Principles of Managerial Finance, Brief Ed., 8e (Zutter/Smart)
Chapter 1 The Role of Managerial Finance
1.1 Finance and the firm.
1) A firm is a business organization that sells goods and services.
2) In finance we say that the goal of the firm ought to be to maximize profits.
3) Other things being equal, it is better to receive money sooner rather than later.
4) Financial managers evaluating decision alternatives or potential actions must consider
________.
A) only risk
B) only return
C) either risk or return
D) risk, return, and the impact on share price
5) If a firm earns a profit, it will necessarily also generate a positive cash flow.
6) If a firm’s stockholders are risk averse, the firm can make its stockholders better off by earning
the highest possible returns on its investments.
7) Which of the following is an example of a firm’s stakeholder?
A) suppliers
B) Federal Reserve
C) media
D) competitors
8) A financial manager must choose between four alternative Assets: 1, 2, 3, and 4. Each asset
costs $35,000 and is expected to provide earnings over a three-year period as described below.
Based on the wealth maximization goal, the financial manager would choose ________.
A) Asset 1
B) Asset 2
C) Asset 3
D) Asset 4
9) In the most recent year, two different companies generated the same earnings per share. The
stocks of these two companies should trade at the same price.
10) One reason that firms exist is that most investors are risk averse, so they are not willing to
make the kinds of risky investments that firms typically undertake.
11) Which of the following is TRUE of stakeholders?
A) They are the owners of a firm.
B) They are groups to whom a firm has financial obligations.
C) They are groups having a direct economic link to a firm.
D) They include only the bondholders, common stockholders, and preferred stockholders.
12) Which of the following is TRUE regarding cash flow?
A) Profits do not necessarily result in cash flows available to the stockholders.
B) It is guaranteed that the board of directors will increase dividends when net cash flows
increase.
C) A firm’s income statement will never show a positive profit when its cash outflows exceed its
cash inflows.
D) An increase in revenue will always result in an increase in cash flow.
13) Investors who are risk averse will make risky investments as long as they expect
compensation for doing so.
14) Which of the following is TRUE of cash flows and risk?
A) Lower cash flow and lower risk result in an increase in share price.
B) Higher cash flow and lower risk result in an increase in share price.
C) Higher cash flow and higher risk result in an increase in share price.
D) Lower cash flow and higher risk result in an increase in share price.
15) The goal of business ethics is to motivate business and market participants to adhere to both
the letter and the spirit of laws and regulations in all aspects of business and professional
practice.
16) The primary goal of a financial manager is ________.
A) minimizing risk
B) maximizing profit
C) maximizing wealth
D) minimizing return
17) Corporate owners earn a return ________.
A) by realizing gains through increases in share price and interest earnings
B) by realizing gains through increases in share price and cash dividends
C) through capital appreciation and retained earnings
D) through interest earnings and earnings per share
18) The wealth of the owners of a corporation is represented by ________.
A) profits
B) earnings per share
C) share value
D) cash flow
19) Wealth maximization as the goal of a firm implies enhancing the wealth of ________.
A) the auditors
B) the creditors
C) the Federal Reserve
D) the firm’s stockholders
20) The amount earned during the accounting period on each outstanding share of common stock
is called ________.
A) dividend per share
B) earnings per share
C) net profits after taxes
D) book value per share
21) Firm A generates more cash flow while taking less risk than Firm B. The stock price of Firm
A should be higher than the stock price of Firm B.
22) Which of the following is NOT a reason that a firm that maximizes profits may fail to
maximize shareholder wealth.
A) The timing of profits matters. Shareholders might prefer lower profits that arrive sooner.
B) Risk matters. Shareholders are risk averse, so they prefer less risky investments that generate
lower profits.
C) Shareholder wealth depends on cash flow which is not the same as profit.
D) If a firm maximizes profits by engaging in unethical business practices, it’s stock price may
be adversely affected.
23) ________ pool investment capital, make risky investment decisions, and manage risky
investments on behalf of investors who would otherwise not be able to do so own their own.
A) Firms
B) Stockholders
C) Stakeholders
D) Regulators
24) Finance is ________.
A) the system of verifying, analyzing, and recording business transactions
B) the science of the production, distribution, and consumption of goods and services
C) the science and art of how individuals and businesses raise, allocate, and invest money
D) the art of merchandising products and services
25) In March 2017, Amazon and Clorox reported nearly identical earnings per share, but the
stock price of Amazon was more than six times higher than the Clorox stock price. The most
likely explanation for that difference is that ________.
A) Clorox is bad for the environment
B) Amazon is a riskier company
C) investors see better long-term prospects for Amazon
D) Amazon has more shares of stock outstanding
26) The wealth of corporate owners is measured by the share price of the stock.
27) Risk, the magnitude and timing of cash flows are the key determinants of share price, which
represent the wealth of the owners in the firm.
28) A higher earnings per share (EPS) does not necessarily translate into a higher stock price.
29) The profit maximization goal ignores the timing of returns, does not directly consider cash
flows, and ignores risk.
30) When considering a firm’s financial decision alternative, financial managers should accept
only those actions that are expected to maximize shareholder value.
31) An increase in a firm’s risk will always result in a higher share price since the stockholder
must be compensated for the greater risk.
32) An objection to managing a firm on behalf of stakeholders rather than shareholders is that
________.
A) stakeholders have no economic interest in the firm
B) stakeholders have an interest only in short-term outcomes
C) there is no clear way to satisfy all stakeholders whose economic interests may be at odds with
each other
D) the goal of managing on behalf of stakeholders is too narrow
33) An effective ethics program ________.
A) can weaken corporate value
B) has no effect on a corporation’s value
C) can enhance a corporation’s value
D) will result in high employee attrition rate
34) When considering a firm’s financial decision alternative, financial managers should accept
only those actions that are expected to increase the firm’s profitability.
35) ________ are the standards of conduct or moral judgment that apply to persons engaged in
commerce.
A) Government regulations
B) The Uniform Commercial Codes
C) The rules of fair play
D) Business ethics
36) Cash flows and risk are the key determinants in share price. Increased risk, other things
remaining the same, results in ________.
A) a lower share price
B) a higher share price
C) an unchanged share price
D) an undetermined share price
37) Cash flows and risk are the key determinants in share price. Increased cash flow results in
________, other things remaining the same.
A) a lower share price
B) a higher share price
C) an unchanged share price
D) an undetermined share price
1.2 Managing the firm.
1) A treasurer is responsible for the firm’s accounting activities, such as corporate accounting,
tax management, financial accounting, and cost accounting.
2) ________ decisions focus on how a company will spend its financial resources on long-term
projects that ultimately determine whether the firm successfully creates value for its owners.
A) Investment
B) Financing
C) Working capital
D) Risk management
3) The principle of the time value of money basically says that ________.
A) because firms pay managers a great deal, managers need to use their time very effectively
B) money received today is more valuable than money received in the future because money in
the future is more risky
C) money received today is more valuable than money received in the future because firms and
individuals can invest money they have today and earn a return on that money
D) because of the principal-agent problem, investors cannot trust that money firms promise to
pay in the future will ever arrive
4) The primary principle that finance borrows from economics is ________.
A) generally accepted accounting principles
B) cash is king
C) marginal cost-benefit analysis
D) shareholder value maximization
5) Financing decisions deal with the left-hand side of the firm’s balance sheet.
6) Which of the following activities of a finance manager determines the types of assets the firm
holds?
A) budget allocation
B) investment decisions
C) financing decisions
D) analyzing and planning cash flows
7) You own a building supply store. Today you sold construction materials to a contractor for
$10,000 that you acquired a week ago for $8,000. You paid for the materials in cash, but you
sold them to the contractor on credit, and you expect him to pay his bill in a few months. Based
on this information during the week you earned a positive profit but experienced a negative cash
flow.
8) There is a tendency for CEOs of larger companies to earn more money than CEOs of smaller
companies. Suppose a CEO decides to acquire another company, thus increasing the size of the
CEO’s firm. Suppose also that the price of the stock of the acquiring firm falls when it learns of
the upcoming acquisition. This appears to be an example of ________.
A) a CEO pursuing profit maximization rather than wealth maximization
B) the principal-agent problem
C) a CEO behaving unethically
D) the general principal that acquisitions are generally not good investments
9) A corporation’s stockholders elect its CEO.
10) The money that firms raise to finance their activities is called ________.
A) the capital budget
B) working capital
C) capital
D) accruals
11) Marginal cost-benefit analysis states that financial decisions should be made and actions
should be taken only when the added benefits exceed the added costs.
12) The treasurer typically manages a firm’s cash, investing surplus funds when available and
securing outside financing when needed.
13) A corporate treasurer’s focus tends to be more external, while the controller’s focus is more
internal.
14) The accrual method recognizes revenue at the point of sale and recognizes expenses when
incurred.
15) A treasurer is commonly responsible for handling ________.
A) tax management
B) corporate accounting
C) investing surplus funds
D) cost accounting
16) Which of the following is TRUE of accrual basis accounting?
A) Expenses are recognized either when they are incurred or cash is paid.
B) Revenue is recognized when a customer pays cash.
C) Expenses are recognized when they are incurred.
D) Revenue is recognized when a customer pays cash or shows interest to purchase the product
or service.
17) Johnson, Inc. has just ended the calendar year making a sale in the amount of $10,000 of
merchandise purchased during the year at a total cost of $7,000. Although the firm paid in full
for the merchandise during the year, it is yet to collect at year end from the customer. The net
profit and cash flow from this sale for the year are ________.
A) $3,000 and $10,000, respectively
B) $3,000 and -$7,000, respectively
C) $7,000 and -$3,000, respectively
D) $3,000 and $7,000, respectively
18) A firm has just ended its calendar year making a sale in the amount of $150,000 of
merchandise purchased during the year at a total cost of $112,500. Although the firm paid in full
for the merchandise during the year, it is yet to collect at year end from the customer. The net
profit and cash flow from this sale for the year are ________.
A) $0 and $150,000, respectively
B) $37,500 and -$150,000, respectively
C) $37,500 and -$112,500, respectively
D) $150,000 and $112,500, respectively
19) Stockholders expect to earn higher rates of return on investments with lower risk and lower
rates of return on investments with higher risk.
20) As the risk of a stock investment increases, investors’ ________.
A) return will increase
B) return will decrease
C) required rate of return will decrease
D) required rate of return will increase
21) The principal-agent problem arises when ________.
A) the owners of the firm are not the people managing the firm
B) the owners of the firm also manage the firm
C) managers serve on a firm’s board of directors
D) a firm is organized as a sole proprietorship
22) Which of the following works as a conduit of information between the firm and its investors?
A) the treasurer
B) the controller
C) the director of internal audit
D) the director of investor relations
23) ________ decisions refer to how a firm manages its short-term resources on a day-to-day
basis.
A) Financing
B) Investment
C) Working capital
D) Managerial finance
24) There is a tradeoff between risk and return (i.e., to earn higher returns you generally have to
take more risk) because ________.
A) investors like risk and return and want more of both
B) investors are risk averse, so they will not accept riskier investments unless they offer higher
returns
C) to earn higher returns you have to make bigger investments and bigger investments are
always riskier than smaller ones
D) investors care about returns but not about risks
25) The time value of money principle implies that all other things being equal, investments that
produce profits faster are preferred over those that produce more distant profits.