Question 1

The development of pro forma income statements and balance sheets is an important step in the financial planning function performed by financial managers.

Accepted Answer

Pro forma income statements and balance sheets help financial managers project future financial performance and make informed decisions about budgeting, investments, and financing.

Question 2

Covenants are terms included in long-term loan agreements that are intended to protect borrowers from unfair policies imposed by lenders.

Accepted Answer

Covenants are actually terms included in loan agreements to protect lenders by ensuring that borrowers abide by certain conditions, such as maintaining a specific level of financial performance.

Question 3

Pro forma income statements forecast the assets a firm will need in the next accounting period.

Accepted Answer

Pro forma income statements focus on forecasting the firm's projected revenues and expenses, and do not directly relate to the assets needed in the next accounting period. However, pro forma financial statements, which include both income statement and balance sheet projections, can provide insight into the assets a firm may require in the future.

Question 4

A factor is a company that provides long-term financing to firms by purchasing the firm's bonds and other long-term securities at a discount.

Accepted Answer

A factor is a financial intermediary that purchases receivables from companies, typically offering short-term financing, not long-term financing through purchasing bonds and other long-term securities.

Question 5

Trade credit is credit granted by sellers when they provide firms with materials, parts, or finished goods without requiring payment until some period after delivery.

Accepted Answer

Trade credit is a type of credit that allows businesses to make purchases and pay for them at a later date. It is primarily offered by suppliers or vendors who provide goods or services to their customers with the expectation of receiving payment at a later date.

Question 6

Commercial paper is a short-term unsecured promissory note issued by large corporations.

Accepted Answer

Commercial paper is indeed a short-term (usually less than 270 days) unsecured promissory note issued by large corporations to raise funds for their short-term financing needs.

Question 7

If an invoice contains the terms 2/10 net 30, the supplier is offering a 10 percent cash discount off the invoice price if the buyer pays quickly (within two days).

Accepted Answer

The terms 2/10 net 30 mean the supplier is offering a 2 percent discount if the invoice is paid within 10 days, not 10 percent within two days. The full payment is due within 30 days if the discount is not taken.

Question 8

A revolving credit agreement is a guaranteed line of credit in which a bank makes a binding commitment to provide a business with funds up to a specified credit limit at any time during the term of the agreement. In exchange for the bank's commitment, the firm pays a commitment fee on the unused funds.

Accepted Answer

This statement accurately describes a revolving credit agreement.

Question 9

A covenant is a restriction lenders impose on borrowers as a condition of providing long-term debt financing.

Accepted Answer

This statement is true. Covenants can include financial ratios, limitations on additional borrowing, restrictions on dividend payments, and requirements to maintain certain levels of insurance, among other things.

Question 10

A pro forma balance sheet projects the types and amounts of revenues a firm will need to execute future plans and shows the amount of additional financing needed to acquire those assets.

Accepted Answer

A pro forma balance sheet projects the types and amounts of assets, liabilities, and equity a firm will need to execute future plans and shows the amount of additional financing needed to acquire those assets. It does not focus solely on revenues.

Question 11

A line of credit is a financial arrangement between a firm and a bank in which the bank pre-approves credit up to a specified limit and guarantees that this credit will be available even if the borrower's credit rating deteriorates.

Accepted Answer

A line of credit is indeed a financial arrangement where a bank pre-approves a specified limit of credit to a firm or individual, but the availability of this credit is not guaranteed if the borrower's credit rating deteriorates. The bank may review and adjust the terms or revoke the line of credit if there's a significant negative change in the borrower's financial situation.

Question 12

When the economy is booming and profits are increase, retained earnings tend to decrease.

Accepted Answer

When the economy is booming and profits are increasing, companies tend to retain more of their earnings instead of distributing them as dividends. This results in retained earnings increasing instead of decreasing.

Question 13

Corporations sell commercial paper at a lower price than the amount the company will pay the holder when the paper comes due. The difference between the initial price and the price paid to the holder when the paper matures represents the interest earned on the note.

Accepted Answer

This statement is true. The difference between the initial price of the commercial paper and the amount paid to the holder at maturity represents the interest earned on the note. This is because the commercial paper is sold at a discount, which means that the holder pays less than the face value of the note. The holder then receives the face value of the note at maturity, which is higher than the amount paid initially, resulting in interest earnings for the holder.

Question 14

A firm that extends credit for only 30 days is likely to receive its payments faster than a firm that allows customers 60 or 90 days, but such a policy is likely to cause a loss of sales.

Accepted Answer

By extending credit for only 30 days, the firm is likely to receive payments faster. However, customers who need longer credit periods may be deterred from purchasing from the firm, causing a loss of sales.

Question 15

One key reason commercial paper is popular with companies is that it typically carries a lower interest rate than banks charge on short-term loans.

Accepted Answer

Commercial paper typically carries a lower interest rate than short-term bank loans, making it an attractive option for companies looking to raise funds.

Question 16

Spontaneous financing arises as a natural result of a firm's business operations without the need for special arrangements.

Accepted Answer

Spontaneous financing refers to the funds generated through a firm's regular business operations, such as sales revenue or accounts payable, without the need for additional borrowing or special arrangements. Therefore, it arises naturally and does not require any specific actions or arrangements.

Question 17

Seema Parvani runs a seasonal nursery business in British Columbia. Given the uneven nature of her cash payments and cash receipts, she probably wouldn't receive much benefit from developing a cash budget.

Accepted Answer

A cash budget is still useful for businesses with uneven cash flows like Seema's seasonal nursery business as it helps in managing cash inflows and outflows during different seasons and plan for possible shortfalls or surpluses.

Question 18

A drawback of commercial paper is that it takes a long time to mature, thus making it a risky asset to hold if the firm is likely to need cash in the near future.

Accepted Answer

Commercial paper is actually a short-term debt instrument that matures within a few days to a few months, making it a relatively low-risk asset to hold if the firm is financially stable.

Question 19

Another way firms can meet long-term needs is by reinvesting their earnings. The profits that a firm reinvests are called retained earnings.

Accepted Answer

Retained earnings are indeed the profits that a firm reinvests to meet its long-term needs.

Question 20

Commercial paper is usually issued at a discount, meaning that it is initially sold at a lower price than the company will pay the holder when the paper comes due.

Accepted Answer

This is correct. Commercial paper is typically sold at a discount to its face value, which is the amount that the issuing company will pay to the holder when the paper matures. The discount reflects the cost of financing for the issuing company and provides a return to the investor.

Quiz 8: Finance: Acquiring and Using Funds to Maximize Value