A toy manufacturer following the hedging principle will generally finance seasonal inventory
build-up prior to the Christmas season with
A) selling equipment.
B) long-term bonds since this is a recurring financing need.
C) trade credit.
D) common equity to avoid interest on a recurring annual need.
Question 2
Bellington, Inc is considering the purchase of new, sophisticated machinery for a special
three-year project.
The machinery requires a special lubricating oil that probably will never be
used, but must be available at all times should the machine break down. Bellington purchases
2,000 of lubricating oil to keep on hand just in case it is needed. At the end of the three-year
project, it is expected the lubricating oil can be sold back to the distributor for 2,000. Which of the
following statements is MOST correct?
A) The 2,000 represents an additional investment in working capital that should be included in
the capital budgeting analysis.
B) The 2,000 for the lubricating oil should be excluded from the analysis because it is recovered
at the end of three years, so the final cost is zero.
C) The 2,000 for lubricating oil is simply an accounting entry and does not represent a real cash
flow.
D) The lubricating oil is a sunk cost that should be excluded from the analysis.
Is the principle of cause and effect unfounded?
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