Question

When considering how to finance the acquisition of an asset, which of the following statements is true? A) The amount borrowed should be larger than the cost of the assets acquired. B) The cash flows generated by the assets should dictate the type of note (noninterest bearing, installment, etc) the company uses to finance the asset. C) The cash flow required by the type of note used should dictate the type of asset acquired. D) In order to minimize debt the company should not borrow unless there is no cash to fund the acquisition of the asset.

Answer 1

Evaluating each of the options:

Option A: There is no requirement that the borrowed amount should be greater than cost of asset as we might have some retained earnings to buy the asset.

Option B: The cash flows to be generated from the asset should determine the terms of debt as one type of asset may generate cash flows annually while another type of asset will generate cash flows at a later point of time. So this should be considered.

Option C: The debt cash flow should not dictate the asset inflows.

Option D: Sometimes going for debt is an advantage because of financial leverage as interest paid will be allowable as deduction for tax calculation. So this option is also wrong.

So the correct answer is OPTION B.