Chapter 15

Question 1

why do firms fail financially

Answer 1

undercapitalization, poor control over cash flow and inadequate expense control

Question 2

what do financial managers do

Answer 2

plan, budget, control funds, obtain funds, collect funds, conduct audits, manage taxes, and advise top management on financial matters

Question 3

what are 3 budgets in a financial plan

Answer 3

1. capital budget (spending plan for huge assets like property)
2. cash budget (projected cash balance at the end of a given period)
3. operating budget (summarizes the information in the other two budgets)

Question 4

what are firms major financial needs

Answer 4

1. managing day by day operations
2. controlling credit operations
3. acquiring needed inventory
4. making capital expenditures

Question 5

whats the difference between debt financing and equity financing

Answer 5

debt financing raises funds by borrowing and equity raises funds from within the firm through investments of retained earnings, sale of stock to investors, or sale of part ownership to venture capitalist

Question 6

whats short term financing vs long term financing

Answer 6

short term raises funds to be repaid in less than a year whereas long term financing raises funds to be repaid over a longer period

Question 7

why should businesses use trade credit

Answer 7

trade credit is the least expensive and the most convenient for of short term financing

Question 8

what is meant by a line of credit

Answer 8

line of credit is an agreement by a bank to lend a specific amount of money to he business at any time, if the money is available

Question 9

whats the difference between secured loan vs unsecured loan

Answer 9

unsecured: has no collateral backing it
secured: have collateral backed by assets such as accounts receivable, inventory, or other property of value

Question 10

is factoring a form of secured loan

Answer 10

no, factoring means selling accounts receivable at a discounted rate to a factor

Question 11

what are the major sources of long term financing

Answer 11

debt financing is the sale of bonds to investors and long term loans from banks and other financial institutions. Equity financing is obtained through the sale of company stock, from the firms retained earnings, or from venture capital firms

Question 12

what are 2 major forms of debt financing

Answer 12

selling bonds and borrowing from individuals, banks, and other financial institutions. Bonds can be secured y some form collateral or can be unsecured (debenture bonds). The same is true of loans.

Question 13

what are the advantages of issuing bonds

Answer 13

1. management retains control since bondholders cannot vote for the board of directors
2. interest paid on bonds is tax deductible
3. bonds are only a temporary source of financing, and after they’re paid off the debt is eliminated
4. bonds can be paid back early id they are callable, and sometimes bonds can be converted to common stock

Question 14

what are disadvantages of issuing bonds

Answer 14

1. bc bonds are an increase in debt, they may adversely affect the markets perception of the company
2. the firm must pay interest on its bonds
3. the firm must repay the bonds face value on the maturity date

Question 15

what are major forms of equity financing

Answer 15

equity financing involves selling stock, using retained earnings, or acquiring funds through venture capitalists

Question 16

what are advantages to a firm of selling stock

Answer 16

1. the stock investment never has to be repaid to stockholders, since they become owners in the company
2. there’s no legal obligation to pay stock dividends
3. the company incurs no debts, so it may appear financially stronger

Question 17

what are disadvantages to a firm of selling stock

Answer 17

1. stockholders become owners of the firm and can affect its management by voting for the board of directors
2. its more costly to pay dividends since they are paid in after tax profits
3. managers may be tempted to make stockholders happy in the short term rather than plan for long term needs

Question 18

whats leverage

Answer 18

leverage is borrowing funds to invest in expansion, major asset purchases, or research and development. Firms measure the risk of borrowing against the potential for higher profits

Question 19

whats a venture capital

Answer 19

money that is invested in new or emerging companies that are perceived as having great profit potential

Question 20

what are capital expenditures

Answer 20

major investments in either tangible long term assets

Question 21

whats a debenture bond

Answer 21

bond that is unsecure

Question 22

what is cost of capital

Answer 22

the rate of return a company must earn in order to meet the demands of its lenders and explanations of its equity holders

Question 23

what is an IPO

Answer 23

Initial public offering: the first public offering of a corporation’s stock

Question 24

what are risk/return trade offs

Answer 24

the principle that the greater the risk a lender takes in making a loan, the higher the interest rate required