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John Moffat.
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AshleyMarc1997
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Pop Co is switching from using mainly long-term fixed rate finance to fund its working capital to using mainly short-term variable rate finance.
Which of the following statements about the change in Pop Co’s working capital financing policy is true?
A Finance costs will increase
B Re-financing risk will increase
C Interest rate risk will decrease
D Overcapitalisation risk will decreaseThe correct answer is B
Can you please explain that why re-financing risk will increase because the company has adopted aggressive financing policy. But why it results in increase in finance cost?
John Moffat
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The answer is not saying that the finance cost will increase (although it might) it is saying that the risk of re-financing will increase.
The reason is that the lender of short-term finance (such as an overdraft) can demand repayment at any time which means there is risk about replacing the finance. With long-term finance there will be a fixed long-term agreement for the borrowing and so there is less risk in the short-term of having to replace it with more borrowing.
AshleyMarc1997
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