Chapter 18 – Financial Management
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.
295. After enjoying increased sales and profits of 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.
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300. Reality Films, Inc. is a very profitable company whose stock has appreciated in market
value during the past ten years. Even though the firm was established several years ago,
it does not pay its stockholders dividends. Reality Films reinvests its earnings. Which of
the following statements might best reflect the sentiments of its chief financial officer
(CFO)?
A. There is no purpose in paying dividends to stockholders when it is not required by
law. After all, dividends are not tax deductible!
B. Stockholders receive interest payments twice each year. They do not receive
dividends.
C. Retained earnings are an important source of equity funds for the company.
Reinvestment of earnings helps to lower the overall cost of capital.
D. Retained earnings increase a firm’s cost of capital. The higher the cost of capital, the
higher the rate of return to investors.
Feedback: Retained earnings are a favorable source of meeting long-term capital needs. A
company that reinvests its profits saves interest payments, dividends, and even underwriting
fees. The use of retained earnings also lowers the overall cost of capital, which helps to
increase the rate of return to investors.
301.
Chapter 18 – Financial Management
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.
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302. What is financial management? Identify the duties and responsibilities of financial
managers.
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309. 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.
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310. 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):
311. 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.
312.
Chapter 18 – Financial Management
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.
313. 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.
