Corporate Finance Exam 3

If a firm takes actions that reduce its days sales outstanding (DSO), then, other things held constant, this will lengthen its cash conversion cycle (CCC). True False

False

If one of your firm's customers is "stretching" its accounts payable, this may be a nuisance but it does not represent a real financial cost to your firm as long as the customer periodically pays off its entire balance. True False

False

Which of the following actions would be likely to shorten the cash conversion cycle? - Change the credit terms offered to customers from 3/10 net 30 to 1/10 net 50. - Begin to take cash discounts on inventory purchases; the terms are 2/10 net 30. - Adopt a new manufacturing process that saves some labor costs but slows down the conversion of raw materials to finished goods from 10 days to 20 days. - Change the credit terms offered to customers from 2/10 net 30 to 1/10 net 60. - Adopt a new manufacturing process that speeds up the conversion of raw materials to finished goods from 20 days to 10 days.

Adopt a new manufacturing process that speeds up the conversion of raw materials to finished goods from 20 days to 10 days.

Which of the following statements is CORRECT? - The capital structure that maximizes the stock price is generally the capital structure that also maximizes earnings per share. - All else equal, an increase in the corporate tax rate would tend to encourage a company to increase its debt ratio. - Since debt financing raises the firm's financial risk, increasing a company's debt ratio will always increase its WACC. - Since debt is cheaper than equity, increasing a company's debt ratio will always reduce its WACC. - When a company increases its debt ratio, the costs of equity and debt both increase. Therefore, the WACC must also increase.

All else equal, an increase in the corporate tax rate would tend to encourage a company to increase its debt ratio.

Which of the following statements is CORRECT? - Although short-term interest rates have historically averaged less than long-term rates, the heavy use of short-term debt is considered to be an aggressive strategy because of the inherent risks associated with using short-term financing. - If a company follows a policy of "matching maturities," this means that it matches its use of common stock with its use of long-term debt as opposed to short-term debt. - Net working capital is defined as current assets minus the sum of payables and accruals, and any decrease in the current ratio automatically indicates that net working capital has decreased. - If a company follows a policy of "matching maturities," this means that it matches its use of short-term debt with its use of long-term debt. - Net working capital is defined as current assets minus the sum of payables and accruals, and any increase in the current ratio automatically indicates that net working capital has increased.

Although short-term interest rates have historically averaged less than long-term rates, the heavy use of short-term debt is considered to be an aggressive strategy because of the inherent risks associated with using short-term financing.

Which of the following statements is CORRECT, holding other things constant? - An increase in the personal tax rate is likely to increase the debt ratio of the average corporation. -If changes in the bankruptcy code make bankruptcy less costly to corporations, then this would likely reduce the debt ratio of the average corporation. -An increase in the company's degree of operating leverage is likely to encourage a company to use more debt in its capital structure. - An increase in the corporate tax rate is likely to encourage a company to use more debt in its capital structure. - Firms whose assets are relatively liquid tend to have relatively low bankruptcy costs, hence they tend to use relatively little debt.

An increase in the corporate tax rate is likely to encourage a company to use more debt in its capital structure.

Which of the following events is likely to encourage a company to raise its target debt ratio, other things held constant? - An increase in the personal tax rate. - An increase in the company's operating leverage. - The Federal Reserve tightens interest rates in an effort to fight inflation. - The company's stock price hits a new high. - An increase in the corporate tax rate.

An increase in the corporate tax rate.

Which of the following would increase the likelihood that a company would increase its debt ratio, other things held constant? - An increase in the corporate tax rate. - An increase in the personal tax rate. - The Federal Reserve tightens interest rates in an effort to fight inflation. - The company's stock price hits a new low. - An increase in costs incurred when filing for bankruptcy.

An increase in the corporate tax rate.

Net working capital is defined as current assets divided by current liabilities. True False

False

Dimon Products' sales are expected to be $5 million this year, with 90% on credit and 10% for cash. Sales are expected to grow at a stable, steady rate of 10% annually in the future. Dimon's accounts receivable balance will remain constant at the current level, because the 10% cash sales can be used to support the 10% growth rate, other things held constant. True False

False

Which of these items will not generally be affected by an increase in the debt ratio? Total risk. Financial risk. Market risk. The firm's beta. Business risk.

Business Risk

Which of the following items should a company report directly in its monthly cash budget? - Cash proceeds from selling one of its divisions. - Accrued interest on zero coupon bonds that it issued. - New shares issued in a stock split. - New shares issued in a stock dividend. - Its monthly depreciation expense.

Cash proceeds from selling one of its divisions.

Which of the following statements is NOT CORRECT? - Accruals are "free" in the sense that no explicit interest is paid on these funds. - A conservative approach to working capital management will result in most, if not all, permanent current operating assets being financed with long-term capital. - The risk to a firm that borrows with short-term credit is usually greater than if it borrowed using long-term debt. This added risk stems from the greater variability of interest costs on short-term debt and possible difficulties with rolling over short-term debt. - Bank loans generally carry a higher interest rate than commercial paper. - Commercial paper can be issued by virtually any firm so long as it is willing to pay the going interest rate.

Commercial paper can be issued by virtually any firm so long as it is willing to pay the going interest rate.

Which of the following statements is CORRECT? - Commercial paper is a form of short-term financing that is primarily used by large, strong, financially stable companies. - Short-term debt is favored by firms because, while it is generally more expensive than long-term debt, it exposes the borrowing firm to less risk than long-term debt. - Commercial paper can be issued by virtually any firm so long as it is willing to pay the going interest rate. - Commercial paper is typically offered at a long-term maturity of at least five years. - Trade credit is provided only to relatively large, strong firms.

Commercial paper is a form of short-term financing that is primarily used by large, strong, financially stable companies.

Firm A has a higher degree of business risk than Firm B. Firm A can offset this by using less financial leverage. Therefore, the variability of both firms' expected EBITs could actually be identical.

False

Two operationally similar companies, HD and LD, have identical amounts of assets, operating income (EBIT), tax rates, and business risk. Company HD, however, has a much higher debt ratio than LD. Company HD's return on invested capital (ROIC) exceeds its after-tax cost of debt, (1-T) rd. Which of the following statements is CORRECT? - Company HD has a higher times interest earned (TIE) ratio than Company LD. - Company HD has a higher return on equity (ROE) than Company LD, and its risk, as measured by the standard deviation of ROE, is also higher than LD's. - The two companies have the same ROE. - Company HD's ROE would be higher if it had no debt. - Company HD has a higher return on assets (ROA) than Company LD.

Company HD has a higher return on equity (ROE) than Company LD, and its risk, as measured by the standard deviation of ROE, is also higher than LD's.

Companies HD and LD have identical tax rates, total assets, and return on invested capital (ROIC), and their ROIC exceeds their after-tax cost of debt, (1-T) rd. However, Company HD has a higher debt ratio and thus more interest expense than Company LD. Which of the following statements is CORRECT? - Company HD has a lower ROA than Company LD. - Company HD has a lower ROE than Company LD. - The two companies have the same ROA. - The two companies have the same ROE. - Company HD has a higher net income than Company LD

Company HD has a lower ROA than Company LD.

Other things held constant, which of the following would tend to reduce the cash conversion cycle? - Place larger orders for raw materials to take advantage of price breaks. - Take all cash discounts that are offered. - Continue to take all cash discounts that are offered and pay on the net date. - Offer longer payment terms to customers. - Carry a constant amount of receivables as sales decline.

Continue to take all cash discounts that are offered and pay on the net date.

If a firm busy on terms of 2/10 net 30, it should pay as early as possible during the discount period. True False

False

If a firm has a large percentage of accounts over 30 days old, this is proof positive that its receivables manager is not doing a good job. True False

False

Net working capital, defined as current assets minus the sum of payables and accruals, is equal to the current ratio minus the quick ratio. True False

False

Which of the following statements concerning the cash budget is CORRECT? - Cash budgets do not include financial items such as interest and dividend payments. - Cash budgets do not include cash inflows from long-term sources such as the issuance of bonds. - Changes that affect the DSO do not affect the cash budget. - Capital budgeting decisions have no effect on the cash budget until projects go into operation and start producing revenues. - Depreciation expense is not explicitly included, but depreciation's effects are reflected in the estimated tax payments.

Depreciation expense is not explicitly included, but depreciation's effects are reflected in the estimated tax payments.

Which of the following is NOT directly reflected in the cash budget of a firm that is in the zero tax bracket? - Depreciation. - Cumulative cash. - Repurchases of common stock. - Payment for plant construction. - Payments lags.

Depreciation.

If a firm sells on terms of 2/10 net 30 days, and its DSO is 28 days, then the fact that the 28-day DSO is less than the 30-day credit period tells us that the credit department is functioning efficiently and there are no past-due accounts. True False

False

If a firm switched from taking trade credit discounts to paying on the net due date, this might cost the firm some money, but such a policy would probably have only a negligible effect on the income statement and no effect whatever on the balance sheet. True False

False

"Stretching" accounts payable is a widely accepted, entirely ethical, and costless financing technique. True False

False

A firm's business risk is largely determined by the financial characteristics of its industry, especially by the amount of debt the average firm in the industry uses.

False

A firm's peak borrowing needs will probably be overstated if it bases its monthly cash budget on the assumption that both cash receipts and cash payments occur uniformly over the month but in reality payments are concentrated at the beginning of each month. True False

False

An increase in any current asset must be accompanied by an equal increase in some current liability. True False

False

An informal line of credit and a revolving credit agreement are similar except that the line of credit creates a legal obligation for the bank and thus is a more reliable source of funds for the borrower. True False

False

As the text indicates, a firm's financial risk has identifiable market risk and diversifiable risk components.

False

Because money has time value, a cash sale is always more profitable than a credit sale. True False

False

On average, a firm collects checks totaling $250,000 per day. It takes the firm approximately 4 days from the day the checks were mailed until they result in usable cash for the firm. Assume that (1) a lockbox system could be employed which would reduce the cash conversion procedure to 2 1/2 days and (2) the firm could invest any additional cash generated at 6% after taxes. The lockbox system would be a good buy if it costs $25,000 annually. True False

False

Other things held constant, if a firm "stretches" (i.e., delays paying) its accounts payable, this will lengthen its cash conversion cycle (CCC). True False

False

Provided a firm does not use an extreme amount of debt, financial leverage typically affects both EPS and EBIT, while operating leverage only affects EBIT.

False

Short-term marketable securities are held for two separate and distinct purposes: (1) to provide liquidity as a substitute for cash and (2) as a non-operating investment. Marketable securities held while awaiting reinvestment are not available for liquidity purposes. True False

False

Since depreciation is a non-cash charge, it neither appears on nor has any effect on the cash budget. Thus, if the depreciation charge for the coming year doubled or halved, this would have no effect on the cash budget. True False

False

Since receivables and payables both result from sales transactions, a firm with a high receivables-to-sales ratio must also have a high payables-to-sales ratio. True False

False

The MM model is the same as the Miller model, but with zero corporate taxes. True False

False

The Miller model begins with the MM model without corporate taxes and then adds personal taxes.

False

The cash budget and the capital budget are handled separately, and although they are both important, they are developed completely independently of one another. True False

False

The facts (1) that no explicit interest is paid on accruals and (2) that the firm can control the level of these accounts at will makes them an attractive source of funding to meet working capital needs. True False

False

The graphical probability distribution of ROE for a firm that uses financial leverage would tend to be more peaked than the distribution if the firm used no leverage, other things held constant.

False

The maturity matching, or "self-liquidating," approach to financing involves obtaining the funds for permanent current assets with a combination of long-term capital and short-term capital that varies depending on the level of interest rates. When short-term rates are relatively high, short-term assets will be financed with long-term debt to reduce costs. True False

False

The overriding goal of inventory management is to ensure that the firm never suffers a stock-out, i.e., never runs out of an inventory item. True False

False

The relative profitability of a firm that employs an aggressive current asset financing policy will improve if the yield curve changes from upward sloping to downward sloping. True False

False

Trade credit can be separated into two components: free trade credit, which is credit received after the discount period ends, and costly trade credit, which is the cost of discounts not taken. True False

False

Two firms, although they operate in different industries, have the same expected earnings per share and the same standard deviation of expected EPS. Thus, the two firms must have the same business risk.

False

When a firm has risky debt, its debt can be viewed as an option on the total value of the firm with an exercise price equal to the face value of the equity. True False

False

Firms U and L both have a return on invested capital (ROIC) of 12% and each has the same amount of assets. Firm U is unleveraged, i.e., it is 100% equity financed, while Firm L is financed with 50% debt and 50% equity. Firm L's debt has an after-tax cost of 4.8%. Both firms have positive net income. Which of the following statements is CORRECT? - Firm L has a lower ROA than Firm U. - Firm L has a lower ROE than Firm U. - Firm L has the higher times interest earned (TIE) ratio. - Firm L has a higher EBIT than Firm U. - The two companies have the same times interest earned (TIE) ratio.

Firm L has a lower ROA than Firm U.

Two operationally similar companies, HD and LD, have the same total assets, operating income (EBIT), tax rate, and business risk. Company HD, however, has a much higher debt ratio than LD. Also HD's return on invested capital (ROIC) exceeds its after-tax cost of debt, (1-T)rd. Which of the following statements is CORRECT? - HD should have a higher times interest earned (TIE) ratio than LD. - HD should have a higher return on equity (ROE) than LD, but its risk, as measured by the standard deviation of ROE, should also be higher than LD's. - Given that ROIC > (1-T) rd, HD's stock price must exceed that of LD. - Given that ROIC > (1-T) rd, LD's stock price must exceed that of HD. - HD should have a higher return on assets (ROA) than LD.

HD should have a higher return on equity (ROE) than LD, but its risk, as measured by the standard deviation of ROE, should also be higher than LD's.

Which of the following statements is CORRECT? - A conservative financing policy is one where the firm finances part of its fixed assets with short-term capital and all of its net working capital with short-term funds. - If a company receives trade credit under terms of 2/10 net 30, this implies that the company has 10 days of free trade credit. - One cannot tell if a firm uses a current asset financing policy that matches maturities, is conservative, or is aggressive without an examination of its cash budget. - If a firm has a relatively aggressive current asset financing policy vis-á-vis other firms in its industry, then its current ratio will probably be relatively high. - Accruals are an expensive but commonly used way to finance working capital.

If a company receives trade credit under terms of 2/10 net 30, this implies that the company has 10 days of free trade credit.

Which of the following statements is CORRECT? - If a firm that sells on terms of net 30 changes its policy to 2/10 net 30, and if no change in sales volume occurs, then the firm's DSO will probably increase. - If a firm sells on terms of 2/10 net 30, and its DSO is 30 days, then the firm probably has some past-due accounts. - If a firm sells on terms of net 60, and if its sales are highly seasonal, with a sharp peak in December, then its DSO as it is typically calculated (with sales per day = Sales for past 12 months/365) would probably be lower in January than in July. - If a firm changed the credit terms offered to its customers from 2/10 net 30 to 2/10 net 60, then its sales should increase, and this should lead to an increase in sales per day, and that should lead to a decrease in the DSO. - Other things held constant, the higher a firm's days sales outstanding (DSO), the better its credit department.

If a firm sells on terms of 2/10 net 30, and its DSO is 30 days, then the firm probably has some past-due accounts.

Which of the following statements is NOT CORRECT? - Credit policy has an impact on working capital because it influences both sales and the time before receivables are collected. - The cash budget is useful to help estimate future financing needs, especially the need for short-term working capital loans. - If a firm wants to generate more cash flow from operations in the next month or two, it could change its credit policy from 2/10 net 30 to net 60. - Managing working capital is important because it influences financing decisions and the firm's profitability. - A company may hold a relatively large amount of cash and marketable securities if it is uncertain about its volume of sales, profits, and cash flows during the coming year.

If a firm wants to generate more cash flow from operations in the next month or two, it could change its credit policy from 2/10 net 30 to net 60.

Which of the following statements is CORRECT? - A change in the personal tax rate should not affect firms' capital structure decisions. - "Business risk" is differentiated from "financial risk" by the fact that financial risk reflects only the use of debt, while business risk reflects both the use of debt and such factors as sales variability, cost variability, and operating leverage. - The optimal capital structure is the one that simultaneously (1) maximizes the price of the firm's stock, (2) minimizes its WACC, and (3) maximizes its EPS. - If changes in the bankruptcy code make bankruptcy less costly to corporations, then this would likely reduce the debt ratio of the average corporation. - If corporate tax rates were decreased while other things were held constant, and if the Modigliani-Miller tax-adjusted tradeoff theory of capital structure were correct, this would tend to cause corporations to decrease their use of debt.

If corporate tax rates were decreased while other things were held constant, and if the Modigliani-Miller tax-adjusted tradeoff theory of capital structure were correct, this would tend to cause corporations to decrease their use of debt.

Which of the following statements is CORRECT? - There is no reason to think that changes in the personal tax rate would affect firms' capital structure decisions. - A firm with high business risk is more likely to increase its use of financial leverage than a firm with low business risk, assuming all else equal. - If a firm's after-tax cost of equity exceeds its after-tax cost of debt, it can always reduce its WACC by increasing its use of debt. - Suppose a firm has less than its optimal amount of debt. Increasing its use of debt to the point where it is at its optimal capital structure will decrease the costs of both debt and equity financing. - In general, a firm with low operating leverage also has a small proportion of its total costs in the form of fixed costs.

In general, a firm with low operating leverage also has a small proportion of its total costs in the form of fixed costs.

Which of the following statements is CORRECT? - Since debt financing is cheaper than equity financing, raising a company's debt ratio will always reduce its WACC. - Increasing a company's debt ratio will typically reduce the marginal cost of both debt and equity financing. However, this action still may raise the company's WACC. - Increasing a company's debt ratio will typically increase the marginal cost of both debt and equity financing. However, this action still may lower the company's WACC. - Since a firm's beta coefficient it not affected by its use of financial leverage, leverage does not affect the cost of equity. - Since debt financing raises the firm's financial risk, increasing a company's debt ratio will always increase its WACC.

Increasing a company's debt ratio will typically increase the marginal cost of both debt and equity financing. However, this action still may lower the company's WACC.

Which of the following will cause an increase in net working capital, other things held constant? - Merchandise is sold at a profit, but the sale is on credit. - Long-term bonds are retired with the proceeds of a preferred stock issue. - Missing inventory is written off against retained earnings. - Cash is used to buy marketable securities.

Merchandise is sold at a profit, but the sale is on credit.

The firm's target capital structure should be consistent with which of the following statements? - Minimize the cost of debt (rd). - Obtain the highest possible bond rating. - Minimize the cost of equity (rs). - Minimize the weighted average cost of capital (WACC). - Maximize the earnings per share (EPS).

Minimize the weighted average cost of capital (WACC).

Which of the following is NOT commonly regarded as being a credit policy variable? - Collection policy. - Credit standards. - Cash discounts. - Payments deferral period. - Credit period.

Payments deferral period.

Daylight Solutions is considering a recapitalization that would increase its debt ratio and increase its interest expense. The company would issue new bonds and use the proceeds to buy back shares of its common stock. The company's CFO thinks the plan will not change total assets or operating income, but that it will increase earnings per share (EPS). Assuming the CFO's estimates are correct, which of the following statements is CORRECT? - If the plan reduces the WACC, the stock price is also likely to decline. - Since the plan is expected to increase EPS, this implies that net income is also expected to increase. - If the plan does increase the EPS, the stock price will automatically increase at the same rate. - Under the plan there will be more bonds outstanding, and that will increase their liquidity and thus lower the interest rate on the currently outstanding bonds. - Since the proposed plan increases Daylight's financial risk, the company's stock price still might fall even if EPS increases.

Since the proposed plan increases Daylight's financial risk, the company's stock price still might fall even if EPS increases.

Which of the following statements best describes the optimal capital structure? The optimal capital structure is the mix of debt, equity, and preferred stock that maximizes the company's ____. - stock price. - cost of equity. - cost of debt. - cost of preferred stock. - earnings per share (EPS).

Stock price

Which of the following actions should Reece Windows take if it wants to reduce its cash conversion cycle? - Take steps to reduce the DSO. - Start paying its bills sooner, which would reduce the average accounts payable but not affect sales. - Sell common stock to retire long-term bonds. - Sell an issue of long-term bonds and use the proceeds to buy back some of its common stock. - Increase average inventory without increasing sales.

Take steps to reduce the DSO.

If a firm has set up a revolving credit agreement with a bank, the risk to the firm of being unable to obtain funds when needed is lower than if it had an informal line of credit. True False

True

If a firm utilizes debt financing, an X% decline in earnings before interest and taxes (EBIT) will result in a decline in earnings per share that is larger than X.

True

Barette Consulting currently has no debt in its capital structure, has $500 million of total assets, and its return on invested operating capital (ROIC) is 14.5%. The CFO is contemplating a recapitalization where it will issue debt at a cost of 10% and use the proceeds to buy back shares of the company's common stock, paying book value. If the company proceeds with the recapitalization, its operating income, total assets, and tax rate will remain unchanged. Which of the following is most likely to occur as a result of the recapitalization? - The ROA would remain unchanged. - The ROIC would decline. - The ROIC would increase. - The ROE would increase. - The ROA would increase.

The ROE would increase.

Which of the following statements is CORRECT? - The capital structure that maximizes the stock price is also the capital structure that maximizes earnings per share. - The capital structure that maximizes the stock price is also the capital structure that maximizes the firm's times interest earned (TIE) ratio. - Increasing a company's debt ratio will typically reduce the marginal costs of both debt and equity financing; however, this still may raise the company's WACC. - If Congress were to pass legislation that increases the personal tax rate but decreases the corporate tax rate, this would encourage companies to increase their debt ratios. - The capital structure that maximizes the stock price is also the capital structure that minimizes the weighted average cost of capital (WACC).

The capital structure that maximizes the stock price is also the capital structure that minimizes the weighted average cost of capital (WACC).

Which of the following statements is CORRECT? - The capital structure that minimizes a firm's weighted average cost of capital is also the capital structure that maximizes its stock price. - The capital structure that minimizes the firm's weighted average cost of capital is also the capital structure that maximizes its earnings per share. - If a firm finds that the cost of debt is less than the cost of equity, increasing its debt ratio must reduce its WACC. - Other things held constant, if corporate tax rates declined, then the Modigliani-Miller tax-adjusted tradeoff theory would suggest that firms should increase their use of debt. - A firm can use retained earnings without paying a flotation cost. Therefore, while the cost of retained earnings is not zero, its cost is generally lower than the after-tax cost of debt.

The capital structure that minimizes a firm's weighted average cost of capital is also the capital structure that maximizes its stock price.

Which of the following statements is CORRECT? - The capital structure that minimizes the interest rate on debt also maximizes the expected EPS. - The capital structure that minimizes the required return on equity also maximizes the stock price. - The capital structure that minimizes the WACC also maximizes the price per share of common stock. - The capital structure that gives the firm the best credit rating also maximizes the stock price. - The capital structure that maximizes expected EPS also maximizes the price per share of common stock.

The capital structure that minimizes the WACC also maximizes the price per share of common stock.

Blueline Publishers is considering a recapitalization plan. It is currently 100% equity financed but under the plan it would issue long-term debt with a yield of 9% and use the proceeds to repurchase common stock. The recapitalization would not change the company's total assets, nor would it affect the firm's return on invested capital (ROIC), which is currently 15%. The CFO believes that this recapitalization would reduce the WACC and increase stock price. Which of the following would also be likely to occur if the company goes ahead with the recapitalization plan? -The company's earnings per share would decline. - The company's cost of equity would increase. -The company's ROA would increase. -The company's ROE would decline. -The company's net income would increase.

The company's cost of equity would increase.

Other things held constant, which of the following events is most likely to encourage a firm to increase the amount of debt in its capital structure? - The costs that would be incurred in the event of bankruptcy increase. - Management believes that the firm's stock has become overvalued. - Its degree of operating leverage increases. - The corporate tax rate increases. - Its sales become less stable over time.

The corporate tax rate increases.

Which of the following statements is CORRECT? - If a firm lowered its fixed costs while increasing its variable costs, holding total costs at the present level of sales constant, this would decrease its operating leverage. - The debt ratio that maximizes EPS generally exceeds the debt ratio that maximizes share price. - If a company were to issue debt and use the money to repurchase common stock, this action would have no impact on its return on invested capital. (Assume that the repurchase has no impact on the company's operating income.) - If changes in the bankruptcy code made bankruptcy less costly to corporations, this would likely reduce the average corporation's debt ratio. - Increasing financial leverage is one way to increase a firm's return on invested capital.

The debt ratio that maximizes EPS generally exceeds the debt ratio that maximizes share price.

Which of the following is NOT associated with (or does not contribute to) business risk? Recall that business risk is affected by a firm's operations. - Sales price variability. - The extent to which operating costs are fixed. - The extent to which interest rates on the firm's debt fluctuate. - Input price variability. - Demand variability.

The extent to which interest rates on the firm's debt fluctuate.

Which of the following statements is CORRECT? - The factors that affect a firm's business risk are affected by industry characteristics and economic conditions. Unfortunately, these factors are generally beyond the control of the firm's management. - One of the benefits to a firm of being at or near its target capital structure is that this eliminates any risk of bankruptcy. - A firm's financial risk can be minimized by diversification. - The amount of debt in its capital structure can under no circumstances affect a company's business risk. - A firm's business risk is determined solely by the financial characteristics of its industry.

The factors that affect a firm's business risk are affected by industry characteristics and economic conditions. Unfortunately, these factors are generally beyond the control of the firm's management.

Which of the following is NOT a situation that might lead a firm to increase its holdings of short-term marketable securities? - The firm is going from its peak sales season to its slack season, so its receivables and inventories will experience a seasonal decline. - The firm is going from its slack season to its peak sales season, so its receivables and inventories will experience seasonal increases. - The firm has just sold long-term securities and has not yet invested the proceeds in operating assets. - The firm just won a product liability suit one of its customers had brought against it. - The firm must make a known future payment, such as paying for a new plant that is under construction.

The firm is going from its slack season to its peak sales season, so its receivables and inventories will experience seasonal increases.

Which of the following statements is CORRECT? - The optimal capital structure simultaneously maximizes EPS and minimizes the WACC. - The optimal capital structure minimizes the cost of equity, which is a necessary condition for maximizing the stock price. - The optimal capital structure simultaneously minimizes the cost of debt, the cost of equity, and the WACC. - The optimal capital structure simultaneously maximizes stock price and minimizes the WACC. - As a rule, the optimal capital structure is found by determining the debt-equity mix that maximizes expected EPS.

The optimal capital structure simultaneously maximizes stock price and minimizes the WACC.

If debt financing is used, which of the following is CORRECT? -The percentage change in net operating income will be equal to a given percentage change in net income. -The percentage change in net income relative to the percentage change in net operating income will depend on the interest rate charged on debt. - The percentage change in net income will be greater than the percentage change in net operating income. -The percentage change in sales will be greater than the percentage change in EBIT, which in turn will be greater than the percentage change in net income. -The percentage change in net operating income will be greater than a given percentage change in net income.

The percentage change in net income will be greater than the percentage change in net operating income.

If a firm's suppliers stop offering cash discounts, then its use of trade credit is more likely to increase than to decrease, other things held constant. True False

True

If a profitable firm finds that it simply must "stretch" its accounts payable, then this suggests that it is undercapitalized, i.e., that it needs more working capital to support its operations. True False

True

It is possible that two firms could have identical financial and operating leverage, yet have different degrees of risk as measured by the variability of EPS

True

Which of the following statements is CORRECT? - The cash budget and the capital budget are developed separately, and although they are both important to the firm, one does not affect the other. - Since depreciation is a non-cash charge, it neither appears on nor has any effect on the cash budget. - The target cash balance should be set such that it need not be adjusted for seasonal patterns and unanticipated fluctuations in receipts, although it should be changed to reflect long-term changes in the firm's operations. - The typical cash budget reflects interest paid on loans as well as income from the investment of surplus cash. These numbers, as well as other items on the cash budget, are expected values; hence, actual results might vary from the budgeted amounts. - Shorter-term cash budgets, in general, are used primarily for planning purposes, while longer-term budgets are used for actual cash control.

The typical cash budget reflects interest paid on loans as well as income from the investment of surplus cash. These numbers, as well as other items on the cash budget, are expected values; hence, actual results might vary from the budgeted amounts.

A conservative current operating asset financing approach will result in permanent current assets and some seasonal current assets being financed using long-term securities. True False

True

A firm that follows an aggressive current asset financing approach uses primarily short-term credit and thus is more exposed to an unexpected increase in interest rates than is a firm that uses long-term capital and thus follows a conservative financing policy. True False

True

A firm's capital structure does not affect its calculated free cash flows, because FCF reflects only operating cash flows.

True

A firm's collection policy, i.e., the procedures it follows to collect accounts receivable, plays an important role in keeping its average collection period short, although too strict a collection policy can reduce profits due to lost sales. True False

True

A firm's peak borrowing needs will probably be overstated if it bases its monthly cash budget on the assumption that both cash receipts and cash payments occur uniformly over the month but in reality receipts are concentrated at the beginning of each month. True False

True

A line of credit can be either a formal or an informal agreement between a borrower and a bank regarding the maximum amount of credit the bank will extend to the borrower during some future period, assuming the borrower maintains its financial strength. True False

True

A promissory note is the document signed when a bank loan is executed, and it specifies financial aspects of the loan. True False

True

A revolving credit agreement is a formal line of credit. The firm must generally pay a fee on the unused balance of the committed funds to compensate the bank for the commitment to extend those funds. True False

True

Accruals are "free" capital in the sense that no explicit interest must normally be paid on accrued liabilities. True False

True

Accruals are "spontaneous," but unfortunately, due to law and economic forces, firms have little control over the level of these accounts. True False

True

Although short-term interest rates have historically averaged less than long-term rates, the heavy use of short-term debt is considered to be an aggressive current operating asset financing strategy because of the inherent risks of using short-term financing. True False

True

As a rule, managers should try to always use the free component of trade credit but should use the costly component only if the cost of this credit is lower than the cost of credit from other sources. True False

True

Cash is often referred to as a "non-earning" asset. Thus, one goal of cash management is to minimize the amount of cash necessary for conducting a firm's normal business activities. True False

True

Changes in a firm's collection policy can affect sales, working capital, and profits. True False

True

Determining a firm's optimal investment in working capital and deciding how that investment should be financed are critical to working capital management. True False

True

Different borrowers have different risks of bankruptcy, and bankruptcy is costly to lenders. Therefore, lenders charge higher rates to borrowers judged to be more at risk of going bankrupt.

True

Financial risk refers to the extra risk stockholders bear as a result of using debt as compared with the risk they would bear if no debt were used.

True

Firms hold cash balances in order to complete transactions (both routine and precautionary) that are necessary in business operations and as compensation to banks for providing loans and services. True False

True

For a firm that makes heavy use of net float, being able to forecast collections and disbursement check clearings is essential. True False

True

For a zero-growth firm, it is possible to increase the percentage of sales that are made on credit and still keep accounts receivable at their current level, provided the firm can shorten the length of its collection period sufficiently. True False

True

If Miller and Modigliani had incorporated the costs of bankruptcy into their model, it is unlikely that they would have concluded that 100% debt financing is optimal.

True

Loans from commercial banks generally appear on balance sheets as notes payable. A bank's importance is actually greater than it appears from the dollar amounts shown on balance sheets because banks provide nonspontaneous funds to firms. True False

True

Net operating working capital is defined as operating current assets minus operating current liabilities.. True False

True

Not taking cash discounts is costly, and as a result, firms that do not take them are usually those that are performing poorly and have inadequate cash balances. True False

True

One of the effects of ceasing to take trade credit discounts is that the firm's accounts payable will rise, other things held constant. True False

True

Setting up a lockbox arrangement is one way for a firm to speed up the collection of payments from its customers. True False

True

Shorter-term cash budgets⎯say a daily cash budget for the next month⎯are generally used for actual cash control while longer-term cash budgets⎯say monthly cash budgets for the next year⎯are generally used for planning purposes. True False

True

Suppose a firm changes its credit policy from 2/10 net 30 to 3/10 net 30. The change is meant to meet competition, so no increase in sales is expected. The average accounts receivable balance will probably decline as a result of this change. True False

True

Synchronization of cash flows is an important cash management technique, as proper synchronization can reduce the required cash balance and increase a firm's profitability. True False

True

The MM model with corporate taxes is the same as the Miller model, but with zero personal taxes.

True

The Miller model begins with the MM model with corporate taxes and then adds personal taxes. True False

True

The aging schedule is a commonly used method for monitoring receivables. True False

True

The average accounts receivable balance is a function of both the volume of credit sales and the days sales outstanding. True False

True

The calculated cost of trade credit can be reduced by paying late. True False

True

The calculated cost of trade credit for a firm that buys on terms of 2/10 net 30 is lower (other things held constant) if the firm plans to pay in 40 days than in 30 days. True False

True

The cash conversion cycle (CCC) combines three factors: The inventory conversion period, the average collection period, and the payables deferral period, and its purpose is to show how long a firm must finance its working capital. Other things held constant, the shorter the CCC, the more effective the firm's working capital management. True False

True

The concept of permanent current operating assets reflects the fact that some components of current assets do not shrink to zero even when a business is at its seasonal or cyclical low. Thus, permanent current operating assets represent a minimum level of current assets that must be financed. True False

True

The four primary elements in a firm's credit policy are (1) credit standards, (2) cash discounts offered, (3) credit period, and (4) collection policy. True False

True

The longer its customers normally hold inventory, the longer the credit period supplier firms normally offer. Still, suppliers have some flexibility in the credit terms they offer. If a supplier lengthens the credit period offered, this will shorten the customer's cash conversion cycle but lengthen the supplier firm's own CCC. True False

True

The maturity of most bank loans is short term. Bank loans to businesses are frequently made as 90-day notes which are often rolled over, or renewed, rather than repaid when they mature. However, if the borrower's financial situation deteriorates, then the bank may refuse to roll over the loan. True False

True

The trade-off theory states that the capital structure decision involves a tradeoff between the costs and benefits of debt financing.

True

The twin goals of inventory management are (1) to ensure that the inventories needed to sustain operations are available, but (2) to hold the costs of ordering and carrying inventories to the lowest possible level. True False

True

Uncertainty about the exact lives of assets prevents precise maturity matching in an ex post (i.e., after the fact) sense even though it is possible to match maturities on an ex ante (expected) basis. True False

True

When deciding whether or not to take a cash discount, the cost of borrowing from a bank or other source should be compared to the cost of trade credit to determine if the cash discount should be taken. True False

True

Whenever a firm borrows money, it is using financial leverage.

True

Which of the following statements concerning capital structure theory is NOT CORRECT? - Under MM with zero taxes, financial leverage has no effect on a firm's value. - Under MM with corporate taxes, the value of a levered firm exceeds the value of the unlevered firm by the product of the tax rate times the market value dollar amount of debt. - Under MM with corporate taxes, rs increases with leverage, and this increase exactly offsets the tax benefits of debt financing. - Under MM with corporate taxes, the effect of business risk is automatically incorporated because rsL is a function of rsU. - The major contribution of Miller's theory is that it demonstrates that personal taxes decrease the value of using corporate debt.

Under MM with corporate taxes, rs increases with leverage, and this increase exactly offsets the tax benefits of debt financing.

Which of the following statements is CORRECT? - Conservative firms generally use no short-term debt and thus have zero current liabilities. - A short-term loan can usually be obtained more quickly than a long-term loan, but the cost of short-term debt is normally higher than that of long-term debt. - If a firm that can borrow from its bank at a 6% interest rate buys materials on terms of 2/10 net 30, and if it must pay by Day 30 or else be cut off, then we would expect to see zero accounts payable on its balance sheet. - If one of your firm's customers is "stretching" its accounts payable, this may be a nuisance but it will not have an adverse financial impact on your firm if the customer periodically pays off its entire balance. - Under normal conditions, a firm's expected ROE would probably be higher if it financed with short-term rather than with long-term debt, but using short-term debt would probably increase the firm's risk.

Under normal conditions, a firm's expected ROE would probably be higher if it financed with short-term rather than with long-term debt, but using short-term debt would probably increase the firm's risk.

Which of the following statements is CORRECT? - Electric utilities generally have very high common equity ratios because their revenues are more volatile than those of firms in most other industries. - Drug companies (prescription, not illegal!) generally have high debt-to-equity ratios because their earnings are very stable and, thus, they can cover the high interest costs associated with high debt levels. - Wide variations in capital structures exist both between industries and among individual firms within given industries. These differences are caused by differing business risks and also managerial attitudes. - Since most stocks sell at or very close to their book values, book value capital structures are almost always adequate for use in estimating firms' costs of capital. - Generally, debt-to-total-assets ratios do not vary much among different industries, although they do vary among firms within a given industry.

Wide variations in capital structures exist both between industries and among individual firms within given industries. These differences are caused by differing business risks and also managerial attitudes.

Which of the following statement completions is CORRECT? If the yield curve is upward sloping, then the marketable securities held in a firm's portfolio, assumed to be held for emergencies, should - consist mainly of short-term securities because they pay higher rates. - consist mainly of U.S. Treasury securities to minimize interest rate risk. - consist mainly of short-term securities to minimize interest rate risk. - be balanced between long- and short-term securities to minimize the adverse effects of either an upward or a downward trend in interest rates. - consist mainly of long-term securities because they pay higher rates.

consist mainly of short-term securities to minimize interest rate risk.

A lockbox plan is - used to identify inventory safety stocks. - used to slow down the collection of checks our firm writes. - used to speed up the collection of checks received. - used primarily by firms where currency is used frequently in transactions, such as fast food restaurants, and less frequently by firms that receive payments as checks. - used to protect cash, i.e., to keep it from being stolen.

used to speed up the collection of checks received.

A lockbox plan is most beneficial to firms that - have widely dispersed manufacturing facilities. - have a large marketable securities portfolio and cash to protect. - receive payments in the form of currency, such as fast food restaurants, rather than in the form of checks. - have customers who operate in many different parts of the country. - have suppliers who operate in many different parts of the country.

have customers who operate in many different parts of the country.

Which of the following statements is most consistent with efficient inventory management? The firm has a - low incidence of production schedule disruptions. - below average total assets turnover ratio. - relatively high current ratio. - relatively low DSO. - below average inventory turnover ratio.

low incidence of production schedule disruptions.

Firms generally choose to finance temporary current operating assets with short-term debt because - short-term interest rates have traditionally been more stable than long-term interest rates. - a firm that borrows heavily on a long-term basis is more apt to be unable to repay the debt than a firm that borrows short term. - the yield curve is normally downward sloping. - short-term debt has a higher cost than equity capital. - matching the maturities of assets and liabilities reduces risk under some circumstances, and also because short-term debt is often less expensive than long-term capital.

matching the maturities of assets and liabilities reduces risk under some circumstances, and also because short-term debt is often less expensive than long-term capital.

Which of the following statements is CORRECT? - In managing a firm's accounts receivable, it is possible to increase credit sales per day yet still keep accounts receivable fairly steady, provided the firm can shorten the length of its collection period (its DSO) sufficiently. - Because of the costs of granting credit, it is not possible for credit sales to be more profitable than cash sales. - Since receivables and payables both result from sales transactions, a firm with a high receivables-to-sales ratio must also have a high payables-to-sales ratio. - Other things held constant, if a firm can shorten its DSO, this will lead to a higher current ratio. - A firm that makes 90% of its sales on credit and 10% for cash is growing at a constant rate of 10% annually. Such a firm will be able to keep its accounts receivable at the current level, since the 10% cash sales can be used to finance the 10% growth rate.

n managing a firm's accounts receivable, it is possible to increase credit sales per day yet still keep accounts receivable fairly steady, provided the firm can shorten the length of its collection period (its DSO) sufficiently.

Which of the following statements is CORRECT? As a firm increases the operating leverage used to produce a given quantity of output, this will - normally lead to a decrease in its business risk. - normally lead to a decrease in the standard deviation of its expected EBIT. - normally lead to a decrease in the variability of its expected EPS. - normally lead to a reduction in its fixed assets turnover ratio. - normally lead to an increase in its fixed assets turnover ratio.

normally lead to a reduction in its fixed assets turnover ratio.

The major contribution of the Miller model is that it demonstrates that - personal taxes decrease the value of using corporate debt. - financial distress and agency costs reduce the value of using corporate debt. - equity costs increase with financial leverage. - debt costs increase with financial leverage. - personal taxes increase the value of using corporate debt.

personal taxes decrease the value of using corporate debt.

When a firm has risky debt, its equity can be viewed as an option on the total value of the firm with an exercise price equal to the face value of the debt. True False

true