Online Financial-Management Questions Video

Maintaining a cash reserve is a core element of prudent working capital management. Firms hold cash to meet transaction needs, precautionary needs, and sometimes speculative opportunities. The precautionary motive is particularly important, as it allows firms to handle unexpected expenses, revenue shortfalls, or economic disruptions without relying on costly external financing. Adequate liquidity reduces the risk of financial distress and enhances operational flexibility. Financial management theory emphasizes balancing the opportunity cost of holding cash against the benefits of liquidity. Option C accurately reflects this precautionary and liquidity-focused rationale.

Dividends paid to shareholders can be determined by analyzing the relationship between net income and retained earnings. Net income represents the total earnings generated during the period, while retained earnings show the portion of net income that is reinvested in the company rather than distributed to shareholders. The basic relationship is:

Net Income = Dividends Paid + Increase in Retained Earnings.

In this case, net income is $50,000 and retained earnings increased by $30,000. Therefore, dividends paid must be the remaining portion of earnings:

$50,000 − $30,000 = $20,000.

The change in total assets is not directly relevant for calculating dividends, as asset growth can be financed through retained earnings, debt, or equity issuance. From a financial management perspective, this calculation helps analysts assess dividend policy, payout ratios, and the firm’s balance between returning cash to shareholders and reinvesting in growth. Option A correctly identifies the dividends paid based on standard accounting relationships used in financial statement analysis.

Return on assets (ROA) measures how effectively a firm uses its assets to generate profits and is calculated as Net Income ÷ Total Assets. To find net income, the formula is rearranged:

Net Income = ROA × Total Assets.

With an ROA of 10% (0.10) and total assets of $500 million, net income equals $50 million. ROA is a critical profitability metric in financial statement analysis because it links income to the asset base, allowing comparisons across firms and industries regardless of size. A higher ROA indicates more efficient asset utilization. Option C correctly applies the ROA formula and reflects standard financial analysis practice.

Asset tangibility directly affects a firm’s ability to obtain debt financing because lenders prefer collateral-backed loans. Firms with higher tangible assets face lower borrowing constraints and typically carry higher leverage. This relationship is well documented in capital structure research and financial management textbooks. Tangible assets reduce credit risk and expected losses in default, allowing firms to raise debt more easily and at lower cost. Option B correctly captures this core capital structure relationship.