978-0132757089 Chapter 01 Part 2

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5) If managers are making decisions to maximize shareholder wealth, then they are primarily

concerned with making decisions that should:

A) positively affect profits.

B) increase the market value of the firm’s common stock.

C) either increase or have no effect on the value of the firm’s common stock.

D) accomplish all of the above.

Topic: 1.3 The Goal of the Financial Manager

Keywords: shareholder wealth maximization

Principles: Principle 3: Cash Flows Are the Source of Value

6) Profit maximization is not an adequate goal of the firm when making financial decisions

because:

A) it does not necessarily reflect shareholder wealth maximization.

B) it ignores the risk inherent in different projects that will generate the profits.

C) it ignores the timing of a project’s returns.

D) all of the above are correct.

Topic: 1.3 The Goal of the Financial Manager

Keywords: profit maximization

Principles: Principle 3: Cash Flows Are the Source of Value

7) Which of the following goals is in the best long-term interest of stockholders?

A) Profit maximization

B) Risk minimization

C) Maximizing of the market value of the existing shareholders’ common stock

D) Maximizing sales revenues

Topic: 1.3 The Goal of the Financial Manager

Keywords: maximizing stock price

Principles: Principle 3: Cash Flows Are the Source of Value

8) Which of the following would be most likely to align the interests of managers and

shareholders?

A) Fixed but high salaries

B) Large bonuses

C) Stock options

D) All of the above

E) None of the above

Topic: 1.3 The Goal of the Financial Manager

Keywords: agency problem

9) What does the agency problem refer to?

A) The conflict that exists between the board of directors and the employees of the firm.

B) The problem associated with financial managers and Internal Revenue agents.

C) The conflict that exists between stockbrokers and investors.

D) The problem that results from potential conflicts of interest between the manager of a

business and the stockholders.

E) None of the above.

Topic: 1.3 The Goal of the Financial Manager

Keywords: agency problem

10) Purchasing a security of a company that is issuing their stock for the first time publicly

would be considered:

A) a secondary market transaction.

B) an initial public offering.

C) a seasoned new issue.

D) both A and B.

Topic: 1.3 The Goal of the Financial Manager

Keywords: initial public offering

11) In regard to the agency problem, ________ are the principal owners of a corporation.

A) shareholders

B) managers

C) employees

D) suppliers

Topic: 1.3 The Goal of the Financial Manager

Keywords: agency problem

12) Which of the following is true regarding an initial public offering?

A) The corporation gets proceeds from the investor.

B) Investors get proceeds from other investors.

C) The security is sold for the first time to the public.

D) Both A and C.

E) All of the above.

Topic: 1.3 The Goal of the Financial Manager

Keywords: financial intermediaries

13) The goal of the firm should be the maximization of profit.

Topic: 1.3 The Goal of the Financial Manager

Keywords: profit maximization

Principles: Principle 3: Cash Flows Are the Source of Value

14) One of the problems associated with profit maximization is that it ignores the timing of a

project’s return.

Topic: 1.3 The Goal of the Financial Manager

Keywords: profit maximization

Principles: Principle 3: Cash Flows Are the Source of Value

15) The goal of profit maximization is equivalent to the goal of maximization of share value.

Topic: 1.3 The Goal of the Financial Manager

Keywords: profit maximization

Principles: Principle 3: Cash Flows Are the Source of Value

16) The goal of profit maximization ignores the timing of profit.

Topic: 1.3 The Goal of the Financial Manager

Keywords: profit maximization

Principles: Principle 3: Cash Flows Are the Source of Value

17) In order to maximize shareholder wealth, a firm must consider historical costs as an integral

part of their decision-making.

Topic: 1.3 The Goal of the Financial Manager

Keywords: goal of the firm

Principles: Principle 1: Money Has a Time Value

18) Financial management is concerned with the maintenance and creation of wealth.

Topic: 1.3 The Goal of the Financial Manager

Keywords: goal of the firm

Principles: Principle 3: Cash Flows Are the Source of Value

19) Shareholder wealth is measured by the market value of the firm’s common stock.

Topic: 1.3 The Goal of the Financial Manager

Keywords: shareholder wealth maximization

Principles: Principle 3: Cash Flows Are the Source of Value

20) The agency problem arises due to the separation of ownership and control in a corporation.

Topic: 1.3 The Goal of the Financial Manager

Keywords: agency problem

21) Briefly discuss mechanisms that can be used to align the interests of shareholders and

managers.

Topic: 1.3 The Goal of the Financial Manager

Keywords: agency problem

1) Consider the following equally likely project outcomes:

Profit

X Y

Pessimistic prediction $ 0 $500

Expected outcome $ 500 $500

Optimistic prediction $1000 $500

A) Project Y has less uncertainty than Project X.

B) Project X has more variability than Project Y.

C) A and B.

D) Since Projects X and Y have the same expected outcomes of $500, investors will view them

as identical in value.

Topic: 1.4 The Four Basic Principles of Finance

Keywords: uncertainty

Principles: Principle 2: There Is a Risk-Return Tradeoff

2) Consider the timing of the profits of the following certain investment projects:

Profit

L S

Year 1 $ 0 $ 3000

Year 2 $ 3000 $ 0

A) Project S is preferred to Project L.

B) Project L is preferred to Project S.

C) Projects S and L are equally desirable.

D) A goal of profit maximization would favor Project S only.

Topic: 1.4 The Four Basic Principles of Finance

Keywords: profit maximization

Principles: Principle 1: Money Has a Time Value

3) In finance, we assume that investors are generally:

A) neutral to risk.

B) averse to risk.

C) fond of risk.

D) none of the above.

Topic: 1.4 The Four Basic Principles of Finance

Keywords: risk

Principles: Principle 2: There Is a Risk-Return Tradeoff

4) Consider cash flows for Projects X and Y such as:

Project X Project Y

Year 1 $3000 $ 0

Year 2 $ 0 $3000

A rational person would prefer receiving cash flows sooner because:

A) the money can be reinvested.

B) the money is nice to have around.

C) the investor may be tired of a particular investment.

D) the investor is indifferent to either proposal.

Topic: 1.4 The Four Basic Principles of Finance

Keywords: time value of money

Principles: Principle 1: Money Has a Time Value

5) Which of the following should be considered when assessing the financial impact of business

decisions?

A) The amount of projected earnings

B) The risk-return tradeoff

C) The timing of projected earnings; i.e., when they are expected to occur

D) The amount of the investment in a given project

E) All of the above

Topic: 1.4 The Four Basic Principles of Finance

Keywords: risk-return tradeoff

Principles: Principle 2: There Is a Risk-Return Tradeoff

6) Financial management is concerned with which of the following?

A) Creating economic wealth

B) Making investment decisions that optimize economic value

C) Making business decisions that optimize economic wealth

D) Raising capital that is needed for growth

E) All of the above

Topic: 1.4 The Four Basic Principles of Finance

Keywords: financial management

Principles: Principle 3: Cash Flows Are the Source of Value

7) If one security has a greater risk than another security, how will investors respond?

A) They will require a lower rate of return for the investment that has greater risk.

B) They would be indifferent regarding their expectation of rates of return for either investment.

C) They will require a higher rate of return for the investment that has greater risk.

D) None of the above.

Topic: 1.4 The Four Basic Principles of Finance

Keywords: efficient capital markets

Principles: Principle 2: There Is a Risk-Return Tradeoff

8) How could you compensate an investor for taking on a significant amount of risk?

A) Increase the expected rate of return

B) Raise more debt capital

C) Offer stock at a higher price

D) Increase sales

Topic: 1.4 The Four Basic Principles of Finance

Keywords: risk-return tradeoff

Principles: Principle 2: There Is a Risk-Return Tradeoff

9) If an investor had a choice of receiving $1,000 today, or $1,000 in five years, which would the

average investor prefer?

A) $1,000 in five years because they are not good at saving money.

B) $1,000 today because it will be worth more than $1,000 received in five years.

C) $1,000 in five years because it will be worth more than $1,000 received today.

D) Investors would be indifferent to when they would receive the $1,000.

E) None of the above.

Topic: 1.4 The Four Basic Principles of Finance

Keywords: time value of money

Principles: Principle 1: Money Has a Time Value

10) Why do investors prefer receiving cash sooner rather than later, according to finance theory?

A) Incremental profits are greater than accounting profits.

B) Money received earlier can be reinvested and returns can be increased.

C) Tax considerations are important when investing.

D) Diversification leads to increased value.

Topic: 1.4 The Four Basic Principles of Finance

Keywords: time value of money

Principles: Principle 1: Money Has a Time Value

11) Investors choose to invest in higher risk investments because these investments offer higher:

A) expected returns.

B) inflation.

C) actual returns.

D) future consumption.

Topic: 1.4 The Four Basic Principles of Finance

Keywords: risk-return tradeoff

Principles: Principle 2: There Is a Risk-Return Tradeoff

12) Foregoing the earning potential of a dollar today is referred to as the:

A) time value of money.

B) opportunity cost concept.

C) risk/return tradeoff.

D) creation of wealth.

Topic: 1.4 The Four Basic Principles of Finance

Keywords: opportunity cost

Principles: Principle 1: Money Has a Time Value

13) In measuring value, the focus should be on:

A) cash flow.

B) accounting profits.

C) time value of money.

D) earnings per share.

Topic: 1.4 The Four Basic Principles of Finance

Keywords: cash flow

Principles: Principle 3: Cash Flows Are the Source of Value

14) Which of the following is a characteristic of an efficient market?

A) Small number of individuals

B) Opportunities exist for investors to profit from publicly available information.

C) Security prices reflect fair value of the firm.

D) Immediate response occurs for new public information.

Topic: 1.4 The Four Basic Principles of Finance

Keywords: efficient markets

Principles: Principle 4: Market Prices Reflect Information

15) Diversification increases when ________ decreases.

A) variability

B) return

C) risk

D) A and C

E) all of the above

Topic: 1.4 The Four Basic Principles of Finance

Keywords: diversification

Principles: Principle 2: There Is a Risk-Return Tradeoff

16) Investors prefer $1 today versus $1 in the future due to:

A) time value of money.

B) opportunity cost.

C) agency problems.

D) A and B.

E) all of the above.

Topic: 1.4 The Four Basic Principles of Finance

Keywords: time value of money

Principles: Principle 1: Money Has a Time Value

17) Which of the following statements is FALSE?

A) All risk can be diversified away.

B) Measuring a project’s risk is difficult.

C) Projects should focus on incremental cash flows.

D) Taxes play a significant role in project analysis.

Topic: 1.4 The Four Basic Principles of Finance

Keywords: risk

Principles: Principle 2: There Is a Risk-Return Tradeoff

18) For the risk-averse financial manager, the more risky a given course of action, the higher the

expected return must be.

Topic: 1.4 The Four Basic Principles of Finance

Keywords: risk-return tradeoff

Principles: Principle 2: There Is a Risk-Return Tradeoff

19) The financial manager should examine available risk-return trade-offs and make his decision

based upon the greatest expected return.

Topic: 1.4 The Four Basic Principles of Finance

Keywords: risk-return tradeoff

Principles: Principle 2: There Is a Risk-Return Tradeoff

20) Only a few financial decisions involve some sort of risk-return tradeoff.

Topic: 1.4 The Four Basic Principles of Finance

Keywords: risk-return tradeoff

Principles: Principle 2: There Is a Risk-Return Tradeoff

21) For markets to be efficient, price adjustments to new information must be correct.

Topic: 1.4 The Four Basic Principles of Finance

Keywords: efficient markets

Principles: Principle 4: Market Prices Reflect Information

22) Even though diversification can reduce risk, it also makes it more difficult to measure a

project’s or an asset’s risk.

Topic: 1.4 The Four Basic Principles of Finance

Keywords: risk

Principles: Principle 2: There Is a Risk-Return Tradeoff

23) In an efficient market, prices will quickly adjust to new information.

Topic: 1.4 The Four Basic Principles of Finance

Keywords: efficient markets

Principles: Principle 4: Market Prices Reflect Information

24) Briefly discuss why financial decision makers must focus on incremental cash flows when

evaluating new projects.

Topic: 1.4 The Four Basic Principles of Finance

Keywords: incremental cash flows

Principles: Principle 3: Cash Flows Are the Source of Value

25) Discuss the risk/return tradeoff and how it relates to finance.

Topic: 1.4 The Four Basic Principles of Finance

Keywords: risk-return tradeoff

Principles: Principle 2: There Is a Risk-Return Tradeoff

26) What is incremental cash flow and how is it used in project analysis?

Topic: 1.4 The Four Basic Principles of Finance

Keywords: incremental cash flows

Principles: Principle 3: Cash Flows Are the Source of Value