Fundamentals of Corporate Finance, 3e (Berk/DeMarzo/Harford)
Chapter 3 Time Value of Money: An Introduction
3.1 Cost-Beneit Analysis
1) In general, if an action increases a irm’s value by providing beneits with a value greater
than any costs involved, then that action is good for the irm’s investors.
AACSB Objective: Analytic Skills
Author: DS
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2) To enable costs and beneits to be compared, they are typically converted into cash value
at the time the beneit is received.
AACSB Objective: Analytic Skills
Author: DS
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3) Costs and beneits must be put in common terms if they are to be compared.
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
4) Whenever a good trades in a competitive market, the price determines the value of the
good.
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
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5) Which of the following is the overarching principle that a inancial manager should
follow when making decisions?
A) Decisions should generate the greatest beneits for the irm.
B) Decisions should provide beneit to the irm without incurring costs.
C) Decisions should be on behalf of the irm’s owners that give the greatest beneit to those
owners, the irm’s employees and the irm’s other stakeholders.
D) Decisions should increase the value of the irm to its investors.
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
6) What is a competitive market?
A) a market in which goods have a diferent ask price and bid price
B) a market in which a good can be bought and sold at the same price
C) a market in which a good is sold at a lower price than that for which it can be bought
D) a market in which a good is bought for a lower price than that for which it can be sold
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
7) An elderly relative ofers to sell you their used 1958 Cadillac Eldorado for $52,000. You
note that very similar cars are selling on the open market for $87,000. You don’t care for
classic cars and would rather buy a new Ford Explorer for $35,000. What is the net value of
buying the Cadillac?
A) $87,000, since the Cadillac could be sold for this price.
B) $52,000, since the Cadillac could be bought for this price.
C) $35,000, since this is the diference between purchase and resale price of the Cadillac.
D) $35,000, since this is the value of the car that you really want to buy.
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
2
8) A U.S.-based manufacturer of sunscreen is contemplating using funds to purchase
courtside advertising at major tennis matches such as the French Open and the Australian
Open. Advertising at such well viewed international events will then raise the domestic
sales of the manufacturers products. Which of the following factors is the most relevant
when analyzing this decision?
A) the cost of the machine used to produce the sunscreen
B) the manufacturing process of the sunscreen
C) the cost of the existing advertising campaign
D) the cost of the courtside advertising at the tennis matches
AACSB Objective: Relective Thinking Skills
Author: DS
Question Status: Previous Edition
9) A irm that provides tax services to the public intends to ofer a premium tax-return
service at a higher price than their current services. The managers of the company ask
experts in marketing to determine how much an efective ad campaign for such a service
would cost, and by how much sales would increase. They consult experts in economics to
calculate the increases in revenue from the success of the campaign, experts in operations
to determine the cost of ofering the service, and experts in strategy to anticipate possible
counter-moves by competitors. Which of the following points about the role of inancial
managers does this example illustrate?
A) Real-world decisions are complex and require information from many sources if the
decisions are to be valid.
B) Determining the costs associated with making a decision is easier than determining the
potential beneits of the decision.
C) All of the costs and beneits associated with a decision can never be fully identiied.
D) Ultimately the decision whether to take a certain course of action rests with the
inancial managers of a company.
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
3
10) Why is the personal decision a inancial manager makes as to whether to buy or to rent
an apartment as a personal residence most like the professional decision that manager
makes as to whether her irm should try to acquire a stake in a fast growing new Internet-
based company?
A) Both decisions involve the purchase of assets that are essential for the existence of the
investor
B) Both decisions involve the rental of a useful asset.
C) Both decisions have the potential to afect the irm.
D) Both decisions should be made based upon the tradeof beneits and costs across time.
AACSB Objective: Relective Thinking Skills
Author: DS
Question Status: Previous Edition
11) Which of the following statements regarding the cost-beneit analysis is NOT correct?
A) The irst step in evaluating a project is to identify its costs and beneits.
B) In the absence of competitive markets, we can use one-sided prices to determine exact
cash values.
C) Competitive market prices allow us to calculate the value of a decision without worrying
about the tastes or opinions of the decision maker.
D) Because competitive markets exist for most commodities and inancial assets, we can
use them to determine cash values and evaluate decisions in most situations.
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Author: JN
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12) Use the information for the question(s) below.
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13) Use the information for the question(s) below.
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14) Use the information for the question(s) below.
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15) Use the information for the question(s) below.
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16) Use the information for the question(s) below.
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Author: JN
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17) Use the information for the question(s) below.
AACSB Objective: Analytic Skills
Author: JN
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18) Steve is ofered an investment where for every $1.00 invested today, he will receive
$1.10 at the end of each of the next ive years. Steve concludes that in ive years he will
have $1.10 for every $1.00 invested and that this investment will increase his personal
value. What is Steve’s major error in reasoning when making this decision?
A) He ignores the fact that the costs and beneits of the investment are not stated in the
same terms.
B) He ignores the beneits of consuming the $1.00 today against the beneits of consuming
the $1.00 ive years from now.
C) He fails to consider the costs of not consuming the $1.00 today.
D) He considers that the value of the cash he may have in the future is the same as the
value of cash he has today.
AACSB Objective: Relective Thinking Skills
Author: DS
Question Status: Previous Edition
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