Cash flow problems usually occur when the loan repayment schedule is longer than the economic life of an investment.

Cash flow problems usually occur when the loan repayment schedule is longer than the economic life of an investment.

• A. True
• B. False
• C. Sometimes
• D. Always

Answer: (B)

Cash flow problems come from not having enough cash in each period to cover debt service, not simply from the loan lasting longer than the asset’s productive life. You can arrange a loan so payments are spread over a term that matches or is longer than the asset’s life, reducing annual debt service, or you can plan for a balloon or refinance at the end. The key is whether the investment’s yearly cash inflows are sufficient to cover the payments in every year. An asset could generate strong cash flow for its 10-year life while the loan runs 15 years, and still be fine if the extra years are managed; or you could have problems with a short loan if cash inflows are weak. So the statement isn’t universally true.

Cash flow problems come from not having enough cash in each period to cover debt service, not simply from the loan lasting longer than the asset’s productive life. You can arrange a loan so payments are spread over a term that matches or is longer than the asset’s life, reducing annual debt service, or you can plan for a balloon or refinance at the end. The key is whether the investment’s yearly cash inflows are sufficient to cover the payments in every year. An asset could generate strong cash flow for its 10-year life while the loan runs 15 years, and still be fine if the extra years are managed; or you could have problems with a short loan if cash inflows are weak. So the statement isn’t universally true.