978-0073524597 Test Bank Chapter 18 Part 3

Document Type
Test Prep
Book Title
Understanding Business 10th Edition
James M. McHugh, Susan M. McHugh, William G. Nickels
Chapter 18 - Financial Management
155. Acquiring funds through debt financing actually decreases the overall risk of the firm.
156. Acquiring funds through debt financing enhances the firm's ability to increase profits.
157. Leverage refers to the use of borrowed funds to increase a firm's rate of return.
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.
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.
160. 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.
161. 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.
162. 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.
Chapter 18 - Financial Management
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.
164. 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.
165. 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.
166. 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.
167. 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.
Chapter 18 - Financial Management
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.
169. Effective managers strive to minimize their firm's cost of capital.
Feedback: The cost of capital is the rate of return a company must earn in order to meet the
demands of its lenders and expectations of its equity holders. Reducing the cost of acquiring
funds will increase the firm's profitability.
170. ________ 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
171. _____________ 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
172. 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
173. 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.
174. Undercapitalization refers to the problem of:
A. insufficient start-up funds.
B. inadequate control of expenses.
C. inappropriate cash flows.
D. under-valued capital stock.
175. 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.
Chapter 18 - Financial Management
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
177. Which business function involves credit management/collecting funds from
A. Accounting
B. Production
C. Marketing
D. Finance
178. 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.
186. Sarah intends to major in finance and find employment in corporate financial
management. As a finance major, Sarah will discover her ________ knowledge to be
valuable in mastering the objectives of her finance classes.
A. marketing
B. psychology
C. sociology
D. accounting
Feedback: Financial managers analyze information prepared by accountants in order to
prepare strategies for improving the financial health of an organization. Thus, a financial
manager cannot make sound decisions without understanding accounting information.
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
Chapter 18 - Financial Management
Which of the following activities is most likely to be performed by a financial
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.
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

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