CH 18, 19, Appendix B Business Dynamics

__________Blank examine the data prepared by __________Blank and then make recommendations to top management regarding strategies for improving the firm.

Financial managers; accountants

Which business function involves credit management/collecting funds from customers?

finance

A __________Blank represents a long-term debt obligation issued by a corporation or a government.

bond

Businesses acquire long-term financing from two major sources,

debt financing and equity financing

Successful use of financial leverage requires a firm to

earn a higher return on its investments than the interest rate it pays to acquire funds.

Explanation:

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.

The financial manager of Delta Graphics negotiated a __________Blank with the bank that allows the company to borrow up to $75,000 without collateral. This arrangement eliminates the need to renegotiate the terms of the loan and complete new paperwork each time Detail Graphics borrows money. The preapproved short-term loan agreement is contingent upon the bank having the funds available.

line of credit

Explanation:

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.

__________Blank 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.

Commercial paper

By selling shares of ownership in the company, Pharma Labs acquires the funds needed to finance its research and development projects. Pharma Labs provides for its long-term funding needs through __________Blank financing.

equity

Explanation:

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.

If an airport that previously relied on metal detectors decides to invest in full body screening ports that scan the entire body to detect weapons or explosive devices, these expensive devices represent __________Blank assets.

long-term

Explanation:

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.

An effective technique to improve cash management would be to

speed up cash collections and slow down cash payments.

Explanation:

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.

Which statement is most accurate?

Financial managers need to understand accounting.

A bank agreed to extend Johanson’s Orchards $250,000 of unsecured short-term funds, contingent upon the bank having the funds available. This arrangement represents a

line of credit.

Explanation: 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.

As a finance manager for a sporting goods store, Ramachandra worries about the firm's borrowing requirements for the upcoming year. He knows the benefit of estimating the company's cash disbursements and short-term investment expectations. Facing these concerns, a(n) __________Blank would provide Ramachandra with valuable information by providing a good estimation of whether the firm will need to do short-term borrowing.

cash budget

Explanation: Cash budgets can be important guidelines that assist managers in anticipating borrowing, debt repayment, cash disbursements, and short-term investment expectations.

__________Blank 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.

Retained earnings

The Making Ethical Decisions box, "Not What the Doctor Ordered" has an important message for managers who make financial decisions. Which statement summarizes this message?

A carefully planned and managed inventory control system helps with a firm’s efficient management of cash flow.

Explanation: The scenario is about a hospital administrator who realizes that efficient cash management is important to meet the hospital’s day-by-day operations. One way to ensure such efficiency is to use a carefully planned and managed inventory control system that reduces the amount of cash an organization has tied up in inventory. A just-in-time inventory system would help reduce the costs of managing inventory.

What is a primary area of concern for financial managers?

undercapitalization

What are the areas of authority and responsibility for a chief financial officer (CFO)?

accounting and finance

Agri-Seed Industries invented a drought resistant grass seed that only needs watering three times each year. In order to expand distribution worldwide, the company 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)

Initial Public Offering (IPO).

Explanation: The first time a company offers to sell its stock to the general public, the event is called an initial public offering.

One of the challenges of effective financial management is

having sufficient cash on hand without compromising the firm's investment potential.

A promissory note that requires the borrower to repay the loan in specified installments is called a(n)

term loan agreement.

Delta Financial Services is contemplating purchasing and installing a new, expensive computer network. This is the type of expenditure that would be included in a(n) __________Blank budget.

capital

Explanation: The capital budget highlights a firm's spending plans for major asset purchases that often require large sums of money.

When Pet Mobile, a mobile veterinary company, first started operations, it extended three months of credit to customers. It soon began to experience a cash flow problem. A finance professional should have been hired to

manage accounts receivable.

Explanation: 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.

The terms of the agreement in a bond issue are referred to as the

indenture terms.

City Pool Supplies offers customer credit terms of 2/15 net 30. This gives customers a

2 percent discount if they pay within 15 days.

Explanation: The terms 2/15, net 30 indicate that a 2 percent 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.

Long-term financing would normally be used to purchase

buildings.

Reise Jewelers obtains needed short-term funds by selling its accounts receivable to Commercial Financial. Commercial Financial usually pays Reise about 80 percent of the value of the receivables. Reise Jewelers utilizes __________Blank as a means of raising short-term funds.

factoring

Explanation:

Factoring is the process of selling accounts receivable at a discount for cash. The factor assumes the risk of collecting on the accounts receivable.

A(n) __________Blank job includes forecasting, budgeting, cash flow analysis, cost control, taxes, and credit management.

financial manager's

Explanation:

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.

A plumbing supply company 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

time value of money.

Explanation:

Money has a time value because of the interest-paying investments that are available. To encourage customers to pay earlier, the company would need to reward them with a discount. This would compensate the customers for missed investment opportunities.

If a firm sells shares of stock, it is financing with

equity.

A loan backed by collateral represents a

secured loan.

Majestic Theaters has plans to build a new $30 million movie theater and intends to finance this project through the sale of additional shares of ownership in their firm. Selling new shares of stock represents __________Blank financing.

equity

Explanation:

Equity financing refers to funds raised from either selling shares of ownership or from retained earnings.

When Argon Industries renegotiated its loan agreement, the company borrowed an additional $2 million. The new loan requires Argon Industries to repay the new amount in nine months. Argon’s activity represents __________Blank financing.

debt

Explanation:

Debt financing refers to funds acquired through various forms of borrowing that must be repaid.

Which organization would be most likely to acquire short-term funding by issuing commercial paper?

a well-known, financially stable corporation

Explanation:

Commercial paper consists of unsecured promissory notes. Because the notes are unsecured, only large, financially sound corporations are able to sell them.

If a company secures a one-year bank loan this is considered

short-term financing.

After earning $50 million in net income, Master Millwork distributed $15 million in dividends to its stockholders. Master’s board of directors decided to invest the remaining $35 million back into the business. This $35 million reinvestment of profits represents

retained earnings.

Explanation:

Retained earnings are the profits the company keeps and reinvests in the firm.

A(n) __________Blank is responsible for verifying that the accounting procedures within a firm are consistent with established accounting principles.

internal auditor

Kendra understands the importance of appropriately allocating resources in order to achieve the goals of her interior design service, so she develops a(n)

budget.

Explanation:

A budget sets forth management's expectations for revenues and, based on those financial expectations, allocates the use of specific resources throughout the firm.

A company offers its customers trade credit with terms 2/15 net 30. This implies that

paying within 30 days will let a customer deduct 15 percent off the invoice price.

Explanation:

The terms 2/15, net 30 indicate that a 2 percent 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.

Which activity represents a capital expenditure?

purchasing a building to be used for office space

Explanation:

Capital expenditures are major investments in long-term assets such as land, buildings, and equipment; or intangible assets such as patents.

The owners of Two Sisters Canoe Rentals worry that cash flow this winter may be insufficient to meet the current operating expenses. While they anticipate a surplus of cash inflow as warm weather approaches, they need funds now to meet the company's immediate obligations. The owners can best resolve cash flow concerns by obtaining __________Blank financing.

short-term

Explanation:

Short-term financing is intended to meet the immediate funding needs of an organization. These are funds that will be repaid within a year.

What is a source of short-term funding?

commercial paper

Which type of forecast would be most helpful for a company looking to know the income potential during the next five years?

long-term forecast

Explanation

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.

Magnus, a management consultant, knows that regardless of how good his firm's product might be, the business has little chance of success without a(n)

financial plan.

Explanation

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.

Although best used as a last resort, many small businesses find it convenient to use __________Blank as a short-term source of financing. Although this form of 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.

credit cards

Which statement represents good advice prior to making capital expenditures?

Capital expenditures are major investments. Companies should weigh all possible options before committing available resources to projects that take significant amounts of funds and extended time.

Explanation

In many organizations the purchase of major assets—such as land for future expansion, manufacturing plants to increase production capabilities, research to develop new-product ideas, and equipment to maintain or exceed current levels of output—is essential. Expanding into new markets, however, can be expensive with no guarantee of success. There is no guarantee that this investment will result in good returns for the firm. These investments must be thoroughly evaluated.

A __________Blank forecast predicts the revenues, costs, and expenses a firm will incur for a period of one year or less.

short-term

Which of these provides the buyer with collateral?

secured bond

If a firm sells shares of stock, it is financing with

equity.

Typically, only highly regarded customers with financial stability receive

unsecured loan

__________Blank is the function in business that is responsible for acquiring funds for the firm and managing funds within the firm.

Finance

The financial manager of Delta Graphics negotiated a __________Blank with the bank that allows the company to borrow up to $75,000 without collateral. This arrangement eliminates the need to renegotiate the terms of the loan and complete new paperwork each time Detail Graphics borrows money. The preapproved short-term loan agreement is contingent upon the bank having the funds available.

line of credit

Explanation

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.

Recently, an electronics manufacturer borrowed $600,000 from a bank to secure financing for a planned expansion. The __________Blank loan agreement requires that the electronics manufacturer provide the title to its factory as collateral.

secured

Explanation

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.

A __________Blank forecast predicts the future cash inflows and outflows in future periods.

cash flow

A loan backed by collateral represents a

secured loan.

As Ewen considers approaching a venture capital firm to provide funding for his new mobile app, he should realize that a venture capital firm will

probably want an ownership interest in the business.

Explanation

Venture capitalists typically expect a share of ownership in the company.

One of the challenges of effective financial management is

having sufficient cash on hand without compromising the firm's investment potential.

A promissory note that requires the borrower to repay the loan in specified installments is called a(n)

term loan agreement.

The financial failure of a firm is often due to

undercapitalization.

Explanation

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.

As a finance manager for a sporting goods store, Ramachandra worries about the firm's borrowing requirements for the upcoming year. He knows the benefit of estimating the company's cash disbursements and short-term investment expectations. Facing these concerns, a(n) __________Blank would provide Ramachandra with valuable information by providing a good estimation of whether the firm will need to do short-term borrowing.

cash budget

Explanation

Cash budgets can be important guidelines that assist managers in anticipating borrowing, debt repayment, cash disbursements, and short-term investment expectations.

According to the Spotlight on Small Business box, many small businesses rely on the use of credit cards or factoring as a source of short-term financing because

small firms often find it difficult to qualify for loans from banks or the Small Business Administration.

Explanation

Entrepreneurs need money to turn their million-dollar ideas into reality. Unfortunately, small businesses are often in a struggle to stay alive since many small businesses don't qualify for traditional bank or SBA loans. This forces many entrepreneurs to seek financing through a patchwork of high-cost sources such as factoring or credit cards.

Money has a time value because

money earns interest over time.

The interest paid on __________Blank represents a tax-deductible business expense.

bonds

Explanation

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.

__________Blank provide financing to new or emerging companies with high profit potential. In return, these organizations expect a share of ownership in the company.

Venture capital firms

Finance managers spend the majority of their time managing

short-term financial needs.

Through equity financing, stockholders become __________Blank of the firm.

owners

A plumbing supply company 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

time value of money.

Explanation

Money has a time value because of the interest-paying investments that are available. To encourage customers to pay earlier, the company would need to reward them with a discount. This would compensate the customers for missed investment opportunities.

Long-term financing would normally be used to purchase

buildings.

Which statement about corporate bonds is correct?

Interest paid to bondholders represents a tax-deductible business expense.

Explanation

Corporate bonds are essentially long-term IOUs issued by corporations. The interest paid on long-term debt is a tax-deductible expense.

The rate of return a company must earn to meet the demands of its lenders and expectations of its equity holders is called

cost of capital.

After earning $50 million in net income, Master Millwork distributed $15 million in dividends to its stockholders. Master’s board of directors decided to invest the remaining $35 million back into the business. This $35 million reinvestment of profits represents

retained earnings.

Explanation

Retained earnings are the profits the company keeps and reinvests in the firm.

When using __________Blank financing, the company incurs a legal obligation to repay the amount borrowed.

debt

Jeri started a cake decorating business last year. Unfortunately, it failed quickly. She realized that she lacked the necessary funds to promote her business and get it off the ground. What did Jeri experience?

undercapitalization

Explanation

Undercapitalization occurs when a business has insufficient start-up funds.

The Making Ethical Decisions box, "Not What the Doctor Ordered" has an important message for managers who make financial decisions. Which statement summarizes this message?

A carefully planned and managed inventory control system helps with a firm’s efficient management of cash flow.

Explanation

The scenario is about a hospital administrator who realizes that efficient cash management is important to meet the hospital’s day-by-day operations. One way to ensure such efficiency is to use a carefully planned and managed inventory control system that reduces the amount of cash an organization has tied up in inventory. A just-in-time inventory system would help reduce the costs of managing inventory.

The first step in the financial planning process is

forecasting financial needs.

The overall objective of financial planning is to

optimize the firm's profitability.

A firm negotiates a(n) __________Blank 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.

line of credit

The owners of Two Sisters Canoe Rentals worry that cash flow this winter may be insufficient to meet the current operating expenses. While they anticipate a surplus of cash inflow as warm weather approaches, they need funds now to meet the company's immediate obligations. The owners can best resolve cash flow concerns by obtaining __________Blank financing.

short-term

Explanation

Short-term financing is intended to meet the immediate funding needs of an organization. These are funds that will be repaid within a year.

One of the primary factors that influences the interest rate a firm pays on long-term loans is the

general level of market interest rates.

Explanation

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.

After enjoying increased sales of and profits from several popular products, a company plans to expand its production facilities. The firm prefers financing this project with a funding source that avoids interest and dividend payments as well as underwriting costs. What type of financing will best meet the needs of this company?

retained earnings

Explanation

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.

Which of these is a common source of long-term financing for a corporation?

a bond issue

Explanation

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.

__________Blank are collections of stocks that are traded on exchanges but are traded more like individual stocks than like mutual funds.

ETFs

Corporations benefit from securities markets primarily by

obtaining the capital they need to finance their operations.

A bond's face value is the same as its

principal.

National Woodworking, known for its very generous dividend policy, easily attracts investors. These dividend payments basically represent

a part of the firm's profit distributed to stockholders.

Explanation

A dividend is a part of the firm's profits that is distributed to shareholders.

Rezi Manufacturing plans to issue an IPO of $100 million of common stock. The firm will likely rely on the advice and assistance of

an investment banker.

Explanation

Investment bankers are specialists who assist in the issue and sale of new securities.

Which situation would be considered insider trading?

You buy 500 shares of Just-in-Time Manufacturing because you heard from the CEO's administrative assistant that the CEO was just fired. You figure that this emotional news has got to help the stock price.

Explanation

Insider trading involves buying or selling a stock based on company information that is not available to the general public.

Trading in newly issued securities takes place in the _______Blank market.

primary

If a publicly traded corporation fails to maintain specific minimum requirements, the exchange can __________Blank the firm's securities.

delist

According to the Standard & Poor's Investor Services ratings, which of these ratings indicates a highly speculative bond?

C

If a stock's closing price for the day is 32.47, the stock's price in U.S. dollars would be

$32.47

Bonds that pay very high interest rates and typically have a higher risk of default are known as __________Blank bonds.

junk

A disadvantage of issuing bonds is that

bonds increase the firm's debt.

Explanation

Bonds increase debt and may adversely affect the market's perception of the firm.

Which of these represents a special feature included with some bond issues?

convertibility of a debt security (bond) into an equity security (stock)

Explanation

Convertible bondholders can choose to exchange their bonds for shares of stock in the same company.

Most businesses prefer to meet their long-term financial needs through

retained earnings.

Explanation

Retained earnings require no interest or dividend payments. In addition, retained earnings involve no investment banker fees.

After operating for years as a privately held corporation, a company plans to publicly trade its stock. As a midsized firm, this company wants to avoid excessive paperwork, and the fear of being delisted in the future. The __________Blank provides the best fit for the company’s plans.

over-the-counter market

Explanation

The over-the-counter (OTC) market provides companies and investors with a means to trade stocks not listed on the national securities exchanges. The OTC market is a network of several thousand brokers that maintain contact with one another and buy and sell securities through a nationwide electronic system.

Laticia has an ownership interest in many different companies, yet she owns the shares of stock of just one investment. Laticia undoubtedly owns shares in a(n)

mutual fund.

Explanation

A mutual fund is an investment group that buys stocks and bonds of many different organizations and then sells shares in the investment group to the public.

The traditional market barometer used to measure the direction of the stock market is the

Dow Jones Industrial Average (the Dow).

Investment bankers __________Blank new issues of bonds or stocks by purchasing, at a discount, the entire stock or bond issue of a firm and selling the issue to interested investors at a higher price.

underwrite

According to the Adapting to Change box, “Bears, Bonds, Business, and Football,” how was the renovation of the Bears’s football stadium, Soldier Field, financed?

through the sale of bonds

Explanation

The bonds were to be funded through a 2 percent portion of the city’s hotel tax and concern has grown about whether the tax can cover costs. Regardless of where the Bears play their games, the debt has to be repaid. The expense to the team is zero.

Another name for the fixed rate of interest attached to a bond is the

coupon rate.