Question

Which of the following statements is incorrect?

a) All the answers are correct except one.
b) Short-term notes payable is a discretionary source of financing.
c) Because cash is a low-return asset, firms should seek to minimize the amount of their cash balance, therefore, the cash balance of a firm probably will not change by the same percentage as sales.
d) After applying the percent of sales forecasting, frequently, the firms will find that they might be forecasting a higher level of assets than liabilities and equity implying that the managers would need to arrange for more liabilities and/or equity to finance the level of assets needed to support the volume of sales expected.
e) Inventory is likely to fluctuate roughly in proportion to long-term debt, and therefore the percent of sales method cannot be applied.

Answer 1

The incorrect statement is that inventory is likely to fluctuate in proportion to long-term debt, as inventory is typically related to sales while long-term debt is not. In the secondary loan market, the value paid for a loan depends on the borrower's payment history and changes in interest rates. When accessing financial capital, firms consider control against financial obligations.

Step-by-step explanation:

The statement (e) "Inventory is likely to fluctuate roughly in proportion to long-term debt, and therefore the percent of sales method cannot be applied" is incorrect. When applying the percent of sales method, one would expect that certain balance sheet items, such as inventory, will vary directly with sales. However, long-term debt does not vary directly with sales but is related to the firm's financing decisions and the maturity structure of its debt.

Regarding the secondary market for loans, a loan buyer might pay:

• Less for a loan if the borrower has been late on payments, indicating higher risk.
• More or less depending on whether interest rates have risen or fallen since the loan was made. If rates have risen, existing loans with lower rates are less valuable, and vice versa.
• More for a loan if the borrower is demonstrating higher profitability, which suggests lower risk.

Lastly, in choosing how to access financial capital, a firm must consider the trade-offs between control and financial obligation. Borrowing allows a firm to maintain control but requires consistent interest payments; issuing stock dilutes control but does not require fixed payments.