Question

Which one of the following statements is correct?

a.Firms should generally finance all of their assets with long-term debt.
b.Firms that follow restrictive financial policies can generally avoid short-term debt financing.
c.Short-term borrowing is generally more expensive than long-term borrowing.
d.Long-term interest rates tend to be more volatile than short-term rates.
e.A firm is less apt to face financial distress if it adopts a flexible financial policy rather than a restrictive policy.

Answer 1

The correct statement is that a firm is less likely to face financial distress with a flexible financial policy. Such a policy provides liquidity and adaptability, important for managing financial challenges.

Step-by-step explanation:

The correct statement among the given options is: e. A firm is less apt to face financial distress if it adopts a flexible financial policy rather than a restrictive policy.

Firms have various options to finance their assets, including bank loans, bonds, and stock issuance. Bank borrowing tends to be more customized, which can be preferable for smaller firms, as banks provide closer oversight through monitoring of sales and expenses. Large firms, conversely, may opt to issue bonds to raise significant capital for investments, to refinance existing debt, or for acquisitions. Issuing stock equates to selling a portion of the company ownership and hence answering to shareholders and a board of directors.

A flexible financial policy, which may include a mix of short-term and long-term financing options, tends to provide greater liquidity and adaptability in managing assets and liabilities. This approach helps firms to better handle unexpected financial needs and opportunities, in contrast to a restrictive policy which may limit a firm's capability to respond to market demands and may increase the risk of financial distress when faced with unforeseen financial challenges.