Chapter 12—A Firm‘s Sources of Financing
TRUE/FALSE
1. The basic factors that determine how a firm is financed are restricted to the firm’s past economic
performance, the nature of its assets, and the personal preferences of owner(s) with respect to the
marketing mix.
2. A firm with potential for large profits, as opposed to high growth potential, has many more possible
sources of financing than does a firm that offers only unattractive returns.
3. Most startup investors limit their investing to firms that offer potentially high returns within a one to
three year period.
4. The age of a company has little impact on the types of financing available to it.
5. Venture capitalists restrict their investment in startup companies.
6. Assets such as the quality of a firm’s employees are considered tangible in nature and thus have
substantial value as collateral.
7. Goodwill is considered a intangible asset.
8. For every firm, there is a “right” answer to the question of balancing debt and equity, and it is
important that the small business owner find that balance.
9. Borrowing money rather than issuing common stock typically increases the potential for higher rates
of return to owners.
10. Debt financing as opposed to equity financing allows owners to retain voting control of the company.
11. If a firm finances with equity rather than with debt, it will bear no interest expense and thus yield
greater net income.
12. Generally, as long as a firm’s operating income return on its assets in greater than the cost of debt, the
owners’ return on equity investment will decrease as the firm uses more debt.
13. Use of debt financing increases potential returns when a company is performing well, but it also
increases the possibility of lower—even negative—returns if the company does not attain its goals in a
given year.
14. Small business owners sometimes accept higher levels of debt because doing so permits them to retain
all of the stock and full ownership.
15. Approximately one-half of the financing for startups comes from personal savings.
16. One potential problem with acquiring funds from friends and relatives is that they might feel they have
the right to interfere in the management of the business.
17. The main advantage of using credit cards for financing is the relatively low interest rate compared to
bank loans.
18. Lines of credit are legal obligations to provide capital.
19. A chattel mortgage is a loan for which real property, such as land or a building, serves as collateral.
20. The five C’s of credit are character, capacity, capital, conditions, and collateral.
21. Both wholesalers and equipment manufacturers/suppliers can be used as sources of funds.
22. Companies that have business dealings with a new firm are possible sources of funds for financing
inventory and equipment.
23. The amount of trade credit available to a new company is dependent on the supplier’s confidence in
the firm and not the type of business.
24. Asset-based lending is a type of financing secured by assets such as equipment and inventory.
25. If a company has a signed purchase order from a creditworthy customer and the gross profit margin on
the order is anticipated to be 36 percent, purchase-order financing is likely.
26. For entrepreneurial ventures with the potential for becoming significant businesses, initial public
offerings have been the fastest-growing source of financing over the past two decades.
27. A source of early-stage capital financing for a company is financing from commercial banks.
28. Commercial investors are sometimes called business angels.
29. A company that has over 100 employees with locations in several states is typically the type of
company in which business angels make an investment.
30. Around 5 percent of the business plans reviewed by venture capitalists are funded.
31. Small Business Administration loans include guaranty loans and loans directly from the SBA.
32. Qualified small businesses that cannot obtain business loans through normal lending channels can get
loans directly from the SBA through its 7(a) Loan Guaranty Program.
33. A small business that needs to purchase real estate could apply for a 7(a) guaranty loan.
34. State and local governments are becoming less involved in financing new businesses.
35. Private placement is the selling of stock to select venture capitalists.
36. The private sale of a firm’s common stock is regulated by the Securities and Exchange Commission.
37. When a stock sale is restricted to private placement, an entrepreneur can avoid many of the demanding
requirements of the securities laws.
38. Common stock can be sold to underwriters, but they do not guarantee the sale of securities.
MULTIPLE CHOICE
1. Anna’s new business looks like it can grow quickly and become profitable in its first year. Anna will
likely find _____ possible sources of financing than those with less potential for growth and profits.
a.
fewer
b.
about the same number of
c.
more
d.
many more
2. Andrew is a venture capitalist who would like to find a good new business in which to invest. He’s
done this before so he has learned to limit his investing to firms with potentially high returns in a
_____ period.
a.
6-12 month
b.
1-2 year
c.
3-5 year
d.
5-10 year
3. Ben left the corporate rat race to start his own business that will allow him to earn a small income
while providing plenty of time to pursue his love of pottery making. He does not expect either growth
or high profits. Ben’s prospects for attracting outside financing are:
a.
plentiful.
b.
limited.
c.
moderate.
d.
nonexistent.
4. When Ben left the corporate rat race to start his own pottery business, he used some of his retirement
savings to finance the business. This practice is known as:
a.
self-starting.
b.
cashing out.
c.
bootstrapping.
d.
folly.
5. People like Ben who “bootstrap” company financing are
a.
enhancing the “corporate image” of the enterprise by the way they raise capital.
b.
depending on their own initiative to obtain the capital necessary to start up and grow.
c.
subordinating future capital formation to short-term financial performance.
d.
waiting to establish a reputation in the marketplace before raising the bulk of the needed
capital.
6. If he holds true to the average, Donald Trump likely invests approximately _____ of his investment in
later-stage businesses.
a.
one-fourth
b.
one-half
c.
three-fourths
d.
nearly all
7. Cameron has applied for a loan to expand his young business. When bankers look for evidence of
whether he will be able to repay a loan, they usually base their assessment on
a.
what Cameron’s firm has done in the past.
b.
what Cameron says the firm will do in the future.
c.
the opinion of investment analysts.
d.
the business plan of the enterprise.
8. Williams Alternative Power, Inc., a company developing solar panels, has done considerable research
and limited production during its two year life. It is about ready for its IPO. At this stage of its life
cycle, its ability to attract venture capital is:
a.
greater.
b.
lessened.
c.
optimal.
d.
limited.
9. Carla is a loan analyst at the bank. When Cameron applied for a loan, Carla looked at his balance
sheet for ________ assets to evaluate a possible loan for his company’s financing.
a.
direct and indirect
b.
tangible and intangible
c.
those founded upon past performance and those depending on future performance
d.
industry-specific and firm-specific
10. Williams Alternative Power, Inc. a company developing solar panels, is applying for a loan. The
research the company has done for the manufacturing process would be a(n) _____ asset for the loan
evaluation.
a.
collateral
b.
intangible
c.
revolving
d.
tangible
11. Floyd’s income statement showed for the current year his company had an operating income of
$30,000 and his balance sheet showed total assets of $200,000. His return on assets is _________
percent.
a.
30
b.
15
c.
12
d.
6
12. If a Eugenie finances her firm with equity rather than debt, her net income could potentially be greater
because
a.
equity financing almost always leads to better firm performance than debt financing.
b.
the terms of equity financing are more stable than the terms of debt financing.
c.
equity financing has a positive impact on asset selection.
d.
there is no interest expense.
13. Elyse wants to calculate her return on equity but has forgotten the formula. You tell her that return on
equity equals
a.
net income divided by owners equity.
b.
owners equity divided by net income.
c.
total assets divided by owners equity.
d.
owners equity divided by total assets.
14. To determine how well her business is doing, Darlene should monitor the return on her investment
(equity) because it is a better measure of performance than
a.
the return on assets ratio.
b.
the current ratio.
c.
the quick ratio.
d.
the absolute dollar amount of income.
15. David is trying to decide whether to add capital through investing more of his own money or through
borrowing money from the bank. To help him decide, you remind him that as long as his firm’s rate
of return on its assets is greater than the cost of the debt, his rate of return on equity will _____ as the
firm uses more debt.
a.
decrease
b.
increase
c.
remain the same
d.
fluctuate
16. If the firm’s rate of return on its assets is _____ than the cost of borrowing, then the owners’ rate of
return on equity will _____ as the firm uses _____ debt.
a.
less, decrease, less
b.
greater, decrease, more
c.
greater, increase, more
d.
less, increase, more
17. Even with all his billions and influence, Donald Trump, as an equity investor, cannot demand more
than
a.
those who have invested debt in the enterprise.
b.
what is earned.
c.
anticipated future financing.
d.
established cash flows.
18. Glenda is trying to decide between the use of debt and the use of equity to finance her young business.
She should remember that:
a.
her return on assets will be less if she uses debt financing.
b.
using other people’s money to finance one’s business is seldom a good idea.
c.
the lender will have partial control of the business.
d.
debt must be repaid even if the company does not make a profit.
19. One factor that influences the choice between debt and equity is the
a.
returns anticipated from the enterprise.
b.
risk of nationalization.
c.
degree of control the owners hope to retain.
d.
state of the owners’ estate plan.
20. It’s been George’s “baby” from the beginning and he really doesn’t want to be accountable to any
outsider for the decisions he makes in his business. In George’s case, he should seek initially to secure
_____ financing.
a.
debt
b.
equity
c.
internal
d.
asset
21. Maguire was considering selling stock as a source of funds but was concerned about:
a.
damaging his corporate image.
b.
the loss of voting control of the company.
c.
the effect that might have on future financing.
d.
estate planning.
22. Penelope is planning to launch her first business. She will most likely acquire her initial financing
from:
a.
venture capitalists.
b.
personal savings.
c.
wealthy individuals.
d.
the securities market.
23. Although not the primary source of financing for most small business startups, another source of early
financing is:
a.
family members.
b.
commercial banks.
c.
business suppliers.
d.
asset-based lenders.
24. Renata has asked her family members to help her launch her new business. She must consider that:
a.
along with their financial futures, she may be putting the relationships at risk.
b.
family members are not always the best business analysts.
c.
some family members are unable to offer financial assistance.
d.
getting their support does not guarantee the success of her business.
25. In the beginning, some entrepreneurs use ____________ as a source of financing.
a.
asset-based lenders.
b.
personal credit cards
c.
wealthy individuals.
d.
venture capitalists.
26. Which financing source has the greatest advantage of speed?
a.
local bank
b.
credit card
c.
angel investor
d.
venture capitalist
27. A line of credit is the _____ amount of credit a bank will provide a borrower at any one time.
a.
average
b.
annual
c.
maximum
d.
minimum
28. Abby is wanting to obtain a loan for a large oven for her bakery. Since the oven will last
approximately 8 years, the ideal loan would be a _____ loan.
a.
mortgage
b.
trade credit
c.
asset-based
d.
term
29. Small firms frequently run into problems when:
a.
they offer equipment as collateral for a term loan.
b.
they under-utilized the equipment purchased with the loan.
c.
they overestimate the cash inflows from the equipment purchased with the loan.
d.
they fail to match a term loan’s payment terms with the expected cash inflows from the
equipment purchased with the loan.
30. Granville owns a construction company and would like to purchase a mobile construction office. The
bank would likely offer him a _____ mortgage.
a.
chattel
b.
real estate
c.
revolving
d.
term
31. If Joan is applying for a loan for a shelving system to improve her retail sales where the system will
serve as collateral, what type of loan would be the most appropriate?
a.
chattel mortgage
b.
line of credit
c.
real estate mortgage
d.
term loan
32. In his presentation to his banker when he applies for a business loan to purchase additional equipment,
Alan should emphasize:
a.
how much profit the new equipment will, generate.
b.
how he will be able to repay the principal of the loan.
c.
how energy-efficient the new equipment is.
d.
how much income he will generate for the bank.
33. When considering a loan application, bankers will consider:
a.
the credit score of the applicant.
b.
the four Cs of credit
c.
the five Cs of credit.
d.
the applicant’s character only.
34. Joann is buying an existing convenience store. When she considers which bank to use, her best
choice would be:
a.
a national bank that processes credit card payments.
b.
the credit union where she is already a member.
c.
a bank close to her store.
d.
the largest one in her town, which is located on the other side of town from her store.
35. LIBOR is _____ the prime rate.
a.
approximately equal to
b.
considerably higher than
c.
considerably lower than
d.
a lagging indicator of
36. In addition to the interest rate on his business loan, Paul should also give attention to:
a.
the maturity date.
b.
the reserve requirement.
c.
the tax liability of the loan.
d.
the LIBOR on the day the loan is approved.
37. A balloon payment
a.
is an up front payment to obtain a loan.
b.
may be required by the bank at about midway in the loan term.
c.
may be due at any time during the term of a loan.
d.
is used to lift (remove) a loan covenant.
38. A loan covenant is very likely to require
a.
a bank officer on the board of advisors.
b.
salary limitations.
c.
voting rights.
d.
a fixed business strategy.
39. Even though Evan’s company is a corporation, the bank imposed a loan covenant that required Evan
to:
a.
make a balloon payment after three years.
b.
pay a loan origination fee.
c.
make quarterly rather than monthly payments.
d.
personally guarantee the loan.
40. A source of short-term funds for many small companies with inventories is
a.
trade credit.
b.
long-term bank loans.
c.
mortgages.
d.
asset-based notes.
41. Instead of borrowing money from suppliers to purchase equipment, an increasing number of small
businesses are
a.
obtaining trade credit instead.
b.
making these purchases outright.
c.
choosing to lease the equipment.
d.
opting to streamline assembly processes to reduce expenditures.
42. Barbara runs an Italian restaurant and is currently considering leasing or purchasing some updated
equipment. What statement is correct?
a.
Since the equipment she is buying will become outdated in two years, leasing would be a
better option than purchasing.
b.
Since the restaurant is new and she is wanting to protect her cash flow, purchasing would
be better since purchasing costs less than leasing.
c.
If the equipment is leased, the restaurant’s lines of credit will be increased.
d.
Leasing is always more expensive than purchasing over the term of the lease
43. Irwin has applied for a loan from an asset-based lending company. As security he will offer:
a.
land and buildings.
b.
accounts receivable and inventory.
c.
equipment and buildings.
d.
inventory and equipment.