan was used to start his new business,
which unfortunately failed within 6 months. The bank can now claim Rod's house and
car to satisfy its claim.
Feedback: Collateral is a valued asset that is pledged to the lender, at the time a loan is
secured. If the borrower fails to pay the loan, the lender can take possession of the collateral.
Answer: True
Bloom’s: Apply
18-32
132.As the chief financial officer (CFO) for a medium-sized service company, Shelley is
concerned about the possibility of temporary cash shortages. Given the irregular cash
flows from seasonal sales, she wants to ensure that her company's bank will provide
adequate funds to cover any potential cash flow problem. The best strategy to ease
Shelley's concern would be to arrange a revolving credit agreement with the bank.
Feedback: A revolving credit agreement is a guaranteed line of credit. This type of

arrangement is a good way to obtain funds for unexpected cash needs.
Answer: True
Bloom’s: Apply
133. Tri-State Concrete Construction Company relies on factoring to meet its short-term
financing needs. This means that Tri-State borrows money from a finance company and
pledges its accounts receivable as collateral.
Feedback: Factoring does not involve borrowing money. It is the sale of an asset (accounts
receivable) for cash.
Answer: False
Bloom’s: Apply
134. Big Ticket Technologies holds commercial paper issued by Prude Insurance
Corporation that matures in 180 days. However, shortly after Big Ticket purchased the
commercial paper, Prude Insurance went out of business. The finance manager for Big
Ticket is not worried because his loan to the corporation is secured by collateral that he
can now claim.
Feedback: Commercial paper is an unsecured promissory note. No assets are pledged by the
company as collateral. In this case, the one firm lent money to the other firm, on the short
term, for 270 days or less.
Answer: False
Bloom’s: Apply
18-33
135. Most companies require long-term capital to purchase fixed assets such as plant and
equipment, to develop new products and services, or to finance an expansion.
Answer: True
Bloom’s: Remember
Learning Objective: 18-05 Identify and describe different sources of long-term financing
136. Equity financing refers to the money a firm receives from the sale of bonds.
Answer: False
Bloom’s: Remember
137. When using equity financing, firms incur a legal obligation to repay the amount of
money invested.
Answer: False
Bloom’s: Remember
138. A term-loan agreement requires the borrower to repay the loan in one lump sum at the
end of the loan period.
Answer: False
Bloom’s: Remember
139. The interest paid for debt financing is a tax-deductible expense for the firm.
Answer: True
Bloom’s: Remember
140. According to the risk/return trade-off, the higher the risk, the lower the interest rate
charged by the lender.
Answer: False
18-34
141. A share of stock represents a company-issued IOU including a promise to repay on a

certain date.
Answer: False
Bloom’s: Remember
142. A bond represents a long-term debt obligation of a corporation or government.
Answer: True
Bloom’s: Remember
Topic: Bonds
143. An unsecured corporate bond is known as a debenture bond.
Answer: True
Bloom’s: Remember
Topic: Bonds
144. A debenture bond is backed only by the reputation of the issuer.
Answer: True
Bloom’s: Remember
Topic: Bonds
145. The types of organizations which can issue bonds are privately and publicly held
corporations, exclusively.
Answer: False
Bloom’s: Remember
Topic: Bonds
18-35
146. The indenture terms refer to the agreements of a bond issue, such as how much interest
it promises to pay and when it promises to repay the issue.
Answer: True
Bloom’s: Remember
Topic: Bonds
147. Funds obtained from venture capitalists are considered equity financing.
Answer: True
Bloom’s: Remember
148. Retained earnings represent a source of equity financing.
Answer: True
Bloom’s: Remember
149. The first time a company offers to sell its stock to the general public is called an initial
private label (IPL).
Answer: False
Bloom’s: Remember
150. Corporations must comply with the Securities and Exchange Commission (SEC)
requirements in order to sell their stock publicly.
Answer: True
Bloom’s: Remember
151. Venture capital is money that is invested in new or emerging companies that are
perceived as having great profit potential.
Answer: True
18-36
Bloom’s: Remember
152. Venture capitalists expect lower than average returns on their investment since they are
exposed to little risk.
Answer: False
Bloom’s: Remember
153. Most companies have the ready cash available to make large purchases.
Answer: False
Bloom’s: Remember
154. Acquiring funds through equity financing requires the firm to pay annual dividends.
Answer: False
Bloom’s: Remember
Topic: Figure 18.6
155. Acquiring funds through debt financing actually decreases the overall risk of the firm.
Answer: False
Bloom’s: Remember
156. Acquiring funds through debt financing enhances the firm's ability to increase profits.
Answer: True
18-37
157. Leverage refers to the use of borrowed funds to increase a firm's rate of return.
Answer: True
Bloom’s: Remember
158. The cost of capital is the rate of return a firm must earn in order to meet the demands of
its lenders and expectations of its equity holders.
Answer: True
Bloom’s: Remember
159. Long-term loans are often more expensive than short-term loans.
Feedback: Because long-term loans involve larger amounts of funding than short-term loans,
they are generally more expensive to the firm than short-term loans are. Also, since the
repayment period could be quite long, lenders are not assured that their capital will be repaid
in full. Thus most long-term loans require collateral.
Answer: True
160. Corporations that issue debenture bonds are required to provide collateral.
Feedback: Bonds can be either secured or unsecured. Unsecured bonds have no specific
assets pledged as collateral. This type of bond is called a debenture.
Answer: False
Topic: Bonds
161. Corporations that issue stock to raise long-term funds accept the legal obligation to
repay the amount borrowed.
Feedback: Stock represents equity capital or owner-provided funds. Stockholders are owners
of the firm and are not repaid their investment.
Answer: False
18-38
162. Unlike bonds, stocks offer the advantage of tax-deductible interest payments.
Feedback: Interest payments made by a firm are a tax-deductible expense. However, interest
is paid to creditors, not owners. Since shares of stock represent shares of ownership, there is
no interest paid on stock.
Answer: False
163. One important consideration for a firm accepting funds from a venture capitalist is the
ownership interest demanded by the venture capital firm.
Feedback: The share of ownership is the incentive for a venture capital firm to invest in a
promising start-up company. Venture capitalists hope to profit as part owners from the
financial assistance they offer.
Answer: True
164.According to the Reaching Beyond Our Borders box, some of the largest sovereign
wealth funds are operated by Norway, Saudi Arabia, and Singapore.
Feedback: Some of the largest sovereign wealth funds are operated by Norway, United Arab
Emirates, Saudi Arabia, China, Kuwait, and Singapore.
Answer: True
18-39
165.As mentioned in the Reaching Beyond Our Borders box, sovereign wealth funds can
easily purchase more than 10% of a U.S. company without investigation by the U.S.
government.
Feedback: The government carefully investigates any SWF that tries to purchase more than
10% of a U.S. company.
Answer: False
166.Central Vermont Power issued $200 million of bonds to finance a major upgrade of one
of its largest power plants. The issuance of these bonds indicates that Central Vermont
utilizes equity capital to meet its long-term financing needs.
Feedback: Bonds represent a long-term debt obligation of the company. This is not means of
financing with equity.
Answer: False
Bloom’s: Apply
167.As a financial manager for a very profitable manufacturer of specialty steel, Kurt has
been asked to investigate sources of long-term funds to finance the construction of a new
facility. Kurt would prefer a funding source that does not require interest payments or
involve major underwriting fees. Kurt will consider using retained earnings to fund the
construction project.
Feedback: Retained earnings are profits that have been reinvested in the company. Since
Kurt's company is profitable, such funds may be available. Using retained earnings saves the
company interest payments, dividends, and any possible underwriting fees. Also, there is no
dilution of ownership.
Answer: True
Bloom’s: Apply
18-40
168.Financial managers at Sasha Deal Electronics have always had a conservative attitude
toward long-term financing. In particular, they are interested in keeping risk to a
minimum. This philosophy suggests that managers at Sasha Deal consider the extensive
use of leverage an attractive financial strategy.
Feedback: Leverage is the use of borrowing to increase a firm's rate of return. One of the
drawbacks of leverage is that reliance on debt increases the financial risk of the firm. If the
firm's earnings on the borrowed funds were less than the interest the firm is required to pay,
the rate of return to the owners would decline. This type of strategy is not likely to appeal to
the conservative financial managers at Sasha Deal.
Answer: False
Bloom’s: Apply
169. An example of a firm using leverage to its advantage is a firm that borrows funds at 9%
and invests those funds to earn 14%.
Feedback: Leverage refers to the use of borrowed funds to increase the firm's rate of return.
Borrowing funds at 9% and then investing those funds in assets yielding more than 9% (in
this case 14%) will increase the firm's rate of return. Leverage is risky, because there is no
guarantee the firm will earn a return sufficient to cover the cost of borrowing. In this case,
however, the return is sufficient to overcome the cost of borrowing and increase the firm's rate
of return.
Answer: True
Bloom’s: Apply
170. If a firm earns 10% return on funds they borrowed at 15% interest, the owners of the
firm realize a benefit from using leverage.
Feedback: Leverage refers to the use of borrowed funds to increase the firm's rate of return.
Borrowing at 15% interest (cost of capital) and using those funds to earn 10% decreases the
return on investment for the firm.
Answer: False
Bloom’s: Apply
Multiple Choice Questions
18-41
171. ________ examine the data prepared by ________ and then make recommendations to
top management regarding strategies for improving the firm.
A. Accountants; financial managers
B. Accountants; bankers
C. Financial managers; accountants
D. Financial managers; bankers
Answer: C
Bloom’s: Remember
172. _____________ is the function in business that is responsible for acquiring funds for
the firm, and managing funds within the firm.
A. Accounting
B. Managerial accounting
C. Finance
D. Financial accounting
Answer: C
Bloom’s: Remember
18-42
173. Which of the following correctly identifies areas of authority and responsibility for a
chief financial officer (CFO)?
A. Accounting and finance
B. Marketing and finance
C. Production and accounting
D. Finance and research and development
Answer: A
Bloom’s: Remember
174. No matter the size of the business, finance is a critical activity for:
A. profit-seeking, but not for nonprofit organizations.
B. profit-seeking and nonprofit organizations.
C. nonprofit organizations, but not for profit-seeking businesses.
D. accountants, but not for financial managers.
Answer: B
Bloom’s: Remember
175. Undercapitalization refers to the problem of:
A. insufficient start-up funds.
B. inadequate control of expenses.
C. inappropriate cash flows.
D. undervalued capital stock.
Answer: A
18-43
Bloom’s: Remember
176. Which of the following statements is most accurate?
A. Accounting and finance are not related.
B. Financial managers keep the books for a firm.
C. Financial managers need to understand accounting.
D. Nonprofit organizations must choose between accounting and finance.
Answer: C
Bloom’s: Remember
177. Which of the following is a primary area of concern for financial managers?
A. Undercapitalization
B. Inability to recruit qualified workers
C. Poor advertising messages
D. Inadequate market control
Answer: A
Bloom’s: Remember
18-44
178. Which business function involves credit management/collecting funds from
customers?
A. Accounting
B. Production
C. Marketing
D. Finance
Answer: D
Bloom’s: Remember
179. Which of the following statements about taxes is accurate?
A. Taxes represent an inflow of cash to the firm.
B. Profitable businesses usually pay taxes.
C. Tax management falls within the responsibility of marketing managers.
D. Taxes cannot be managed because of fluctuations in political policy.
Answer: B
Bloom’s: Remember
180. A(n) __________ is responsible for verifying that the accounting procedures within a
firm are consistent with established accounting principles.
A. managerial accountant
B. tax accountant
C. bookkeeper
D. internal auditor
Answer: D
18-45
Bloom’s: Remember
181. Which of the following commonly results in the financial failure of a firm?
A. Diversification
B. Undercapitalization
C. Control of expenses
D. Management of cash flows
Feedback: Undercapitalization refers to the problem of insufficient cash to adequately fund

the firm's activities. Our text suggests that undercapitalization and inadequate control over
cash flows and expenses are the most common ways for a firm to fail financially.
Answer: B
182. A(n) _____________ job includes forecasting, budgeting, cash flow analysis, cost
control, taxes, and credit management.
A. CPA's
B. investment banker's
C. financial manager's
D. portfolio manager's
Feedback: Financial managers examine the financial data prepared by accountants and make
recommendations to top executives regarding strategies for improving firm performance.
They manage the firm's taxes, cash, credit accounts, and inventory.
Answer: C
18-46
183. Which of the following companies is undercapitalized?
A. A large corporation that has been hit with a major lawsuit because one of its products has a
design flaw that has led to serious injuries
B. A new company struggling because it has insufficient start-up funds
C. A medium-sized company that has decided to buy out a smaller competitor
D. An electric utility that has recently experienced a significant increase in the cost of coal
and labor
Feedback: Undercapitalization is the problem of having insufficient start-up funds.
Answer: B
184.Susan started a cake decorating business that failed. She is convinced that she lacked the
necessary funds to promote her business and get it off the ground. Susan experienced:
A. inadequate financial control.
B. undervalued inventory.
C. undercapitalization.
D. a cash flow issue.
Feedback: Undercapitalization occurs when a business has insufficient start-up funds.
Answer: C
Bloom’s: Apply
18-47
185. Carlos is the manager of Oh! Canada Sporting Goods. During the past six months, his
cash expenditures have exceeded his cash receipts. Oh! Canada is suffering from a(n)
________ problem.
A. accounting
B. undercapitalization
C. cash flow
D. exchange rate
Feedback: Cash flow problems occur when a firm's outflows of cash exceed its inflows. Poor
management of cash flow is a common cause of business failure.
Answer: C
Bloom’s: Apply
186.Ariel, a recent graduate in finance from a well-known university, was hired by a large
corporation to work in tax management. Ariel's goal is:
A. to prepare the company's tax returns.
B. to develop ways to increase taxes in order to enhance the bottom line.
C. to minimize the firm's tax consequences.
D. to be the firm's tax collector.
Feedback: Since tax payments represent an outflow of cash from the business, minimizing a
firm's taxes is an important responsibility of financial managers.
Answer: C
Bloom’s: Apply
18-48
187.Robert intends to major in business. He has never had much interest in subjects with
numbers. He would like to avoid taking any finance courses if possible. Robert should:
A. avoid finance courses and focus on subjects that he enjoys.
B. take a finance course to satisfy graduation requirements.
C. realize that his success in business requires an understanding of financial issues.
D. change majors and go into the arts.
Feedback: Finance and accounting are two areas that everyone involved in business should
study.
Answer: C
Bloom’s: Apply
188. Which of the following activities is most likely to be performed by a financial

manager?
A. design of a marketable product that satisfies an unmet need
B. identification of specific target markets for a firm's goods
C. preparation of the balance sheet and income statement for the firm
D. analysis of the tax implications of various managerial decisions
Feedback: Tax management often is an important part of a financial manager's job.
Answer: D
Bloom’s: Analyze
18-49
189. When Preferred Pet Care Inc., a mobile veterinary care company, first started
operations, it extended three months of credit to customers. It soon began to experience
a cash flow problem. A finance professional was hired to:
A. manage accounts receivable.
B. manage accounts payable.
C. develop tax strategies.
D. audit the company ledgers.
Feedback: Particularly in small companies such as the example in this question, monitoring
and collecting payments owed by customers is an important effort that leads to better cash
flow.
Answer: A
Bloom’s: Apply
190. The overall objective of financial planning is to:
A. forecast the impact of technological trends.
B. prepare financial statements for managers.
C. optimize the firm's profitability.
D. establish budgets for financial control.
Answer: C
Bloom’s: Remember
18-50
191. The first step in the financial planning process is:
A. forecasting financial needs.
B. preparing financial statements.
C. developing budgets.
D. establishing financial control.
Answer: A
Bloom’s: Remember
192. A _________ forecast predicts the revenues, costs, and expenses a firm will incur for a
period of one year or less.
A. near-horizon
B. short-term
C. capital expenditures
D. tactical
Answer: B
Bloom’s: Remember
193. A _________ forecast predicts the future cash inflows and outflows in future periods.
A. money based
B. short-term
C. cash flow
D. long-term
Answer: C
18-51
Bloom’s: Remember
194. A _________ forecast predicts the revenues, costs, and expenses a firm will incur for a
period longer than one year.
A. cash flow
B. short-term
C. capital expenditures
D. long-term
Answer: D
Bloom’s: Remember
195. In order to assist in revenue realization, a(n) ________ allocates resources throughout
the firm.
A. forecast
B. balance sheet
C. budget
D. income statement
Answer: C
Bloom’s: Remember
Topic: Budgeting
18-52
196. Which of the following shows a firm's spending plans on fixed assets such as large
equipment?
A. Capital budget
B. Operating budget
C. Cash budget
D. Surplus budget
Answer: A
Bloom’s: Remember
Topic: Budgeting
197. The budget that estimates a firm's projected cash inflows and outflows, as well as cash
shortages or surpluses during a given time period is called the ________ budget.
A. capital
B. operating
C. cash
D. monetary
Answer: C
Bloom’s: Remember
Topic: Budgeting
18-53
198. ___________ refers to the process that identifies variances by comparing actual
revenues and expenses to projected revenues and expenses.
A. Factor analysis
B. Forecasting
C. Financial planning
D. Financial control
Answer: D
Bloom’s: Remember
199. An effective budget requires:
A. a successful advertising campaign.
B. accurate forecasts.
C. management approval.
D. stakeholder consensus.
Answer: B
Bloom’s: Remember
Topic: Budgeting
18-54
200. If a company wants to predict how much money it can make this coming year, it would
benefit from developing a:
A. master budget.
B. consolidated income statement.
C. short-term forecast.
D. statement of cash flows.
Feedback: A short-term forecast is a prediction of revenues, costs, and expenses for a period
of one year or less.
Answer: C
Topic: Budgeting
201. Which of the following would be most helpful for a company looking to know the
income potential during the next five years?
A. cash flow forecast
B. long-term forecast
C. short-term forecast
D. capital budget forecast
Feedback: The long-term forecast plays a crucial part in the company's long-term plan. The
long-term financial forecast gives top management, as well as operations managers, some
sense of the income or profit potential possible, over a period of time greater than one year.
Answer: B
18-55
202. Carolina Financial Services is considering the purchase and installation of an expensive
computer network. This is the type of expenditure that would be included in a(n):
A. capital budget.
B. cash budget.
C. operating budget.
D. asset budget.
Feedback: The capital budget highlights a firm's spending plans for major asset purchases that
often require large sums of money.
Answer: A
Bloom’s: Apply
Topic: Budgeting
203. The managers of Dakota Clothing regularly compare their actual profits with the firm's
projected profits. When deviations occur, the managers use the feedback to take
corrective action when necessary. The management of Dakota Clothing is exercising
financial:
A. derivatives.
B. control.
C. planning.
D. budgeting.
Feedback: Comparing actual performance with projected results is part of the financial
control process.
Answer: B
Bloom’s: Apply
18-56
204. As a management consultant, Lamont knows that regardless of how good his firm's
product might be, the business has little chance of success without a(n):
A. financial plan.
B. outside consultant.
C. auditor.
D. warranty.
Feedback: Financial planning involves analyzing short-term and long-term money flows to
and from the firm. The overall objective of financial planning is to optimize the firm's
profitability and make the best use of its money.
Answer: A
Bloom’s: Apply
205. Akiko realizes the importance of developing a ________ for her interior design
business. Akiko understands the importance of appropriately allocating resources in
order to achieve the goals of her firm.
A. market prediction
B. financial forecast
C. budget
D. cash flow analysis
Feedback: A budget sets forth management's expectations for revenues and, based on those
financial expectations, allocates the use of specific resources throughout the firm.
Answer: C
Bloom’s: Apply
Topic: Budgeting
18-57
206. As a finance manager at AllSports Communication, Charlie worries about the firm's
borrowing requirements for the upcoming year. He knows the benefit of estimating
AllSports’ cash disbursements and short-term investment expectations. Facing these
concerns, a(n) ________ would provide Charlie with valuable information by providing
a good estimation of whether the firm will need to do short-term borrowing.
A. operating budget
B. cash budget
C. capital budget
D. line item budget
Feedback: Cash budgets can be important guidelines that assist managers in anticipating
borrowing, debt repayment, cash disbursements, and short-term investment expectations.
Answer: B
Bloom’s: Apply
Topic: Budgeting
207. The finance manager at AllSports Communication has asked his assistant, Ben, to
prepare the ________ budget. Ben will gather as much information as possible by
utilizing the firm's other budgets and any documents that summarize proposed financial
activities.
A. master
B. cash
C. capital
D. line item
Feedback: The master budget (also known as the operating budget) summarizes and ties
together all the company's other budgets.
Answer: A
Bloom’s: Apply
Topic: Budgeting
18-58
208. One of the challenges of effective financial management is:
A. to have sufficient cash on hand without compromising the firm's investment potential.
B. ensuring the satisfaction of each of the stakeholder groups.
C. working within the strict regulations of the Financial Accounting Standards Board (FASB).
D. providing the financial data in a timely manner for management consultants to improve
decision making.
Answer: A
Bloom’s: Remember
209. The concept time value of money indicates:
A. the value of a dollar decreases over time as prices increase.
B. the prices of goods and services will fluctuate over time due to inflation and higher costs of
production.
C. monetary systems tend to become more sophisticated over time.
D. a dollar received today is worth more than a dollar received a year from today.
Answer: D
Bloom’s: Remember
210. Money has a time value because:
A. inflation increases the value of money over time.
B. money earns interest over time.
C. monetary systems are more automated than in the past.
D. a dollar received today is worth more than a dollar received yesterday.
Answer: B
18-59
Bloom’s: Remember
211. The rationale behind offering customers credit is:
A. permitting customers to pay with credit cards or on credit makes it easier for them to buy,
and it also attracts new customers.
B. offering customer's credit helps with the firm's cash flow position.
C. offering customer's credit helps match revenues with expenses for the same time period.
D. permitting customers to pay with credit cards or on credit forces a company to rely less on
accounts receivables and more on accounts payables.
Answer: A
Bloom’s: Remember
212. A major concern for firms selling on credit is:
A. the realization that many credit customers always pay their bills.
B. the large amount of assets tied up in accounts receivable.
C. the resulting increase in the debt ratio for the firm.
D. the inability to utilize factoring as a source of financing.
Answer: B
Bloom’s: Remember
18-60
213. To reduce the time and expense of collecting their accounts receivable, some firms:
A. extend credit to new customers.
B. offer extended payment plans to existing customers.
C. adopt a just-in-time inventory policy.
D. accept bank credit cards.
Answer: D
Bloom’s: Remember
214. A just-in-time inventory system allows a firm to:
A. extend credit to new customers.
B. provide sufficient inventory for most contingencies.
C. reduce their investment in inventory.
D. reduce capital expenditures.
Answer: C
Bloom’s: Remember
215. Acquiring funds through borrowing represents:
A. debt financing.
B. venture capital.
C. speculative capital.
D. equity financing.
Answer: A
Bloom’s: Remember
18-61
216. If a firm sells shares of stock, it is financing with ________.
A. debt
B. liabilities
C. spectator capital
D. equity
Answer: D
Bloom’s: Remember
217. If a company secures a three-year bank loan, this is considered __________.
A. short-term financing
B. asset funding
C. liability funding
D. long-term financing
Answer: D
Bloom’s: Remember
18-62
218. If a company secures a one-year bank loan this is considered _______.
A. short-term financing
B. asset funding
C. liability funding
D. long-term financing
Answer: A
Bloom’s: Remember
219. The effective management of accounts receivable requires financial managers to:
A. review the credit history of new customers.
B. provide prompt cash payments to suppliers.
C. allow customers more time in paying their past due accounts.
D. refuse bank-issued credit cards.
Feedback: Finance managers are responsible for carefully evaluating old and new credit
customers to determine if they have a favorable history of meeting their credit obligations on
time.
Answer: A
18-63
220. Which of the following would normally involve long-term financing?
A. Workers’ salaries
B. Unanticipated emergencies
C. Purchase of modern equipment
D. Expanding current inventory
Feedback: Long-term financing is used for major purchases or projects that are financed for a
time period greater than one year such as new-product development, building or purchasing
new facilities, and replacing capital equipment.
Answer: C
221.The Making Ethical Decisions box “Good Finance or Bad Medicine” has an important
message for managers who make financial decisions. Which of the following statements
summarizes this message?
A. Managers must balance good economic decisions with socially forward thinking.
B. Financial decisions must be based on what insurance companies are willing to pay.
C. Checking academic credentials of recently graduated doctors is imperative due to the cost
of lawssuits that patients may file if they learn that they were served by a surgeon without a
license.
D. The support of a good law firm is worth every penny a hospital might pay. The finance
manager should always budget for a legal team.
Feedback: The story is about a hospital finance manager who wants to limit drug inventories
in order to boost cash flow. Doctors want immediate access to any and all medicines that may
be important to treat patients. The ethical dilemma is about balancing the need to limit costs
with the need to support the needs of doctors and their patients in a timely way.
Answer: A
AACSB: Ethics
18-64
222.With plans to build a $50 million theme park, Extreme Entertainment, Inc., intends to
finance this project through the sale of additional shares of ownership in their firm.
Selling new shares of stock represents ___________ financing.
A. retained
B. debt
C. initial offering
D. equity
Feedback: Equity financing refers to funds raised from either selling shares of ownership or
from retained earnings.
Answer: D
Bloom’s: Apply
223. The owner of Mountain Cycle Shop worries that cash flows this winter may be
insufficient to meet his current operating expenses. While he anticipates a surplus of
cash inflows as warm weather approaches, he needs funds now to meet his immediate
obligations. He can best resolve his cash flow concerns by obtaining ________
financing.
A. intermediate
B. contingency
C. short-term
D. long-term
Feedback: Short-term financing is intended to meet the immediate funding needs of an

organization. These are funds that will be repaid within a year.
Answer: C
Bloom’s: Apply
18-65
224. Lancer Wholesale Company wants to improve cash flow. Which of the following
strategies would be most likely to help Lancer achieve this objective?
A. Relaxing its credit policy for new customers
B. Offering cash discounts to buyers who pay their accounts promptly
C. Accepting IOUs from customers who buy in large quantities
D. Offering extended payment plans to qualified buyers
Feedback: Businesses often provide cash or quantity discounts to buyers who pay their
accounts by a certain date. By continually turning accounts receivable into cash, the firm is
increasing cash flow.
Answer: B
Bloom's: Analyze
225. Which of the following presents an effective technique to improve cash management?
A. Speed up cash payments and slow down cash collections
B. Speed up cash collections and slow down cash payments
C. Speed up both collections and payments of cash
D. Slow down both the payment and collections of cash
Feedback: In order to maximize the investment potential of a firm's funds, it's not unusual for
finance managers to suggest that the firm pay bills as late as possible, unless a cash discount
is available. The other half of this rule of thumb is to collect what's owed to the firm as
quickly as possible.
Answer: B
Bloom’s: Analyze
18-66
226. If you are at the Phoenix Sky Harbor International Airport, you will no longer get a pat-
down if you go through the metal detector. The airport now has full body screening ports
that scan the entire body and readily detect weapons or explosive devices that someone
may want to take on board a plane. These expensive devices represent:
A. long-term assets
B. short-term assets
C. intangible assets
D. interest-bearing assets
Feedback: Large capital expenditures such as represented by expensive machinery are long-
term assets. These are purchased by businesses with the understanding that they will be used
in the business's operation for several years.
Answer: A
Bloom’s: Apply
227. Green Builder's Supply, Inc., does not offer customers a cash discount for early payment
of their accounts receivable. As a result, most customers wait to pay their bill on the last
day before late penalties are charged. These customers apparently understand the:
A. time value of money.
B. benefits of tax-deductible expenses.
C. financial community's perception of equity financing.
D. government's regulations of the chemical industry.
Feedback: Money has a time value because of the interest-paying investments that are
available. To encourage customers to pay earlier, New World would need to reward them with
a discount. This would compensate the customers for missed investment opportunities.
Answer: A
Bloom’s: Apply
18-67
228. Which of the following represents a capital expenditure?
A. issuing paychecks to workers
B. paying for advertising on a local radio station
C. purchasing raw materials to be used in the production of a firm's product
D. purchasing a building to be used for office space
Feedback: Capital expenditures are major investments in long-term assets such as land,
buildings, and equipment; or, intangible assets such as patents.
Answer: D
Bloom’s: Analyze
229. By selling shares of ownership in their company, California Scientific acquires the
funds needed to finance their research and development projects. California Scientific
provides for their long-term funding needs through ________ financing.
A. debt
B. equity
C. retained
D. asset
Feedback: Equity financing is generated through the sale of stock. It is also generated when a
firm retains its earnings and reinvests those earnings back into the company.
Answer: B
Bloom’s: Apply
18-68
230. The CFO of a satellite radio company was trying to work his magic today as he solicited
another telecommunications/entertainment company to invest in his company in order to
prevent bankruptcy. Having refinanced the company less than a year ago, the satellite
radio finance manager had a $75 million note coming due today. The current financing
arrangement represents:
A. a long-term sale of stock to private investors.
B. short-term debt financing.
C. the issuance of long-term bonds.
D. a leveraged buy-out.
Feedback: Debt financing refer to funds raised through various forms of borrowing that must
be repaid. In this case, the money was raised less than a year ago, and it is already due to be
repaid. This represents a short-term loan.
Answer: B
Bloom’s: Apply
18-69
231. Which of the following statements represents good advice prior to making capital
expenditures?
A. Capital expenditures represent borrowed funds that must be repaid in one year or less. It is
important to seek the advice of your accountant prior to committing.
B. Capital expenditures represent investment in inventories and expendable assets that the
firm will use in one year or less. It is important to maintain the appropriate level of monthly
cash flow to pay for these expenditures.
C. Most firms do not value capital expenditures on their balance sheets, so it is important to
stay abreast of the market value of these assets at all times, in case you want to sell them.
D. Capital expenditures are major investments, meaning they require large sums of funds.
Companies should weigh all possible options before committing available resources to
projects that take significant amounts of funds and extended time.
Feedback: The investment in long-term assets by making large capital expenditures is not
only time consuming, but risky. There is no guarantee that this investment will result in good
returns for the firm. These investments must be thoroughly evaluated.
Answer: D
Bloom's: Analyze
232. When Liberty Industries renegotiated their loan agreement, they borrowed an additional
$2 million. The new loan requires Liberty to repay the new amount in nine months.
Liberty's activity represents ________ financing.
A. equity
B. debt
C. revitalized
D. secured
Feedback: Debt financing refers to funds acquired through various forms of borrowing that
must be repaid.
Answer: B
Bloom’s: Apply
18-70
233. Finance managers spend the majority of their time managing _____.
A. cash flow.
B. long-term financial needs.
C. short-term financial needs.
D. equity financing.
Answer: C
Bloom’s: Remember
234. Which of the following represents a source of short-term funding?
A. Retained earnings
B. Commercial paper
C. Common stock
D. Corporate bonds
Answer: B
Bloom’s: Remember
18-71
235. The most widely used source of short-term funding is:
A. trade credit.
B. a line of credit.
C. factoring.
D. commercial finance companies.
Answer: A
Bloom’s: Remember
236. ________ is a form of short-term financing. Businesses buy merchandise from their
suppliers, but are not required to pay for their purchases until some future date.
A. Secured credit
B. Trade credit
C. Revolving credit
D. Factoring
Answer: B
Bloom’s: Remember
237. Some suppliers hesitate to offer trade credit to firms with a poor credit history. In these
cases, the supplier may insist that the customer sign a(n):
A. indenture agreement.
B. promissory note.
C. line of credit.
D. factoring agreement.
Answer: B
18-72
Bloom’s: Remember
238. A loan backed by collateral represents a(n):
A. bond trust.
B. debenture bond.
C. pledging factor.
D. secured loan.
Answer: D
Bloom’s: Remember
239. Typically, only highly regarded customers with financial stability receive
___________.
A. secured loans.
B. bank premiums.
C. unsecured loans.
D. commercial paper.
Answer: C
Bloom’s: Remember
18-73
240. Lending institutions may offer a borrower a percentage of the value of the borrower's
accounts receivable so the borrowing firm can continue to operate while it waits to
collect on its credit sales. This process is called __________.
A. establishing a line of credit.
B. inventory valuation.
C. pledging.
D. revolving credit.
Answer: C
Bloom’s: Remember
241. A firm negotiates a(n) _________ with its bank. This arrangement gives the firm access
to a specified amount of unsecured short-term funds, provided the bank has the funds
available.
A. asset drawing account
B. capital drawing agreement
C. reserve account
D. line of credit
Answer: D
Bloom’s: Remember
18-74
242. A ________ refers to a line of credit that is guaranteed by the bank.
A. collateral trust fund
B. revolving credit agreement
C. contract credit agreement
D. commercial credit agreement
Answer: B
Bloom’s: Remember
243. ___________ offer short-term secured loans to high-risk borrowers. These loans usually
require collateral.
A. Commercial finance companies
B. Reserve banks
C. Credit brokers
D. Investment bankers
Answer: A
Bloom’s: Remember
244. Selling accounts receivable to obtain short-term funds is called:
A. pledging.
B. factoring.
C. equity financing.
D. debt financing.
Answer: B
18-75
Bloom’s: Remember
245. Since commercial finance companies offer loans to higher-risk customers than
commercial banks, the interest rates they charge are usually ________ than rates charged
by banks.
A. higher
B. lower
C. more predictable
D. subject to lower taxes
Answer: A
Bloom’s: Remember
246. _________ offers financially stable corporations a technique to raise short-term funds
by issuing unsecured promissory notes to the general public with the promise of
repayment within 270 days.
A. Trade credit
B. A line of credit
C. Factoring
D. Commercial paper
Answer: D
Bloom’s: Remember
18-76
247. Although best used as a last resort, many small businesses find it convenient to use
__________ as a short-term source of financing. Although this form short-term debt
comes with high interest rates, it provides a quick line of credit for many firms,
including start-up companies who may not be able to secure bank loans.
A. factoring
B. credit cards
C. commercial paper
D. promissory notes
Answer: B
Bloom’s: Remember
248. Many small businesses rely on factoring as a source of short-term financing because:
A. factoring provides a much cheaper source of funds than bank loans.
B. interest paid to a factor qualifies for a tax credit.
C. small firms often find it difficult to qualify for bank loans.
D. loans provided by factors do not require collateral.
Feedback: Factoring is the sale of accounts receivables at a discount for cash. Since factoring
involves a sale of an asset, the funds received are not a loan. Small businesses often find it
difficult to obtain loans from bankers. These same firms often can obtain the needed funds
from factors if their customers are judged to be creditworthy.
Answer: C
18-77
249. Which of the following organizations would be most likely to acquire short-term
funding by issuing commercial paper?
A. A well-known, financially stable corporation
B. A small business that is unable to qualify for loans from commercial banks
C. A firm with a significant percentage of current assets held as accounts receivable
D. A company that prefers equity financing to obtain short-term funds
Feedback: Commercial paper consists of unsecured promissory notes. Because the notes are
unsecured, only large, financially sound corporations are able to sell them.
Answer: A
250. As a result of cash flow shortages, Millard's Department Stores has fallen behind in
payments to suppliers. Some suppliers are withholding shipments to Millard's until they
receive payments on overdue accounts. To meet their immediate needs, Millard's
Department Stores should utilize:
A. vulture capital.
B. long-term financing.
C. contingency capital.
D. short-term financing.
Feedback: Finance managers use short-term financing to run the day-to-day operations. This
includes the purchase of inventory and supplies.
Answer: D
Bloom’s: Apply
18-78
251. Maryland Nursery offers customers credit terms of 3/15 net 30. This gives customers a:
A. 15 percent discount if they pay in three days.
B. 3 percent discount if they pay in thirty days.
C. 3 percent discount if they pay in fifteen days.
D. 15 percent discount if they pay in thirty days.
Feedback: The terms 3/15, net 30 indicate that a 3% discount is offered to customers paying
by the 15th day after the billing. No discount is offered to customers paying between the 16th
and the 30th day after the billing.
Answer: C
Bloom’s: Apply
252. To secure financing for a planned expansion, Ohio Electronics borrowed $400,000 from
King Finance. The ________ loan agreement requires that Ohio Electronics provide the
title to their factory as collateral.
A. recapitalization
B. secured
C. pledged
D. minority
Feedback: A secured loan is a loan that's backed by something of value, such as property or
collateral. If the borrower fails to pay the loan, the lender may take possession of the
collateral.
Answer: B
Bloom’s: Apply
18-79
253. Farmers Savings and Loan agreed to extend Eckert's Orchards $200,000 of unsecured
short-term funds, contingent upon the bank having the funds available. This arrangement
represents a:
A. line of credit.
B. pledge agreement.
C. factoring agreement.
D. trade voucher.
Feedback: A line of credit is an agreement that states that a bank will extend a specified
amount of unsecured short-term credit to a business, provided that the bank has the funds
available.
Answer: A
Bloom’s: Apply
254. Energy-wise Builders, Inc., a leader in residential housing, recently negotiated a

financing arrangement with First Pennsylvania Bank. The short-term funding agreement
guarantees a specified amount of funds would be made available upon Energy-wise's
request. This arrangement represents a:
A. line of credit.
B. pledging agreement.
C. revolving credit agreement.
D. contingency reserve.
Feedback: A revolving credit agreement is a line of credit that is guaranteed by the financial
institution.
Answer: C
Bloom’s: Apply
18-80
255. Virginia Supply offers their customers trade credit with terms 2/15 net 30. This implies
that:
A. Virginia's customers have very little incentive to pay within the discount period.
B. paying within 30 days will let a customer deduct 15% off the invoice price.
C. most customers will pay their bill within 2 days in order to take the maximum discount.
D. the annual financing cost of failing to pay within 15 days is about 48%.
Feedback: The terms state that Virginia Supply will allow a 2 percent discount if a customer
pays within 15 days. If the customer does not pay during the 15-day discount period, the
entire amount is due within 30 days of the invoice date. Thus, the customer pays 2% more for
waiting for 15 additional days before making payment. Using the computational method
described in the text, there are approximately 24 15-day periods in a year, so the annual rate is
2% per period x 24 periods = 48%.
Answer: D
Bloom’s: Apply
256. The financial manager of Carolina Graphics negotiated a ________ with her bank that
allows Carolina to borrow up to $50,000 without collateral. This arrangement eliminates
the need to renegotiate the terms of the loan and complete new paperwork each time
Carolina borrows money. The preapproved short-term loan agreement is contingent upon
the bank having the funds available.
A. line of credit
B. factor agreement
C. cash flow conversion
D. renewable income option
Feedback: A line of credit means that a bank will lend your business a given amount of
unsecured short-term funds, provided that the bank has the funds readily available.
Answer: A
Bloom’s: Apply
18-81
257. Vitale Jewelers obtains needed short-term funds by selling its accounts receivable to the
Friendly Finance Company. Friendly Finance usually pays Vitale about 80% of the value
of the receivables. Vitale Jewelers utilizes ________ as a means of raising short-term
funds.
A. trade credit
B. revolving credit agreements
C. factoring
D. receivable draft agreements
Feedback: Factoring is the process of selling accounts receivable at a discount for cash. The
factor assumes the risk of collecting on the accounts receivable.
Answer: C
Bloom’s: Apply
258. Long-term financing would normally be used to purchase:
A. supplies.
B. inventory.
C. buildings.
D. highly liquid assets.
Answer: C
Bloom’s: Remember
18-82
259. Businesses match their long-term capital needs to:
A. the firm's debt to equity ratio.
B. the ratio of long-term vs. short-term capital available.
C. trade credit discounts.
D. their long-term goals and objectives.
Answer: D
Bloom’s: Remember
260. Businesses acquire long-term financing from two major sources:
A. debt financing and government funds.
B. equity financing and trade credit.
C. retained earnings and commercial paper.
D. debt financing and equity financing.
Answer: D
Bloom’s: Remember
261. When using ________ financing, the company incurs a legal obligation to repay the
amount borrowed.
A. debt
B. equity
C. retained earnings
D. commitment
Answer: A
18-83
Bloom’s: Remember
262. A promissory note that requires the borrower to repay the loan in specified installments
is called a(n):
A. repayment scheduling.
B. term loan agreement.
C. amortization installment.
D. revolving line of credit.
Answer: B
Bloom’s: Remember
263. A less-established company, or a company with a high debt to equity ratio, would be
considered a riskier investment to the lender. Which of the following principles attests to
this axiom?
A. Direct relationship principle
B. Compensating balance concept
C. Risk/return trade-off
D. Cost-benefit analysis
Answer: C
Bloom’s: Remember
18-84
264. A _________ represents a long-term debt obligation issued by a corporation or a
government.
A. share of stock
B. commercial note
C. certificate of deposit
D. bond
Answer: D
Bloom’s: Remember
Topic: Bonds
265. The terms of the agreement in a bond issue are referred to as the:
A. articles of the issue.
B. terms of indebtedness.
C. bond specifications.
D. indenture terms.
Answer: D
Bloom’s: Remember
Topic: Bonds
266. Which of these is backed only by the reputation of the issuer?
A. Venture capital
B. Secured bonds
C. Debenture bonds
D. Long-term financing
Answer: C
18-85
Bloom’s: Remember
Topic: Bonds
267. Which of the following provides the buyer with collateral?
A. Common stock
B. Secured bond
C. Unsecured bond
D. Debenture bonds
Answer: B
Bloom’s: Remember
Topic: Bonds
268. Through equity financing, stockholders become _________ of the firm.
A. creditors
B. employees
C. suppliers
D. owners
Answer: D
Bloom’s: Remember
18-86
269. __________ represent a favorable source of meeting long-term financing needs because
there are no interest payments, dividends, or underwriting fees required when using this
source.
A. Secured bonds
B. Debentures
C. Warrants
D. Retained earnings
Answer: D
Bloom’s: Remember
270. __________ provide financing to new or emerging companies with high profit
potential. In return, these organizations expect a share of ownership in the company.
A. Commercial banks
B. Venture capital firms
C. Federal Reserve banks
D. Investment bankers
Answer: B
Bloom’s: Remember
18-87
271. __________ refers to the strategy of using borrowed funds to increase the rate of return
for stockholders.
A. Leverage
B. Retained earnings
C. Factoring
D. Pledging
Answer: A
Bloom’s: Remember
272. The rate of return a company must earn to meet the demands of its lenders and
expectations of its equity holders is called:
A. opportunity rate.
B. retained earning.
C. cost of capital.
D. acquisition cost.
Answer: C
Bloom’s: Remember
18-88
273. The interest paid on ________ represents a tax-deductible business expense.
A. bonds
B. stock
C. retained earnings
D. depreciated assets
Feedback: Lenders usually require borrowers to pay interest on loans. Firms must also pay
interest to their bondholders. Interest payments are deductible expenses on the firm's income
statement.
Answer: A
Topic: Bonds
274.Which of these is a common source of long-term financing for a corporation?
A. a revolving credit agreement
B. commercial paper
C. a bond issue
D. trade credit
Feedback: When firms issue bonds, they are seeking a very large, long-term loan. Investors
will lend their money to the company in exchange for one or more bonds. The company will
borrow these funds for an extended period of time, anywhere from two to several years, with
the understanding that the bondholder expects repayment, plus interest.
Answer: C
Topic: Bonds
18-89
275. One of the primary factors that influences the interest rate a firm pays on long-term
loans is the:
A. intensity of competition the firm faces with new products.
B. current level of government regulations.
C. general level of market interest rates.
D. exchange rate of the euro to the U.S. dollar.
Feedback: A business's credit rating, the type of collateral offered, and the general level of
market interest rates are factored into the rate of interest a company will pay.
Answer: C
276. Venture capital firms look to invest their funds in firms that __________.
A. operate in established, mature industries.
B. present financial statements indicating stronger than average cash flows.
C. are new with great profit potential.
D. require extra funding to avoid financial difficulties.
Feedback: Venture capital is a source of funds for new and emerging companies with great
profit potential.
Answer: C
18-90
277. Which of these statements about corporate bonds is correct?
A. Bonds provide equity financing.
B. Issuing new bonds dilutes the existing ownership in the firm.
C. Interest paid to bondholders represents a tax-deductible business expense.
D. Debenture bonds require assets pledged as collateral.
Feedback: Corporate bonds are essentially long-term IOUs issued by corporations. The
interest paid on long-term debt is a tax-deductible expense.
Answer: C
18-91
278. Successful use of financial leverage requires a firm to:
A. negotiate with lenders to establish a line of credit.
B. establish and operate a venture capital organization to minimize the use of equity
financing.
C. register with the local government commission that administers market leverage.
D. earn a higher return on its investments than the interest rate it pays to acquire funds.
Feedback: The goal of leverage is to use borrowed funds to increase a firm's rate of return.
This can be accomplished by investing borrowed funds at a higher rate of return than the cost
of acquiring those funds.
Answer: D
279. To maximize the benefits of using financial leverage, a firm should:
A. strive to minimize their cost of capital.
B. avoid securing funds through long-term debt financing.
C. limit their investments to projects with minimum risk levels.
D. incorporate in states with relatively low tax rates.
Feedback: Financial leverage involves raising needed funds through borrowing to increase a
firm's rate of return. By reducing the cost of acquiring funds, the firm positions itself to earn a
rate of return greater than the interest costs associated with borrowing.
Answer: A
18-92
280. As John considers approaching a venture capital firm to provide funding for his new
software firm, he should realize that a venture capital firm will:
A. offer no more than 20 percent of the funding he needs.
B. charge a higher interest rate than a commercial bank.
C. expect the company to provide a steady dividend income.
D. probably want an ownership interest in the business.
Feedback: Venture capitalists typically expect a share of ownership in the company.
Answer: D
Bloom’s: Apply
281. By purchasing stock in Entertainment Today, Veronica has become a(n) ________ the
company.
A. creditor of
B. owner of
C. general partner of
D. venture capitalist in
Feedback: Selling stock in an organization is actually selling ownership in a firm.
Answer: B
Bloom’s: Apply
18-93
282. After earning $30 million in net income, Rolatrim Industries distributed $5 million in
dividends to their stockholders. The board of directors of the firm decided to invest the
remaining $25 million back into the business. This $25 million reinvestment of profits
represents:
A. a trust fund.
B. retained earnings.
C. preferred capital.
D. mutual funds.
Feedback: Retained earnings are the profits the company keeps and reinvests in the firm.
Answer: B
Bloom’s: Apply
283. After enjoying increased sales of and profits from several popular products, Braggs &
Stritton plans to expand their production facilities. The firm, a well-known producer of
lawn care products, prefers financing this project with a funding source that avoids
interest and dividend payments as well as underwriting costs. Which of the following
best meets the needs of Braggs & Stritton?
A. Venture capital
B. Debenture bonds
C. Common stock
D. Retained earnings
Feedback: Retained earnings are often the most favored source of meeting long-term capital
needs since the company saves interest payments, dividend payments, and underwriting costs.
Answer: D
Bloom’s: Apply
18-94
284. Chunky Chicken, Inc., announced yesterday that it plans to issue $100 million in
debenture bonds to fund the expansion of its fast food chain of restaurants. In financial
terms, this means:
A. the corporation will borrow $100 million worth of long-term financing. The bond issue
will not carry any collateral.
B. the corporation will issue $100 million worth of equity financing. The bond issue will be
backed by the property and buildings purchased with the funds.
C. the corporation will borrow $100 million worth of long-term financing. The issue will be
backed by the property and buildings purchased with the funds.
D. the corporation will issue $100 million worth of interest-free bonds. Financiers will be paid
from the revenues created by the individual franchises.
Feedback: Debenture bonds are unsecured bonds that are not supported by collateral. The
company is engaging in debt financing through the issuance of long-term bonds.
Answer: A
Bloom’s: Apply
285. Arborview Plant Science Company has invented a drought resistant grass seed that only
needs watering three times each year. In order to expand distribution worldwide, the
company whose product produces lush green foliage needs a large amount of funding—
fast! The handful of seed scientists that own the company decide to offer shares of stock
to general investors. This first-time offering is a(n):
A. Stock Equity Commission (SEC).
B. Stock Fund Offering (SFO).
C. Broad-Based Offering (BBO).
D. Initial Public Offering (IPO).
Feedback: The first time a company offers to sell its stock to the general public, the event is
called an initial public offering.
Answer: D
Bloom’s: Apply
18-95
286. Arborview Plant Science Company has invented a drought resistant grass seed that only
needs watering three times each year. In order to expand distribution worldwide, the
company whose product produces lush green foliage needs serious funding. The handful
of seed scientists that own the company are seeking ____________, but understand that
they will relinquish a sizeable share of ownership in order to obtain the funds.
A. debenture capital
B. international line of credit
C. leverage
D. venture capital
Feedback: Venture capital is money invested in new or emerging companies that have great
profit potential. Venture capitalists usually demand a share of ownership in return for equity
funding.
Answer: D
Bloom’s: Apply
18-96
287. Which of the following situations represents a successful use of financial leverage?
A. A firm issues new shares of stock and uses the proceeds from the sale to retire its
outstanding debt.
B. A firm borrows money at 8% and earns an 11% return on its investment of these funds.
C. A firm attracts the interest of two venture capitalists, and plays one against the other to gain
the best deal.
D. A retail firm purchases merchandise at $10 and sells it for $15.
Feedback: Leverage refers to the use of borrowed funds to increase the return to stockholders.
Of course, to increase the firm's rate of return to stockholders, the borrowed funds must be
invested to earn more than the interest cost of the borrowed funds. Borrowing at 8% and
investing at 11% is an example of a successful use of leverage.
Answer: B
Bloom’s: Apply
18-97
Essay Questions
288. What is financial management? Identify the duties and responsibilities of financial
managers.
Answer: Financial management is the job of managing a firm's resources so that it can meet
its goals and objectives. It is therefore, a critical activity in both profit-seeking and nonprofit
organizations, no matter the size.
The fundamental charge of financial managers is to obtain money and then plan, use, and
control that money effectively. Responsibilities include forecasting, budgeting, and managing
cash, accounts receivable and inventory.
Financial managers are responsible for paying the organization's bills in a timely manner.
Additionally, they are involved in making decisions about buying merchandise on credit and
collecting payments from customers. They are responsible for collecting overdue payments
and dealing with bad debts.
Another critical area for financial managers is tax management. As tax laws and tax liabilities
have changed, finance specialists have become increasingly involved in the analysis of tax
implications on various types of management decisions. The objective of this analysis is to
find ways to legally minimize the taxes paid by the business.
Finally, some members of the finance department, known as internal auditors, may have the
responsibility of checking the journals, ledger, and financial statements prepared by the firm's
accounting department to ensure that they are consistent with generally accepted accounting
rules and procedures.

Bloom’s: Apply
18-98
289. Identify and describe the major steps involved in financial planning.
Answer: There are three major steps involved in financial planning:
Step one in financial planning is to forecast both short-term and long-term financial needs.
The short-term forecast predicts revenues, costs and expenses for a period of one year or less.
This forecast is the foundation for most other financial plans, so accuracy is critical. A long-
term forecast predicts revenues, costs and expenses for a period longer than one year, and
sometimes for as much as 5 to 10 years into the future. This type of forecast is important in
the formulation of a firm's strategic plan.
The second step in financial planning is to develop a set of budgets. A budget serves as the
primary basis and guide for the firm's financial operations. Most firms develop their budgets
from the short-term and long-term financial forecasts that were developed in step one. Firms
typically develop several types of budgets, including an operating budget, a capital budget, a
cash budget, and a master budget. The master budget ties together all of the other budgets and
summarizes the proposed financial activities of the firm.
The third and final step in financial planning is financial control, which consists of comparing
actual revenues, costs, and expenses to projected values in order to locate any deviations and
take corrective action if necessary. Most firms hold financial reviews at least once a month to
ensure adequate financial control.

Bloom’s: Apply
18-99
290. Explain the role the operating budget, the capital budget, and the cash budget play in
financial planning.
Answer: The operating budget (master budget) ties together all the firm's other budgets and
summarizes the business's proposed financial activities. An operating budget is the projection
of dollar allocations to various costs and expenses incurred in operating the business, given
projected revenues. Operating budgets get into the planning of how much the firm will spend
on operating expenses such as travel, supplies, rent, advertising, salaries, etc.
A capital budget highlights the firm's spending plans for major asset purchases that often
require large sums of money. The acquisition of assets such as property, buildings, machinery,
and equipment is covered in these budgets.
A cash budget estimates a firm's projected cash inflows and outflows that the firm can use to
plan for any cash shortages or surpluses during a given period. It usually will cover specific
periods such as months, quarters, etc. Cash budgets are important guidelines that help
managers to anticipate borrowing, repaying debt, operating expenses, and short-term
investments. The cash budget is often the last budget that is prepared.

Bloom’s: Apply
Topic: Budgeting
18-100
291. Identify and describe three types of short-term financing.
Answer: Students may mention that short-term financing is the key job of the finance manager. They can select
from a wide range of options in answering this question. The following are specific types of short-term
financing:
Trade credit is the most widely used source of short-term financing. This refers to buying goods today and being
able to pay for them later. Discounts are often available with the use of trade credit to encourage firms to pay
quickly.
Promissory notes are often required from customers as a condition of obtaining credit. A promissory note is a
written contract with a promise to pay. Promissory notes can be sold by the supplier to a bank at a discount (the
amount of the note less a fee for the bank's service).
Family and friends are another source of short-term financing, though the text mentions that the National
Federation of Independent Businesses has found that entrepreneurs have come to rely less and less on this source
over the years. It's important to remember to treat this source of funding just as you would treat financing from
any other source.
Commercial banks are also a source of short-term financing, as are commercial finance companies. Businesses
are well advised to keep in contact with banks and build a relationship that ensures financing when needed.
Banks tend to be conservative and are often reluctant to lend money to new or risky ventures. Finance companies
are willing to accept higher levels of risk than commercial banks, but they also charge higher interest rates.
Finance companies typically require borrowers to offer tangible assets as collateral. Banks may also demand
some form of collateral, though in some cases they offer unsecured loans. (The stronger the firm, the more likely
the firm will be able to obtain an unsecured loan.) Other financing options available from commercial banks
include:
 pledging: using accounts receivable as security.
 inventory financing: financing that uses inventory such as raw materials as collateral.
 line of credit: an arrangement in which the bank will lend a given amount so long as the funds are available.
 revolving credit agreement: a line of credit that is guaranteed by the bank.
Factoring involves the process of selling accounts receivable for cash. The factor buys the accounts receivables
at a discount. The discount rate depends on the age of the accounts, the nature of the business, and the condition
of the economy. Also, the discount will be less if the firm selling the receivables is willing to assume the risk for
nonpaying customers.
18-101
Commercial paper consists of unsecured promissory notes, in amounts of $100,000 or more that mature in 270
days or less. The notes state a specific amount of money the business agrees to repay by a stated date. Since
commercial paper is unsecured, only well-known, financially stable corporations typically issue it.
Credit cards are used by about half of all small businesses to form or expand the business. Credit cards provide a
readily available line of credit to a business that can save time and the likely embarrassment of being rejected for
a bank loan. They are extremely risky and costly. Credit cards are an expensive way to borrow money and are
probably best used as a last resort.

Bloom’s: Apply
18-102
292. What is equity financing? Identify and describe the major sources of equity financing.
Answer: Equity capital represents money raised from within the firm or through the sale of
ownership in the firm.
The major sources of equity capital are sale of stock, retained earnings, and funds provided by
venture capital firms.
A share of stock represents a share of ownership in a corporation. The corporation's board of

directors normally decides how many shares of stock will be issued and authorizes the sale of
stock to the public. However, before a company can issue shares for sale to the public it must
meet requirements set by the Securities and Exchange Commission (SEC).
Retained earnings are the profits a company keeps and reinvests. This is a very attractive
source of funds, because it saves the firm from having to pay the interest, dividends or
underwriting fees associated with issuing securities. Moreover, unlike new stock issues, this
source of financing does not dilute ownership. Obviously, however, this source of financing is
limited by the amount of profits the firm has available.
Venture capital firms provide funds to new companies that they believe have great profit
potential. Venture capitalists generally provide their funds in exchange for a share of
ownership in the firm. They also typically expect a high rate of return on their investment.
Many famous companies, including Apple Computer, Compaq, Sun Microsystems, and
Boeing received funds from venture capitalists when they were just starting out.

Bloom’s: Apply
18-103
293. What are two major forms of debt financing? Describe and differentiate between the
two types.
Answer: The two forms of debt financing are (1) selling bonds, and (2) long-term loans from
individuals, banks, and other financial institutions.
Long-term loans are usually due within 3 to 7 years but may extend to 15 or 20 years. A term-
loan agreement is a promissory note that requires the borrower to repay the loan with interest
in specified monthly or annual installments. Loans usually require the payment of interest to
the lender. The lender requires a higher interest payment to compensate for higher-risk loans.
A firm or government issues bonds, in return for a large sum of money. The bond is an IOU
that is held by the bondholder until the borrowed funds are repaid at a future designated date.
The bond indenture specifies how and when bondholders will receive interest payments for
lending their money to the institution. Bonds are like other forms of long-term debt; they may
be secured or unsecured (debenture bonds).

Bloom’s: Apply
294. Explain the term leverage. When is it more favorable for firms to use this strategy?
Answer: Leverage is borrowing funds to invest in expansion, major asset purchases, or

research and development that may take several years to produce a product or service.
Firms will employ leveraging when the risk of borrowing is measurably less than the value of
potential profits that will result from the investment of capital. The goal is that the return on
investment will be greater than the cost of debt.

Bloom’s: Apply
18-104
Multiple Choice Questions
Mini-Case
Tishian's Funeral Home has been in business for over 80 years. Throughout its history, the
firm has been a family-run operation. Today, the business is managed by Mort Tishian, a
grandson of the founder. Unfortunately, Mort Tishian's tenure has been plagued with problems
neither his father nor grandfather before him experienced. The reason is simple: the funeral
business is undergoing rapid change. Small, family-owned funeral homes are losing ground to
a new type of competitor, a large national network service that resembles a franchise system.
More and more families "in their time of need" are choosing the new, highly promoted
competitors instead of the traditional small family-operated funeral homes.
This trend has required a response from organizations like Tishian's Funeral Home. Bigger
and better facilities are needed to remain competitive. All of this puts more pressure on the
family owners to be more active in the financial side of the business. Mort summed it up best
when he said, "Grandpa told people, 'You pay me when you can, I ain't goin' nowheres.'" His
creditors did the same with him. Today, it's a different game. Cash flow is key, and obtaining
funds is no simple task. Additionally, creditors want their money now, not later. Banks are
also more demanding. "Heck, Grandpa knew all the bankers he dealt with personally. I see
new faces every time I go to the bank. If things don't get better, I suspect after eighty years of
service, Tishian's Funeral Home will have its own funeral."
295. Mort Tishian feels it's necessary to predict revenues, costs, and expenses on a six-month
basis. "It's the only way you get an idea of what to expect," explains Mort. In order to
obtain these predictions, Mort needs to develop a(n):
A. cash-basis accounting system.
B. short-term forecast.
C. capital budget.
D. econometric model.
Feedback: A short-term forecast is a prediction of revenue, costs, and expenses for a period of
one year or less.
Answer: B
Bloom’s: Analyze
18-105
296. Mort is seriously considering a major expansion in the size of his funeral home. The
money spent on this type of project would be classified as a(n):
A. capital expenditure.
B. equity expenditure.
C. off-budget expense.
D. depreciation charge.
Feedback: A capital expenditure is a major investment in a long-term asset such as a building,

land, and equipment, or intangible assets such as patents, trademarks, and copyrights.
Answer: A
Bloom’s: Analyze
297. To raise the funds for the major improvements needed at the funeral home, Mort has
talked to two investors about incorporating his business and selling them shares of stock
in the company. Mort is considering the use of:
A. debt financing.
B. commercial paper.
C. equity financing.
D. revolving credit.
Feedback: Equity financing is money raised from retained earnings or through the sale of
ownership in the firm.
Answer: C
Bloom’s: Analyze
18-106
298. Mort approached the chief lending officer at First Virginia Bank about obtaining a
$75,000 loan. The banker said she would approve the loan provided that the funeral
home's building was pledged as collateral. The banker was offering a(n):
A. trade credit agreement.
B. institutional loan.
C. secured loan.
D. revolving credit agreement.
Feedback: A secured loan is one backed by something valuable, such as property.
Answer: C
Bloom’s: Analyze
299. After much searching, Mort located an old banking friend of his father's. The banker
offered Mort up to $25,000 in unsecured funds, which Mort's firm could borrow any
time within a year, as long as the bank has the money available. Mort was offered a(n):
A. revolving credit agreement.
B. asset guarantee pledge.
C. pledging agreement.
D. line of credit.
Feedback: A line of credit is an agreement with a bank to provide a business a maximum

amount of money in an unsecured, short-term loan. However, this agreement is subject to the
bank having the necessary funds available.
Answer: D
Bloom’s: Analyze
18-107
300. After seeing Mort's advertisement: "You Aren't Gettin' Any Younger! Start Planning for
Heaven Today!" a(n) ___________ firm decided the aging population was a good
investment. Although they typically look at start-ups with great promise, they
approached Mort with $6 million dollars for his new idea of a major three-city
expansion that included six new funeral homes, a crematory, and mausoleum. After
researching the offer, Mort agreed to give up 50% ownership of the business in order to
secure these funds. His last thoughts as he began to sign the papers were: "Now, I'll be
able to compete with the big guys!"
A. retained earnings
B. indentured
C. venture capital
D. leveraged buyout
Feedback: Venture capital is money that is invested in new or emerging companies that are
perceived as having great profit potential.
Answer: C
Bloom’s: Analyze
18-108

Test Planning Table For Chapter 18: Learning Objective Knows Basic Understands Applies Principles

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Chapter 18 - Financial Management

TEST PLANNING TABLE FOR CHAPTER 18

LL:1 LL:2 LL:3

1. Explain the role and 1,2,3,4,5,6,7,8,9,10,11,12, 21,22,23,24,25,26,27, 31,32,33,

2. Outline the financial 34,35,36,37,38,39,40,41, 55,56,57,58,59, 60,61,62,63,64,65,

3. Explain why firms 66,67,68,69,70,71,72,73, 84,85,86,87,88,89,90, 96,9798,99,100,101,

4. Identify and describe 102,103,104,105,106,107, 125,126,127,128,129~, 130,131,132,133,134,

5. Identify and describe 135,136,137,138,139,140, 159,160,161,162,163, 166,167,168,169,170,

Total number of test items: 300

True/false questions are in plain text.

True / False Questions

3. A financial manager makes recommendations to top executives regarding strategies for

7. Financial managers examine the data prepared by accountants and make

11. While finance is a critical activity for profit-seeking organizations, by definition

14. Financial managers are responsible for controlling cash flows.

15. Undercapitalization refers to the problem of insufficient start-up funds.

16. Investors and entrepreneurs should have an understanding of financial issues.

20. A comptroller is the chief accounting officer of an organization.

Feedback: Accountants perform the technical aspects of gathering, organizing, classifying,

25. Inadequate expense control typically occurs as a result of undercapitalization.

Feedback: Undercapitalization refers to a problem many beginning business ventures have—

30. To be effective, an internal auditor must be critical of any improprieties or deficiencies

Feedback: An organization's accounting statements would be less reliable if an internal

31. As a financial manager, Sabrina's responsibilities include the interpretation of financial

38. A firm's short-term financial forecast provides a projected sales estimate.

81. Equity financing must be repaid.

Feedback: Although a project of this nature is considered a capital expenditure, it may be

103. Small businesses rely heavily on long-term financing.

118. A revolving credit agreement represents a line of credit that is guaranteed.

124. Commercial paper is unsecured short-term debt.

Feedback: Commercial paper consists of unsecured promissory notes in amounts of $100,000

Feedback: A revolving credit agreement is a guaranteed line of credit. This type of

141. A share of stock represents a company-issued IOU including a promise to repay on a

142. A bond represents a long-term debt obligation of a corporation or government.

143. An unsecured corporate bond is known as a debenture bond.

144. A debenture bond is backed only by the reputation of the issuer.

148. Retained earnings represent a source of equity financing.

Multiple Choice Questions

A. Accountants; financial managers

C. Financial managers; accountants

D. Financial managers; bankers

A. Accounting and finance

B. Marketing and finance

C. Production and accounting

D. Finance and research and development

A. profit-seeking, but not for nonprofit organizations.

B. profit-seeking and nonprofit organizations.

C. nonprofit organizations, but not for profit-seeking businesses.

D. accountants, but not for financial managers.

175. Undercapitalization refers to the problem of:

A. insufficient start-up funds.

B. inadequate control of expenses.

C. inappropriate cash flows.

D. undervalued capital stock.

176. Which of the following statements is most accurate?

A. Accounting and finance are not related.

B. Financial managers keep the books for a firm.

C. Financial managers need to understand accounting.

D. Nonprofit organizations must choose between accounting and finance.

B. Inability to recruit qualified workers

C. Poor advertising messages

D. Inadequate market control

179. Which of the following statements about taxes is accurate?