Foundations of Financial Management Canadian 8th Edition Block Test Bank

Foundations of Financial Management
Canadian 8th Edition Block Test Bank

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c6
Student: ___________________________________________________________________________
1. Working capital management is relatively unimportant to the small businessperson.

True False
2. The financial manager generally needs to devote little time to management of working capital.
True False
3. Liquidating current assets are really capital assets since they have lives greater than one year.
True False
4. Ideally, permanent current assets should be financed with short-term borrowings.

True False
5. As a general rule, it is desirable to finance the permanent assets, including "permanent current assets," with
long-term debt and equity.
True False
6. Increased use of long-term financing is generally a more conservative approach to current asset financing.
True False
7. Short-term interest rates are generally lower than long-term interest rates.
True False
8. The "term structure of interest rates" refers to the relationship between yields on debt and their maturities.
True False
9. The "term structure of interest rates" depicts the competitive cost of funds for the various types of short-term
sources of funds such as Treasury bills, commercial paper, and bankers' acceptances.
True False
10. The "term structure of interest rates" is a schedule that tells when a company's bonds mature and shows how
many dollars a firm must pay in interest payments.
True False
11. In periods of tight money, long-term rates are often higher than short-term rates.
True False
12. During tight money periods, short-term financing may be difficult to find.
True False
13. Heavy use of long-term financing generally leads to lower financing costs.
True False
14. Heavy risk exposure due to short-term borrowing can be compensated for by carrying illiquid assets.
True False
15. Heavy use of long-term debt will allow a firm to carry less liquid, more profitable assets.
True False
16. Use of long-term financing and the carrying of highly liquid assets is a high-risk combination.
True False
17. Firms with predictable cash-flow patterns should assume relatively low levels of risk.
True False
18. Firms with highly volatile and perishable inventory should assume relatively low levels of risk.
True False
19. Immediate access to capital markets allows greater risk-taking capability.
True False
20. A risky financial plan will use long-term financing for capital assets, permanent current assets, and a portion
of temporary current assets.
True False
21. The more short-term financing relative to long-term financing, the more risky the financial structure.
True False
22. Short-term financing is risky because of the possibility of rising short-term rates and the inability of always
being able to refund short-term debt.
True False
23. If a firm uses a conservative financial plan, it will usually have marketable securities at the bottom of a
cyclical sales swing.
True False
24. The expected value is the sum of the probabilities of all expected events.
True False
25. Expected value techniques allow consideration of more than one possible outcome.
True False
26. Over the last several decades, most business firms have increased their liquidity.
True False
27. One reason for long-term diminishing liquidity is more efficient cash management.
True False
28. The key to current asset planning is the ability of management to forecast sales accurately and then match
production schedules with the sales forecast.
True False
29. The use of on-line point-of-sale terminals has made it easier for many retail store managers to manage their
inventory.
True False
30. Short-term interest rates are more dependent upon inflation than on current demand for money.
True False
31. A humped yield curve has lower medium-term rates than both short-term and long-term rates.
True False
32. Inventory remains a significant percentage of current assets for non-financial Canadian corporations.
True False
33. Generally speaking, during the past two decades corporations were relying more and more on short-term
borrowing to carry less liquid assets.
True False
34. When using level production, inventory will peak in the month where unit sales trend above the production
level.
True False
35. Cash, accounts receivables, and inventory all move monthly in the same direction under level production.
True False
36. During an economic "boom" period, a shortage of low-cost financing alternatives exists.
True False
37. The ratio of long-term financing to short-term financing at any point in time will be greatly influenced by
the term structure of interest rates and common stock prices.
True False
38. Yield curves change very little in the short run (3 months).
True False
39. Inflation and interest rates (yields) are inversely related.

True False
40. Humped yield curves have higher intermediate term rates (4-7 year maturities) than either short-term or
long-term rates.
True False
41. If the liquidity premium theory was correct, yield curves would be upward-sloping.
True False
42. The behaviour of various kinds of financial institutions determines the shape of the yield curve, according to
the segmentation theory.
True False
43. According to the expectations hypothesis, short-term rates would be expected to rise if they were far below
long-term rates.
True False
44. Only the segmentation theory has any significant impact on interest rates.
True False
45. Short-term interest rates have historically been more volatile than long-term rates.
True False
46. The successful financial manager is very interested in the term structure of interest rates but is not
concerned with the relative volatility or historical level of interest rates.
True False
47. The faster a firm's growth in sales, the more likely it is that an increasing percentage of financing will be
internally generated.
True False
48. Level production methods smooth production schedules and utilize manpower and equipment more
efficiently than seasonal production methods.
True False
49. The cash budget combines the cash receipts and cash payments schedules in determining cash flow.
True False
50. By using long-term capital to cover short-term needs, the firm is virtually assured of becoming technically
insolvent.
True False
51. The ratio of long-term financing to short-term financing at any given time will be greatly influenced by the
term structure of interest rates.
True False
52. It is not necessary to understand interest rate movements thoroughly when deciding upon short and
long-term debt structure.
True False
53. Hedging is matching the maturities of assets and liabilities to reduce risk.
True False
54. The cash conversion cycle is the time that is taken to collect accounts receivable.
True False
55. The current ratio for non-financial corporations reveals a steady increase in liquidity over time.
True False
56. Working capital management is primarily concerned with the management and financing of
A. cash and inventory.
B. current assets and current liabilities.
C. current assets.
D. receivables and payables.
57. A financial executive devotes the most time to

A. long-range planning.
B. capital budgeting.
C. short-term financing.
D. working capital management.
58. Pressure for current asset buildup often results from

A. decline in sales growth.
B. rapidly expanding sales.
C. increased demands of short-term creditors.
D. none of the other answers are correct.
59. Ideally, all current assets will be

A. financed by short-term debt.
B. long-term in nature.
C. self-liquidating.
D. internally financed.
60. The term "permanent current assets" implies

A. the same thing as capital assets.
B. nonmarketable assets.
C. some minimum level of current assets that is not self-liquidating.
D. inventory.
61. Normally, permanent current assets should be financed by
A. long-term funds.
B. short-term funds.
C. borrowed funds.
D. internally generated funds.
62. Ideally, which of the following types of assets should be financed with long-term financing?
A. capital assets only
B. capital assets and temporary current assets
C. capital assets and permanent current assets
D. temporary and permanent current assets
63. Generally, more use is made of short-term financing because

A. short-term interest rates are generally lower than long-term interest rates.
B. most firms do not have easy access to the capital markets.
C. short-term financing is usually more predictable than long-term financing.
D. two of the answers are correct.
64. During tight money periods

A. long-term rates are higher than short-term rates.
B. short-term rates are higher than long-term rates.
C. short-term rates are equal to long-term rates.
D. the relationship between short and long-term rates remains unchanged.
65. A "normal" term structure of interest rates would depict

A. short-term rates higher than long-term rates.
B. long-term rates higher than short-term rates.
C. no general relationship between short- and long-term rates.
D. medium rates (1-5 years) lower than both short-term and long-term rates.
66. Which of the following is a reason for diminishing liquidity in modern corporations?
A. high interest rates
B. better utilization of cash via computers
C. inflation pushes more cash into inventory
D. all of the choices are reasons for diminishing liquidity
67. An aggressive, risk-oriented firm will likely
A. borrow long-term and carry low levels of liquidity.
B. borrow short-term and carry low levels of liquidity.
C. borrow long-term and carry high levels of liquidity.
D. borrow short-term and carry high levels of liquidity.
68. Which of the following is not a condition under which a prudent manager would accept some risk in
financing?
A. predictable cash-flow patterns
B. inventory is highly perishable
C. price of inventory is stable
D. easy access to capital markets
69. Risk exposure due to heavy short-term borrowing can be compensated for by
A. carrying highly liquid assets.
B. carrying illiquid assets.
C. carrying longer term, more profitable current assets.
D. carrying more receivables to increase cash flow.
70. Which of the following combinations of asset structures and financing patterns is likely to create the least
volatile earnings?
A. illiquid assets and heavy short-term borrowing
B. illiquid assets and heavy long-term borrowing
C. liquid assets and heavy long-term borrowing
D. liquid assets and no debt
71. Which of the following combinations of asset structures and financing patterns is likely to create the most
volatile earnings?
D. liquid assets and heavy short-term borrowing
72. An aggressive working capital policy would have which of the following characteristics?
A. a high ratio of long-term debt to capital assets
B. a low ratio of short-term debt to total debt
C. a high ratio of short-term debt to long-term sources of funds
D. a short average collection period
73. Which of the following techniques allows explicit consideration of more than one possible outcome?
A. operating leverage
B. present value
C. least-squares regression
D. expected value
74. Under normal conditions (70% probability), Financing Plan A will produce $24,000 higher return than Plan
B. Under tight money conditions (30% probability), Plan A will produce $40,000 less than Plan B. What is the
expected value of return for Plan A over Plan B?
A. $28,800
B. $4,000
C. $4,800
D. $35,200
75. The term structure of interest rates

A. is an indication of investors' expectations about inflation and future interest rates.
B. will be downward sloping if short-term interest rates are higher than long-term rates.
C. will be upward sloping under normal conditions.
D. all of the other answers are correct

A. changes daily to reflect current competitive conditions in the money and capital markets.
B. plots returns for securities of different risk.
C. shows the relative interest spread between bonds with different risk ratings such as AAA, AA, A, BBB, etc.
D. depicts interest rates for T-bills over the last year.
77. The term structure of interest rates is influenced by

A. inflation.
B. money supply.
C. Bank of Canada activities.
78. A firm will usually increase the ratio of short-term debt to long-term debt when
A. short-term debt has a lower cost than long-term equity.
B. the term structure is inverted and expected to shift down.
C. the term structure is upward sloping and expected to shift up.
D. the firm is undertaking a large capital budgeting project.
79. When actual sales are greater than forecasted sales
A. inventory will decline.
B. production schedules might have to be revised upward.
C. accounts receivable will rise.
80. If a firm uses level production with seasonal sales

A. as sales decline inventory will increase.
B. as sales decline inventory will decrease.
C. as sales decline accounts receivable will increase.
D. a and c are correct
81. One advantage of level production is that

A. manpower and equipment are used efficiently at lower cost.
B. current assets fluctuate more than with seasonal production.
C. seasonal bulges and sharp declines in current assets occur.
D. none of the choices are advantageous
82. The use of cash budgeting procedures

A. helps the firm plan its current asset levels for a given production plan.
B. makes managing inventory easier under seasonal production.
C. illustrates fluctuating levels of current assets for a given production plan.
83. When the term structure of interest rates is downward sloping and interest rates are expected to decline, the
A. financial manager generally borrows short-term.
B. financial manager borrows at the lower long-term rates.
C. corporation's ratio of short-term to long-term debt is low.
D. none of the other answers are correct
84. Which of the following is a true statement concerning interest rates?

A. short-term rates are not influenced by inflation
B. long-term rates are influenced by current demands for money.
C. inflation during the 1970s and early 1980s had a large effect in boosting interest rates and changing
expectations of future rates.
D. long-term rates have been much more volatile than short-term rates from the 1970s until today.
85. The term structure of interest rates or the yield curve
A. is normal when short-term rates are higher than long-term rates.
B. is inverted when short-term rates are lower than long-term rates.
C. shows the yield to maturity for securities of equal risk over time.
86. A conservatively financed firm would

A. use long-term financing for all capital assets and short-term financing for all other assets.
B. finance a portion of permanent assets and short-term assets with short-term debt.
C. use equity to finance capital assets, long-term debt to finance permanent assets, and short-term debt to
finance fluctuating current assets.
D. use long-term financing for permanent assets and capital assets and a portion of the short-term fluctuating
assets and use short-term financing for all other short-term assets.

A. is based on historical yields.
B. is based on current yields.
C. is based on future yields.
D. is based on current and future prices.
88. Which of the following yield curves would be characteristic at peak periods of economic expansions?
A. upward sloping
B. downward sloping
C. horizontal
D. humped
89. An inverted yield curve would suggest that

A. interest rates are expected to rise.
B. interest rates are expected to fall.
C. inflation is expected to rise in the future.
D. long-term rates are being pushed up by the Bank of Canada's monetary policy.
90. Publishing companies are characterized by

A. fluctuating production to match sales.
B. seasonal sales.
C. low inventories due to computer inventory management.
D. a and b.
91. The belief that investors require a higher return to entice them into holding long-term securities is the
viewpoint of the
A. the expectations hypothesis.
B. segmentation theory.
C. the liquidity premium theory.
D. market credit crunch theory.
92. The theory of the term structure of interest rates, which suggests that long-term rates are determined by the
average of short-term rates expected over the time that a long-term bond is outstanding is the
A. expectations hypothesis.
C. liquidity premium theory.
D. market average rate theory.
93. Some analysts believe that the term structure of interest rates is determined by the behaviour of various
types of financial institutions. This theory is called the
D. theory of industry supply and demand for bonds.

A. is often referred to as the yield curve.
B. depicts the relative level of short and long-term interest rates.
C. is usually constructed with Government of Canada securities of varying maturities.
95. Yield curves change daily to reflect

A. changing conditions in the money and capital markets.
B. new inflation expectations.
C. changing conditions in the overall economy.
96. Government of Canada securities are used to construct yield curves because
A. they are free of default risk.
B. the large number of maturities forms a continuous curve.
C. both a and b are correct.
97. The concept of a self-liquidating asset implies that
A. the working capital associated with a product will be liquidated within a one year period.
B. all the product will be sold, receivables collected, and bills paid over the time period specified.
C. assets associated with the production of a product will be liquidated over the amortized life of the assets.
D. self-liquidating assets will be financed by long-term sources of capital.
98. The cash flow cycle has a major bearing on the firm's
A. dividend policy.
B. liquidity.
C. cash management efficiency.
D. risk.
99. Retail companies like Sears and Chapters exhibit sales patterns that are mostly influenced by
A. cyclical economic indicators.
B. competitive prices
C. seasonality
D. sales promotions.
100. The cash conversion cycle is equal to

A. the cash flow cycle.
B. inventory holding period less the average collection period less the accounts payable period.
C. inventory holding period less the average collection period plus the accounts payable period.
D. inventory holding period plus the average collection period less the accounts payable period.
101. As the economy moves through a business cycle, which of the following term structure of interest rates
theories dominate the shape of the yield curve?
A. the expectations theory
B. the market segmentation theory
C. the liquidity preference theory
D. none of these theories dominate the shape of the yield curve
102. Match each key term with its most correct definition statement.
1. The relationship of short and long-term interest

rates relies on the maturity preference of various expectations
financial institutions. hypothesis ____
2. The relative convertibility of short-term assets to working capital
cash. management ____
3. Assets that are converted to cash within the
normal operating cycle of the firm. capital assets ____
4. Long-term interest rates reflect the average of
expected short-term rates over the life of the "permanent"
long-term security. current assets ____
5. Time periods in which financing may be difficult
to find and interest rates may be quite high by term structure of
normal standards. interest rates ____
6. The financing and management of the current
assets of the firm. trade credit ____
7. Equal monthly production used to smooth out
production schedules and employ manpower and
equipment more efficiently. tight money ____
8. A representative quantity from a probability
distribution arrived at by multiplying each outcome
times the associated probability and summing up the
products. level production ____
9. Financing provided by sellers or suppliers in the
normal course of business. expected value ____
10. Computer terminals in retail stores that may be "temporary"
used for inventory control or other purposes. current assets ____
11. Current assets that will be reduced or converted
to cash within the normal operating cycle of the
firm. liquidity ____
12. Assets that are assumed to be long term in point of sales
nature. terminals ____
13. Depicts in graphical form the relationship
between interest rates and maturities for securities of self-liquidating
equal risk. assets ____
14. Current assets that will not be reduced or
converted to cash within the normal operating cycle segmentation
of the firm. theory ____
103. 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
$50,000 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 $10,000. 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 British
Columbia?
104. 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:
105. Christensen & Assoc. is developing an asset financing plan. Christensen has $500,000 in current assets, of
which 15% are permanent, and $700,000 in capital assets. The current long-term rate is 11%, and the current
short-term rate is 8.5%. Christensen's tax rate is 40%.
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.
B) If Christensen's earnings before interest and taxes are $325,000, calculate net income under each alternative.
C) What are some of the risks associated with each plan?
D) Which plan would you recommend to Christensen? Why?

106. McKinsee Inc. is developing a plan to finance its asset base. The firm has $5,000,000 in current assets, of
which 20% are permanent, and $12,000,000 in capital assets. Long-term rates are currently 9.5%, while
short-term rates are at 7%. 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 $6,000,000, 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 $6,000,000, what will net income be under this alternative?
C) If interest rates were expected to increase, which plan would you recommend? Why?
107. Under normal conditions (80% probability), Financing Plan A will produce $25,000 higher return than
Plan B. Under tight money conditions (20% probability), Plan A will produce $50,000 less than Plan B. What is
the expected value of return for Plan A over Plan B?
A. $25,000
B. $20,000
C. $15,000
D. $10,000

A. is not an indication of investors' expectations about inflation and future interest rates.
B. will be upward sloping if short-term interest rates are higher than long-term rates.
C. will be downward sloping under normal conditions.

A. inventory will increase.
B. production schedules might have to be revised downward.
C. accounts receivable will decrease.
110. Hedging is
A. matching the maturities of assets and liabilities to reduce risk.
B. a risk reduction strategy.
C. almost impossible to achieve perfectly in practice.
111. It is difficult to construct a perfectly hedged financial plan because

A. it is difficult to determine which part of assets is temporary and which part is permanent.
B. exact timing of asset liquidation is difficult.
C. never sure how much short or long-term financing is available at a given time.
112. If a firm uses long-term financing to cover short-term needs it is

A. assuring itself of having adequate capital at all times.
B. is taking a profitable approach to financing.
C. is taking a relatively risky approach to financing.
D. incurring a lower overall interest cost in comparison with short-term financing.
113. The finance manager at Ruthless Manufacturing Inc (RMI) was comparing plans for financing inventory.
Under normal conditions (60% probability), Financing Plan A will produce $60,000 higher return than Plan B.
Under tight money conditions (40% probability), Plan A will produce $50,000 less than Plan B. Which finance
plan should RMI choose and why?
A. Plan A because it will produce $36,000 higher expected value than Plan B.
B. Plan B because it will produce $50,000 higher expected value than Plan A.
C. Plan A because it will produce $16,000 higher expected value than Plan B.
D. Either, as both expected values are equal.

A. is not an indication of investors' expectations about inflation.
D. is an indication of investors' expectations about inflation and future interest rates.
115. Define working capital management. Why is it important to a firm?

116. What influences the amount of liquidity in the firm?
117. List the 5 considerations a financial manager should balance between short-term versus long-term
financing.
118. Explain why short-term financing is less expensive but riskier than long-term financing.
119. Explain why long-term financing is more expensive but less risky than short-term financing.
120. What is the cash conversion cycle? What does the cash conversion cycle consist of?
121. Three basic theories describe the term structure of interest rates, or shape of the yield curve. List end
explain these theories.
c6 Key
1. Working capital management is relatively unimportant to the small businessperson.

FALSE
Block - Chapter 006 #1

Difficulty: Easy
Learning Objective: 1
Type: Con
2. The financial manager generally needs to devote little time to management of working capital.
FALSE

Difficulty: Med
Type: Con
3. Liquidating current assets are really capital assets since they have lives greater than one year.
FALSE

Difficulty: Easy
Type: Con
4. Ideally, permanent current assets should be financed with short-term borrowings.

FALSE

Difficulty: Easy
Type: Con
5. As a general rule, it is desirable to finance the permanent assets, including "permanent current assets," with
long-term debt and equity.
TRUE

Difficulty: Easy
Type: Con
6. Increased use of long-term financing is generally a more conservative approach to current asset financing.
TRUE

Difficulty: Easy
Type: Con
7. Short-term interest rates are generally lower than long-term interest rates.
TRUE

Difficulty: Med
Type: Con
8. The "term structure of interest rates" refers to the relationship between yields on debt and their maturities.
TRUE

Difficulty: Easy
Type: Con
9. The "term structure of interest rates" depicts the competitive cost of funds for the various types of short-term
sources of funds such as Treasury bills, commercial paper, and bankers' acceptances.
FALSE

Difficulty: Med
Type: Con
10. The "term structure of interest rates" is a schedule that tells when a company's bonds mature and shows how
many dollars a firm must pay in interest payments.
FALSE

Difficulty: Easy
Type: Mem
11. In periods of tight money, long-term rates are often higher than short-term rates.
FALSE

Difficulty: Med
Type: Con
12. During tight money periods, short-term financing may be difficult to find.
TRUE

Difficulty: Med
Type: Con
13. Heavy use of long-term financing generally leads to lower financing costs.
FALSE

Difficulty: Easy
Type: Con
14. Heavy risk exposure due to short-term borrowing can be compensated for by carrying illiquid assets.
FALSE

Difficulty: Med
Type: Con
15. Heavy use of long-term debt will allow a firm to carry less liquid, more profitable assets.
TRUE

Difficulty: Easy
Type: Con
16. Use of long-term financing and the carrying of highly liquid assets is a high-risk combination.
FALSE

Difficulty: Easy
Type: Con
17. Firms with predictable cash-flow patterns should assume relatively low levels of risk.
FALSE

Difficulty: Med
Type: Con
18. Firms with highly volatile and perishable inventory should assume relatively low levels of risk.
TRUE

Difficulty: Hard
Type: Con
19. Immediate access to capital markets allows greater risk-taking capability.

TRUE

Difficulty: Med
Type: Con
20. A risky financial plan will use long-term financing for capital assets, permanent current assets, and a portion
of temporary current assets.
FALSE

Difficulty: Med
Type: Con
21. The more short-term financing relative to long-term financing, the more risky the financial structure.
TRUE

Difficulty: Med
Type: Con
22. Short-term financing is risky because of the possibility of rising short-term rates and the inability of always
being able to refund short-term debt.
TRUE

Difficulty: Med
Type: Con
23. If a firm uses a conservative financial plan, it will usually have marketable securities at the bottom of a
cyclical sales swing.
TRUE

Difficulty: Med
Type: Con
24. The expected value is the sum of the probabilities of all expected events.
FALSE

Difficulty: Med
Type: Con
25. Expected value techniques allow consideration of more than one possible outcome.
TRUE

Difficulty: Easy
Type: Con
26. Over the last several decades, most business firms have increased their liquidity.
FALSE

Difficulty: Easy
Type: Mem
27. One reason for long-term diminishing liquidity is more efficient cash management.
TRUE

Difficulty: Easy
Type: Con
28. The key to current asset planning is the ability of management to forecast sales accurately and then match
production schedules with the sales forecast.
TRUE

Difficulty: Easy
Type: Con
29. The use of on-line point-of-sale terminals has made it easier for many retail store managers to manage their
inventory.
TRUE

Difficulty: Easy
Type: Con
30. Short-term interest rates are more dependent upon inflation than on current demand for money.
FALSE

Difficulty: Hard
Type: Con
31. A humped yield curve has lower medium-term rates than both short-term and long-term rates.
FALSE

Difficulty: Med
Type: Con
32. Inventory remains a significant percentage of current assets for non-financial Canadian corporations.
TRUE

Difficulty: Med
Type: Mem
33. Generally speaking, during the past two decades corporations were relying more and more on short-term
borrowing to carry less liquid assets.
TRUE

Difficulty: Med
Type: Mem
34. When using level production, inventory will peak in the month where unit sales trend above the production
level.
FALSE

Difficulty: Easy
Type: Con
35. Cash, accounts receivables, and inventory all move monthly in the same direction under level production.
TRUE

Difficulty: Med
Type: Con
36. During an economic "boom" period, a shortage of low-cost financing alternatives exists.
TRUE

Difficulty: Med
Type: Con
37. The ratio of long-term financing to short-term financing at any point in time will be greatly influenced by
the term structure of interest rates and common stock prices.
FALSE

Difficulty: Med
Type: Con
38. Yield curves change very little in the short run (3 months).
FALSE

Difficulty: Easy
Type: Con
39. Inflation and interest rates (yields) are inversely related.

FALSE

Difficulty: Easy
Type: Mem
40. Humped yield curves have higher intermediate term rates (4-7 year maturities) than either short-term or
long-term rates.
TRUE

Difficulty: Med
Type: Con
41. If the liquidity premium theory was correct, yield curves would be upward-sloping.
TRUE

Difficulty: Med
Type: Con
42. The behaviour of various kinds of financial institutions determines the shape of the yield curve, according to
the segmentation theory.
TRUE

Difficulty: Med
Type: Con
43. According to the expectations hypothesis, short-term rates would be expected to rise if they were far below
long-term rates.
FALSE

Difficulty: Med
Type: Con
44. Only the segmentation theory has any significant impact on interest rates.
TRUE

Difficulty: Easy
Type: Con
45. Short-term interest rates have historically been more volatile than long-term rates.
TRUE

Difficulty: Easy
Type: Mem
46. The successful financial manager is very interested in the term structure of interest rates but is not
concerned with the relative volatility or historical level of interest rates.
FALSE

Difficulty: Easy
Type: Con
47. The faster a firm's growth in sales, the more likely it is that an increasing percentage of financing will be
internally generated.
FALSE

Difficulty: Med
Type: Con
48. Level production methods smooth production schedules and utilize manpower and equipment more
efficiently than seasonal production methods.
TRUE

Difficulty: Med
Type: Con
49. The cash budget combines the cash receipts and cash payments schedules in determining cash flow.
TRUE

Difficulty: Med
Type: Con
50. By using long-term capital to cover short-term needs, the firm is virtually assured of becoming technically
insolvent.
FALSE

Difficulty: Med
Type: Con
51. The ratio of long-term financing to short-term financing at any given time will be greatly influenced by the
term structure of interest rates.
TRUE

Difficulty: Med
Type: Con
52. It is not necessary to understand interest rate movements thoroughly when deciding upon short and
long-term debt structure.
FALSE

Difficulty: Med
Type: Con
53. Hedging is matching the maturities of assets and liabilities to reduce risk.
TRUE

Difficulty: Med
Type: Con
54. The cash conversion cycle is the time that is taken to collect accounts receivable.
FALSE

Difficulty: Med
Type: Con
55. The current ratio for non-financial corporations reveals a steady increase in liquidity over time.
FALSE

Difficulty: Med
Type: Mem
56. Working capital management is primarily concerned with the management and financing of
A. cash and inventory.
B. current assets and current liabilities.
C. current assets.
D. receivables and payables.

Difficulty: Easy
Type: Con
57. A financial executive devotes the most time to

A. long-range planning.
B. capital budgeting.
C. short-term financing.
D. working capital management.

Difficulty: Med
Type: Con
58. Pressure for current asset buildup often results from

A. decline in sales growth.
B. rapidly expanding sales.
C. increased demands of short-term creditors.
D. none of the other answers are correct.

Difficulty: Med
Type: Con
59. Ideally, all current assets will be
A. financed by short-term debt.
B. long-term in nature.
C. self-liquidating.
D. internally financed.

Difficulty: Easy
Type: Con
60. The term "permanent current assets" implies

A. the same thing as capital assets.
B. nonmarketable assets.
C. some minimum level of current assets that is not self-liquidating.
D. inventory.

Difficulty: Easy
Type: Con
61. Normally, permanent current assets should be financed by

A. long-term funds.
B. short-term funds.
C. borrowed funds.
D. internally generated funds.

Difficulty: Easy
Type: Con
62. Ideally, which of the following types of assets should be financed with long-term financing?
A. capital assets only
B. capital assets and temporary current assets
C. capital assets and permanent current assets
D. temporary and permanent current assets

Difficulty: Easy
Type: Con
63. Generally, more use is made of short-term financing because
A. short-term interest rates are generally lower than long-term interest rates.
B. most firms do not have easy access to the capital markets.
C. short-term financing is usually more predictable than long-term financing.
D. two of the answers are correct.

Difficulty: Med
Type: Con
64. During tight money periods

A. long-term rates are higher than short-term rates.
B. short-term rates are higher than long-term rates.
C. short-term rates are equal to long-term rates.
D. the relationship between short and long-term rates remains unchanged.

Difficulty: Easy
Type: Con
65. A "normal" term structure of interest rates would depict

A. short-term rates higher than long-term rates.
B. long-term rates higher than short-term rates.
C. no general relationship between short- and long-term rates.
D. medium rates (1-5 years) lower than both short-term and long-term rates.

Difficulty: Easy
Type: Mem
66. Which of the following is a reason for diminishing liquidity in modern corporations?
A. high interest rates
B. better utilization of cash via computers
C. inflation pushes more cash into inventory
D. all of the choices are reasons for diminishing liquidity

Difficulty: Med
Type: Con
67. An aggressive, risk-oriented firm will likely
A. borrow long-term and carry low levels of liquidity.
B. borrow short-term and carry low levels of liquidity.
C. borrow long-term and carry high levels of liquidity.
D. borrow short-term and carry high levels of liquidity.

Difficulty: Med
Type: Con
68. Which of the following is not a condition under which a prudent manager would accept some risk in
financing?
A. predictable cash-flow patterns
B. inventory is highly perishable
C. price of inventory is stable
D. easy access to capital markets

Difficulty: Med
Type: Con
69. Risk exposure due to heavy short-term borrowing can be compensated for by
A. carrying highly liquid assets.
B. carrying illiquid assets.
C. carrying longer term, more profitable current assets.
D. carrying more receivables to increase cash flow.

Difficulty: Med
Type: Con
70. Which of the following combinations of asset structures and financing patterns is likely to create the least
volatile earnings?
D. liquid assets and no debt

Difficulty: Med
Type: Con
71. Which of the following combinations of asset structures and financing patterns is likely to create the most
volatile earnings?
D. liquid assets and heavy short-term borrowing

Difficulty: Med
Type: Con
72. An aggressive working capital policy would have which of the following characteristics?
A. a high ratio of long-term debt to capital assets
B. a low ratio of short-term debt to total debt
C. a high ratio of short-term debt to long-term sources of funds
D. a short average collection period

Difficulty: Med
Type: Con
73. Which of the following techniques allows explicit consideration of more than one possible outcome?
A. operating leverage
B. present value
C. least-squares regression
D. expected value

Difficulty: Med
Type: Con
74. Under normal conditions (70% probability), Financing Plan A will produce $24,000 higher return than Plan
B. Under tight money conditions (30% probability), Plan A will produce $40,000 less than Plan B. What is the
expected value of return for Plan A over Plan B?
A. $28,800
B. $4,000
C. $4,800
D. $35,200

Difficulty: Med
Type: Con
A. is an indication of investors' expectations about inflation and future interest rates.
B. will be downward sloping if short-term interest rates are higher than long-term rates.
C. will be upward sloping under normal conditions.

Difficulty: Med
Type: Mem

A. changes daily to reflect current competitive conditions in the money and capital markets.
B. plots returns for securities of different risk.
C. shows the relative interest spread between bonds with different risk ratings such as AAA, AA, A, BBB, etc.
D. depicts interest rates for T-bills over the last year.

Difficulty: Med
Type: Con
77. The term structure of interest rates is influenced by

A. inflation.
B. money supply.
C. Bank of Canada activities.

Difficulty: Med
Type: Con
78. A firm will usually increase the ratio of short-term debt to long-term debt when
A. short-term debt has a lower cost than long-term equity.
B. the term structure is inverted and expected to shift down.
C. the term structure is upward sloping and expected to shift up.
D. the firm is undertaking a large capital budgeting project.

Difficulty: Med
Type: Con
A. inventory will decline.
B. production schedules might have to be revised upward.
C. accounts receivable will rise.

Difficulty: Med
Type: Con
80. If a firm uses level production with seasonal sales

A. as sales decline inventory will increase.
B. as sales decline inventory will decrease.
C. as sales decline accounts receivable will increase.
D. a and c are correct

Difficulty: Med
Type: Con
81. One advantage of level production is that

A. manpower and equipment are used efficiently at lower cost.
B. current assets fluctuate more than with seasonal production.
C. seasonal bulges and sharp declines in current assets occur.
D. none of the choices are advantageous

Difficulty: Easy
Type: Con
82. The use of cash budgeting procedures

A. helps the firm plan its current asset levels for a given production plan.
B. makes managing inventory easier under seasonal production.
C. illustrates fluctuating levels of current assets for a given production plan.

Difficulty: Med
Type: Con
83. When the term structure of interest rates is downward sloping and interest rates are expected to decline, the
A. financial manager generally borrows short-term.
B. financial manager borrows at the lower long-term rates.
C. corporation's ratio of short-term to long-term debt is low.

Difficulty: Med
Type: Con
84. Which of the following is a true statement concerning interest rates?

A. short-term rates are not influenced by inflation
B. long-term rates are influenced by current demands for money.
C. inflation during the 1970s and early 1980s had a large effect in boosting interest rates and changing
expectations of future rates.
D. long-term rates have been much more volatile than short-term rates from the 1970s until today.

Difficulty: Med
Type: Mem
85. The term structure of interest rates or the yield curve

A. is normal when short-term rates are higher than long-term rates.
B. is inverted when short-term rates are lower than long-term rates.
C. shows the yield to maturity for securities of equal risk over time.

Difficulty: Med
Type: Con
86. A conservatively financed firm would

A. use long-term financing for all capital assets and short-term financing for all other assets.
B. finance a portion of permanent assets and short-term assets with short-term debt.
C. use equity to finance capital assets, long-term debt to finance permanent assets, and short-term debt to
finance fluctuating current assets.
D. use long-term financing for permanent assets and capital assets and a portion of the short-term fluctuating
assets and use short-term financing for all other short-term assets.

Difficulty: Med
Type: Con
A. is based on historical yields.
B. is based on current yields.
C. is based on future yields.
D. is based on current and future prices.

Difficulty: Med
Type: Con
88. Which of the following yield curves would be characteristic at peak periods of economic expansions?
A. upward sloping
B. downward sloping
C. horizontal
D. humped

Difficulty: Med
Type: Con
89. An inverted yield curve would suggest that

A. interest rates are expected to rise.
B. interest rates are expected to fall.
C. inflation is expected to rise in the future.
D. long-term rates are being pushed up by the Bank of Canada's monetary policy.

Difficulty: Med
Type: Con
90. Publishing companies are characterized by

A. fluctuating production to match sales.
B. seasonal sales.
C. low inventories due to computer inventory management.
D. a and b.

Difficulty: Med
Type: Con
91. The belief that investors require a higher return to entice them into holding long-term securities is the
viewpoint of the
A. the expectations hypothesis.
C. the liquidity premium theory.
D. market credit crunch theory.

Difficulty: Med
Type: Con
92. The theory of the term structure of interest rates, which suggests that long-term rates are determined by the
average of short-term rates expected over the time that a long-term bond is outstanding is the
D. market average rate theory.

Difficulty: Med
Type: Con
93. Some analysts believe that the term structure of interest rates is determined by the behaviour of various
types of financial institutions. This theory is called the
D. theory of industry supply and demand for bonds.

Difficulty: Med
Type: Con

A. is often referred to as the yield curve.
B. depicts the relative level of short and long-term interest rates.
C. is usually constructed with Government of Canada securities of varying maturities.

Difficulty: Med
Type: Mem
95. Yield curves change daily to reflect
A. changing conditions in the money and capital markets.
B. new inflation expectations.
C. changing conditions in the overall economy.

Difficulty: Med
Type: Con
96. Government of Canada securities are used to construct yield curves because
A. they are free of default risk.
B. the large number of maturities forms a continuous curve.
C. both a and b are correct.

Difficulty: Easy
Type: Con
97. The concept of a self-liquidating asset implies that

A. the working capital associated with a product will be liquidated within a one year period.
B. all the product will be sold, receivables collected, and bills paid over the time period specified.
C. assets associated with the production of a product will be liquidated over the amortized life of the assets.
D. self-liquidating assets will be financed by long-term sources of capital.

Difficulty: Easy
Type: Con
98. The cash flow cycle has a major bearing on the firm's
A. dividend policy.
B. liquidity.
C. cash management efficiency.
D. risk.

Difficulty: Easy
Type: Con
99. Retail companies like Sears and Chapters exhibit sales patterns that are mostly influenced by
A. cyclical economic indicators.
B. competitive prices
C. seasonality
D. sales promotions.

Difficulty: Easy
Type: Con
100. The cash conversion cycle is equal to

A. the cash flow cycle.
B. inventory holding period less the average collection period less the accounts payable period.
C. inventory holding period less the average collection period plus the accounts payable period.
D. inventory holding period plus the average collection period less the accounts payable period.

Difficulty: Med
Type: Con
101. As the economy moves through a business cycle, which of the following term structure of interest rates
theories dominate the shape of the yield curve?
A. the expectations theory
B. the market segmentation theory
C. the liquidity preference theory
D. none of these theories dominate the shape of the yield curve

Difficulty: Med
Type: Con
102. Match each key term with its most correct definition statement.
1. The relationship of short and long-term interest rates

relies on the maturity preference of various financial expectations
institutions. hypothesis 4
2. The relative convertibility of short-term assets to working capital
cash. management 6
3. Assets that are converted to cash within the normal
operating cycle of the firm. capital assets 12
4. Long-term interest rates reflect the average of
expected short-term rates over the life of the long-term "permanent"
security. current assets 14
5. Time periods in which financing may be difficult to
find and interest rates may be quite high by normal term structure of
standards. interest rates 13
6. The financing and management of the current assets
of the firm. trade credit 9
7. Equal monthly production used to smooth out
production schedules and employ manpower and
equipment more efficiently. tight money 5
8. A representative quantity from a probability
distribution arrived at by multiplying each outcome
times the associated probability and summing up the
products. level production 7
9. Financing provided by sellers or suppliers in the
normal course of business. expected value 8
10. Computer terminals in retail stores that may be "temporary" current
used for inventory control or other purposes. assets 11
11. Current assets that will be reduced or converted to
cash within the normal operating cycle of the firm. liquidity 2
point of sales
12. Assets that are assumed to be long term in nature. terminals 10
13. Depicts in graphical form the relationship between self-liquidating
interest rates and maturities for securities of equal risk. assets 3
14. Current assets that will not be reduced or converted segmentation
to cash within the normal operating cycle of the firm. theory 1

Difficulty: Med
Type: Con
103. 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
$50,000 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 $10,000. 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 British
Columbia?
No, a branch office should not be opened.

Difficulty: Hard
Type: Con
104. 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:
Expected yield on 2-year security = (7.2% + 7.8%)/ 2yr
= 7.5%
Expected yield on 3-year security = (7.2% + 7.8% + 8.4%)/ 3yr
= 7.8%

Difficulty: Med
Type: Con
105. Christensen & Assoc. is developing an asset financing plan. Christensen has $500,000 in current assets, of
which 15% are permanent, and $700,000 in capital assets. The current long-term rate is 11%, and the current
short-term rate is 8.5%. Christensen's tax rate is 40%.
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.
B) If Christensen's earnings before interest and taxes are $325,000, calculate net income under each alternative.
C) What are some of the risks associated with each plan?
D) Which plan would you recommend to Christensen? Why?
C) Plan A: Interest rates could drop significantly, which would increase the effective cost of long-term
financing at a future point in time.
Plan B: Interest rates could increase, increasing the cost of short-term financing and possibly tightening the
availability of short-term funds. Profit would decrease.
D) (Subjective) It depends upon the interest rate forecast.

Difficulty: Med
Type: Con
106. McKinsee Inc. is developing a plan to finance its asset base. The firm has $5,000,000 in current assets, of
which 20% are permanent, and $12,000,000 in capital assets. Long-term rates are currently 9.5%, while
short-term rates are at 7%. 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 $6,000,000, 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 $6,000,000, what will net income be under this alternative?
C) If interest rates were expected to increase, which plan would you recommend? Why?
C) Plan B produces slightly higher net income. However, since short-term rates are more volatile, a general
increase in interest rates would probably raise the relative cost of short-term financing significantly and possibly
make short-term credit difficult to obtain. The firm's net income could be significantly reduced.

Difficulty: Med
Type: Con
107. Under normal conditions (80% probability), Financing Plan A will produce $25,000 higher return than
Plan B. Under tight money conditions (20% probability), Plan A will produce $50,000 less than Plan B. What is
the expected value of return for Plan A over Plan B?
A. $25,000
B. $20,000
C. $15,000
D. $10,000

Difficulty: Med
Type: Con

A. is not an indication of investors' expectations about inflation and future interest rates.

Difficulty: Med
Type: Mem

A. inventory will increase.
B. production schedules might have to be revised downward.
C. accounts receivable will decrease.

Difficulty: Med
Type: Con
110. Hedging is
A. matching the maturities of assets and liabilities to reduce risk.
B. a risk reduction strategy.
C. almost impossible to achieve perfectly in practice.

Difficulty: Med
Type: Con
111. It is difficult to construct a perfectly hedged financial plan because
A. it is difficult to determine which part of assets is temporary and which part is permanent.
B. exact timing of asset liquidation is difficult.
C. never sure how much short or long-term financing is available at a given time.

Difficulty: Med
Type: Con
112. If a firm uses long-term financing to cover short-term needs it is

A. assuring itself of having adequate capital at all times.
B. is taking a profitable approach to financing.
C. is taking a relatively risky approach to financing.
D. incurring a lower overall interest cost in comparison with short-term financing.

Difficulty: Med
Type: Con
113. The finance manager at Ruthless Manufacturing Inc (RMI) was comparing plans for financing inventory.
Under normal conditions (60% probability), Financing Plan A will produce $60,000 higher return than Plan B.
Under tight money conditions (40% probability), Plan A will produce $50,000 less than Plan B. Which finance
plan should RMI choose and why?
A. Plan A because it will produce $36,000 higher expected value than Plan B.
B. Plan B because it will produce $50,000 higher expected value than Plan A.
C. Plan A because it will produce $16,000 higher expected value than Plan B.
D. Either, as both expected values are equal.

Difficulty: Hard
Type: Con

A. is not an indication of investors' expectations about inflation.
D. is an indication of investors' expectations about inflation and future interest rates.

Difficulty: Med
Type: Mem
115. Define working capital management. Why is it important to a firm?
Working capital management entails arranging short-term financing (current liabilities) to facilitate investment
in the current assets of the firm. With increasing sales there will be growth in the firm's inventories and
receivables, representing more and more cash (capital) tied up in current assets. The current asset investment
must be sufficiently liquid and achieve appropriate returns.

Difficulty: Easy
Type: Mem
116. What influences the amount of liquidity in the firm?
Liquidity in the firm is influenced by asset growth, the sales and production schedule and the cash flow cycle.

Difficulty: Easy
Type: Mem
117. List the 5 considerations a financial manager should balance between short-term versus long-term
financing.
1. the composition of the firm's assets

2. the firm's willingness to accept risk
3. the risks and potential payoffs from each financing alternative
4. the term structure of interest rates
5. the volatility of interest rates

Difficulty: Med
Type: Mem
118. Explain why short-term financing is less expensive but riskier than long-term financing.
1. lower interest rates (usually)

2. short-term rates are volatile
3. risk of default if sales slow down
4. risk that bank may not extend/renew loans

Difficulty: Med
Type: Con
119. Explain why long-term financing is more expensive but less risky than short-term financing.
1. usually higher interest rates

2. you may pay interest on funds you don't always need
3. you have capital at all times

Difficulty: Med
Type: Con
120. What is the cash conversion cycle? What does the cash conversion cycle consist of?
The time it takes from the initial outlay of funds for raw materials until the firm collects funds from its clients
for the finished product, offset to some degree by the firm's purchases bought on credit, is referred to as the
cash conversion cycle.
Basically, the cash conversion cycle will consist of:
1. The time materials are in inventory (calculated as the inventory holding period)
2. Plus the time it takes to collect sales from clients (calculated as the average collection period)
3. Less the time the firm is allowed to delay payment to its suppliers (calculated as the accounts payable
period).

Difficulty: Med
Type: Con
121. Three basic theories describe the term structure of interest rates, or shape of the yield curve. List end
explain these theories.
The liquidity premium theory states that long-term rates should be higher than short-term rates. This premium
of long-term rates over short-term rates exists because short-term securities have greater liquidity, and therefore
higher rates have to be offered to potential long-term bond buyers to entice them to hold these less liquid and
more price-sensitive securities. The greater liquidity of short-term securities is partly because there is less
uncertainty about their future payments. Short-term securities are less price sensitive because underlying yield
changes in the economy do not affect their prices to the same extent as longer-term securities.
The segmentation theory states that securities are divided into market segments by the various financial
institutions investing in the market. Chartered banks prefer short-term securities of one year or less to match
their short-term lending strategies. Mortgage-oriented financial institutions prefer the intermediate-length
securities of between five and seven years, and life insurance companies prefer long-term, 20-to-30-year
securities to offset the long-term nature of their commitments to policyholders. The changing needs, desires,
and strategies of these investors tend to strongly influence the nature and relationship of short-term and
long-term interest rates.
The expectations hypothesis explains the yields on long-term securities as a function of the short-term rates.
The expectations theory says long-term rates reflect the average of short-term expected rates over the time
period that the long-term security is outstanding. The expectations hypothesis is especially useful in explaining
the shape and movement of the yield curve.

Difficulty: Hard
Type: Con
c6 Summary
Category # of Questions
Block - Chapter 006 121
Difficulty: Easy 35
Difficulty: Hard 5
Difficulty: Med 81
Learning Objective: 1 6
Type: Con 105
Type: Mem 16

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Foundations of Financial Management

Canadian 8th Edition Block Test Bank

1. Working capital management is relatively unimportant to the small businessperson.

4. Ideally, permanent current assets should be financed with short-term borrowings.

39. Inflation and interest rates (yields) are inversely related.

57. A financial executive devotes the most time to

58. Pressure for current asset buildup often results from

59. Ideally, all current assets will be

60. The term "permanent current assets" implies

63. Generally, more use is made of short-term financing because

64. During tight money periods

65. A "normal" term structure of interest rates would depict

75. The term structure of interest rates

76. The term structure of interest rates

77. The term structure of interest rates is influenced by

80. If a firm uses level production with seasonal sales

81. One advantage of level production is that

82. The use of cash budgeting procedures

84. Which of the following is a true statement concerning interest rates?

86. A conservatively financed firm would

87. The term structure of interest rates

89. An inverted yield curve would suggest that

90. Publishing companies are characterized by

94. The term structure of interest rates

95. Yield curves change daily to reflect

100. The cash conversion cycle is equal to

1. The relationship of short and long-term interest

C) What are some of the risks associated with each plan?

D) Which plan would you recommend to Christensen? Why?

108. The term structure of interest rates

109. When actual sales are greater than forecasted sales

111. It is difficult to construct a perfectly hedged financial plan because

112. If a firm uses long-term financing to cover short-term needs it is

114. The term structure of interest rates

115. Define working capital management. Why is it important to a firm?

1. Working capital management is relatively unimportant to the small businessperson.

Block - Chapter 006 #1

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Block - Chapter 006 #3

4. Ideally, permanent current assets should be financed with short-term borrowings.

Block - Chapter 006 #4

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Block - Chapter 006 #8

Block - Chapter 006 #9

Block - Chapter 006 #10

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Block - Chapter 006 #12

Block - Chapter 006 #13

Block - Chapter 006 #14

Block - Chapter 006 #15

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Block - Chapter 006 #17

Block - Chapter 006 #18

19. Immediate access to capital markets allows greater risk-taking capability.

Block - Chapter 006 #19

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Block - Chapter 006 #22

Block - Chapter 006 #23

Block - Chapter 006 #24

Block - Chapter 006 #25

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