The Problem of 'Underinvestment' Occurs When Managers Are Reluctant to Undertake

question 10

Multiple Choice

The problem of 'underinvestment' occurs when managers are reluctant to undertake projects with positive net present value because:

• A) shareholders prefer less risk than do lenders and managers.
• B) the increased funds obtained from the projects will rank higher in priority of payments to creditors over shareholders in the event of the entity being liquidated.
• C) the projects would result in a reduction of managers' incentives.
• D) managers prefer to maintain a high level of funds within the entity.

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Definitions:

Flexible Short-term Policy

A financial strategy that allows for maintaining a higher level of current assets, providing a buffer against unforeseen liabilities or expenses.

Restrictive Short-term Policy

A financial policy aimed at minimizing the amount of working capital to reduce short-term financing costs, often at the risk of running low on liquidity.

Current Assets

Assets that are expected to be converted into cash, sold, or consumed within one year or within the normal operating cycle of the business, whichever is longer.

Cash Flow Time Line

A visual representation that maps out all cash inflows and outflows of a project or investment over time.