Chapter 06 – Working Capital and the Financing Decision
106. An aggressive, risk-oriented firm will likely
107. Which of the following is not a condition under which a prudent manager would accept
some risk in financing?
108. Risk exposure due to heavy short-term borrowing can be compensated for by
Chapter 06 – Working Capital and the Financing Decision
109. Which of the following combinations of asset structures and financing patterns is likely
to create the least volatile earnings?
110. Which of the following combinations of asset structures and financing patterns is likely
to create the most volatile earnings?
111. An aggressive working capital policy would have which of following characteristics?
Chapter 06 – Working Capital and the Financing Decision
112. The following are the expected 1 year T-bill rates for the next 4 years: 3%, 4%, 5%, and
6%. What would you expect the rate for 3 year securities would be?
113. Riley Co. is considering a short-term or long-term financing plan for $4,000,000 in
assets. They expect the following 1 year rates over the next 3 years: 6.5%, 7.75%, and 9%.
Their long-term interest rate will be 7.5% for the 3 years. Assuming the rates follow their
expectations, what will be the difference in interest costs over the 3 years?
Chapter 06 – Working Capital and the Financing Decision
114. Genetech has $4,000,000 in assets, have decided to finance 30% with long-term
financing (9% rate) and 70% with short-term financing (7%) rate. What will be their annual
interest costs?
115. When the yield curve is upward sloping, generally a financial manager should:
116. When the yield curve is downward sloping, generally a financial manager should
Chapter 06 – Working Capital and the Financing Decision
117. Match the following with the items below:
1. “temporary” current
Long-term interest rates reflect the average of
expected short-term rates over the life of the long-term
2. self-liquidating
The financing and management of the current assets
4. working capital
Current assets that will not be reduced or converted
Depicts in graphical form the relationship between
Financing provided by sellers or suppliers in the
7. market
Time periods in which financing may be difficult to
find and interest rates may be quite high by normal
8. point of sales
Equal monthly production used to smooth out
production schedules and employ manpower and
9. term structure of
A representative quantity from a probability
distribution arrived at by multiplying each outcome
times the associated probability and summing up the
10. expectations
Current assets that will be reduced or converted to
Computer terminals in retail stores that may be used
13. “permanent”
Assets that are converted to cash within the normal
The relationship of short and long-term interest rates
relies on the maturity preference of various financial
Chapter 06 – Working Capital and the Financing Decision
118. King, Inc., a successful Midwest firm, is considering opening a branch office on the west
coast. Under normal economic conditions, with a 45% probability of occurring, King can
expect to earn a net income of $70,000 per year. In a mini-recession, at 25% probability, King
will earn $20,000. In a severe recession, at a 20% probability, King will lose $15,000. There
is also a slight probability (10%) that King will lose $300,000 if the expansion fails and the
branch office must be closed. Should King open a branch office in California based on these
assumptions?
Chapter 06 – Working Capital and the Financing Decision
119. Using the expectations hypothesis for the term structure of interest rates, calculate the
expected yields for securities with maturities of two and three years on the basis of the
following data:
Chapter 06 – Working Capital and the Financing Decision
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120. Christensen & Assoc. is developing an asset financing plan. Christensen has $1,000,000
in current assets, of which 15% are permanent, and $700,000 in fixed assets. The current
long-term rate is 9%, and the current short-term rate is 6.5%. Christensen’s tax rate is 30%.
a) Construct two financing plans-one conservative, with 80% of assets financed by long-term
sources, and the other aggressive, with only 60% of assets financed by long-term sources. If
Christensen’s earnings before interest and taxes are $525,000, calculate net income under each
alternative.
b) What are some of the risks associated with each plan?
c) If the yield curve is steeply inverted, which financing plan should Christensen choose?
Chapter 06 – Working Capital and the Financing Decision
Chapter 06 – Working Capital and the Financing Decision
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121. McKinsee Inc. is developing a plan to finance its asset base. The firm has $3,000,000 in
current assets, of which 20% are permanent, and $10,000,000 in fixed assets. Long-term rates
are currently 8%, while short-term rates are at 6%. McKinsee’s tax rate is 30%.
a) Construct a conservative financing plan with 80% of assets financed by long-term sources.
If McKinsee’s earnings before interest and taxes are $4,500,000, what will their net income
be?
b) An alternative and more aggressive plan would be to finance 60% of total assets with long-
term financing. Assuming that EBIT was again $4,500,000, what will net income be under
this alternative?
c) If the yield curve was steeply upward sloping, which plan would you recommend? Why?
Chapter 06 – Working Capital and the Financing Decision