13. Short-term versus long-term financing AaAa Generally speaking, short-term de
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13. Short-term versus long-term financing AaAa Generally speaking, short-term debt is riskier than long-term debt, but it also has some advantages. In the following table, identify which type of funding (short-term debt or long-term debt) is being described in each case. Short-term Debt Long-term Debt This loan has more covenants that restrict the firm's actions. This loan is more flexible and can be used to adapt to changing market conditions The lender will insist on a more thorough financial examination before extending this kind of credit. Suppose you are running a firm that needs to raise capital today and you are choosing between short-term and long-term debt. The firm does not currently have a strong enough cash flow to fund new operations internally, but you expect that this situation will soon change and the firm's need for external funds will diminish. Which funding source is likely best for your firm? O Long-term debt Short-term debtExplanation / Answer
The loan has more covenants to restrict the firms actions: Long-Term Debt
Reason: As longer term is riskier the loan carries more covenants
The loan is more flexible and can be used to adapt to changing market conditions: Short-Term Debt
Reason: Short-term is less risky as the money will be returned soon, the loan is more flexible
The lender will insist on more thorough financial examination before extending this kind of credit: Long-Term Debt
Reason: As longer term is riskier and will be paid out over a long period of time, a more horough financial examination is done
In the final part of the question set, You will opt for Long-term debt.
Reason: Cash flow will improve but the need for external funds will diminish (ie reduce) but not go away. It makes sense to opt for long-term debt so that you have money and do not need to repay debt before the cash need becomes more stable. It is better to opt for Long term debt than risk having to renew the short term debt.
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