Principles of Finance, 6e
Besley/Brigham
Chapter 06
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© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
1. Which of the following is not one of the things that causes a corporation to have a significant advantage over a
partnership or a proprietorship?
a.
Limited liability.
b.
Ease of transfer of ownership interest.
c.
Unlimited life.
d.
Elimination of double taxation.
e.
Ability to retain earnings and thus convert income from personal income to capital gains.
ANSWER:
d
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 – Knowledge
Business Program-6 – Reflective Thinking
DISC-FIN-07 – Finance Function
Time Estimate-a – 5 min.
TOPICS:
Firm Organization
2. The primary goal of a publicly-owned firm interested in serving its stockholders should be to
a.
Minimize the debt used by a firm.
b.
Maximize expected EPS.
c.
Minimize the chances of losses.
d.
Maximize the stock price per share.
e.
Maximize expected net income.
ANSWER:
d
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 – Knowledge
Business Program-6 – Reflective Thinking
DISC-FIN-07 – Finance Function
Time Estimate-a – 5 min.
TOPICS:
Goal of Firm
3. Which of the following does not need to be considered when assessing the impact of financial decisions?
a.
Projected earnings.
b.
Financial market conditions.
c.
Timing of the earnings flow.
d.
Riskiness of the firm.
e.
All of the above must be considered.
ANSWER:
e
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 – Knowledge
Business Program-6 – Reflective Thinking
DISC-FIN-07 – Finance Function
Principles of Finance, 6e
Besley/Brigham
Chapter 06
Cengage Learning Testing, Powered by Cognero
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necessity?
a.
Attracting and sustaining new customers.
b.
Hiring and keeping skilled employees.
c.
Keeping up with competition.
d.
Dealing with firms who use “questionable” ethics.
e.
None of the above.
ANSWER:
e
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-5 – Knowledge
Business Program-6 – Reflective Thinking
DISC-FIN-07 – Finance Function
Time Estimate-a – 5 min.
TOPICS:
Business Ethics
15. Which of the following actions is consistent with social responsibility but is necessarily inconsistent with stockholder
wealth maximization?
a.
Investing in a smokestack “scrubber” to reduce the firm‘s air pollution as mandated by law.
b.
Voluntarily installing expensive machinery to treat effluent discharge which currently is being dumped into a
river where it is ruining the drinking water of the community where the plant is located.
c.
Investing in a smokestack filter to reduce sulphur-dioxide emissions in order to reduce the current tax being
levied on the firm by the state for its pollution.
d.
Making a large corporate donation to the local community in order to fund a recreation complex that will be
used by the community and the firm’s employees.
e.
Each of the above actions is consistent with social responsibility and none is necessarily inconsistent with
stockholder wealth maximization.
ANSWER:
e
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-5 – Knowledge
Business Program-6 – Reflective Thinking
DISC-FIN-07 – Finance Function
Time Estimate-a – 5 min.
TOPICS:
Social Responsibility
16. Which of the following statements is correct?
a.
The ability of firms to engage in socially beneficial projects that involve voluntary costs is constrained by
competition and the need of firms to attract capital at low cost.
b.
The actions that maximize a firm’s stock price are inconsistent with maximizing social welfare.
c.
The concepts of social responsibility and ethical responsibility on the part of corporations are completely
different and neither is relevant in maximizing stock price.
d.
In a competitive market, if a group of firms do not spend resources making social welfare improvements, but
another group does, in general, this will not affect the second group’s ability to attract capital.
e.
If government did not mandate socially responsible corporate actions, such as those relating to product safety
Principles of Finance, 6e
Besley/Brigham
Chapter 06
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and fair hiring practices, most firms in competitive markets would still pursue such policies voluntarily.
ANSWER:
a
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-5 – Knowledge
Business Program-6 – Reflective Thinking
DISC-FIN-07 – Finance Function
Time Estimate-a – 5 min.
TOPICS:
Social Welfare
17. Which of the following statements is correct?
a.
The corporate bylaws are the set of rules drawn up by the state to enable managers to run the firm in
accordance with state laws.
b.
Procedures for electing corporate directors are contained in bylaws while the declaration of the activities that
the firm will pursue and the number of directors are included in the corporate charter.
c.
Procedures which govern changes in the bylaws of the corporation are contained in the corporate charter.
d.
Although most companies design a charter, only the bylaws are legally required to be filed with the secretary
of state in order for a corporation to be in official existence.
ANSWER:
b
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-5 – Knowledge
Business Program-6 – Reflective Thinking
DISC-FIN-07 – Finance Function
Time Estimate-a – 5 min.
TOPICS:
Corporate Charter and Bylaws
18. Which of the following statements is correct?
a.
A hostile takeover is a primary method of transferring ownership interest in a corporation.
b.
The corporation is a legal entity created by the state and is a direct extension of the legal status of its owners
and managers, that is, the owners and managers are the corporation.
c.
Unlimited liability and limited life are two key advantages of the corporate form over other forms of business
organization.
d.
In part due to limited liability and ease of ownership transfer, corporations have less trouble raising money in
financial markets than other organizational forms.
e.
Although stockholders of the corporation are insulated by limited legal liability, the legal status of the
corporation does not protect the firm’s managers in the same way.
ANSWER:
d
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-5 – Knowledge
Business Program-6 – Reflective Thinking
DISC-FIN-07 – Finance Function
Time Estimate-a – 5 min.
Principles of Finance, 6e
Besley/Brigham
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a.
A major disadvantage of a regular partnership or a corporation as a form of business is the fact that they do not
offer their owners limited liability, whereas proprietorships do.
b.
An advantage of the corporate form for many businesses is the fact that the corporate tax rate always exceeds
the personal tax rate, which is the rate at which proprietorships and partnerships are taxed.
c.
There are more partnerships and sole proprietorships than corporations in the U.S., but corporations produce
more goods and services than do other forms of business.
d.
Because corporations enjoy the benefits of limited liability, easy transferability of ownership interest,
unlimited life, and favorable tax status relative to the situation for partnerships and proprietorships, most large
businesses choose to incorporate.
e.
Because lawyers have the incorporation process so automated (e.g., word processors for drawing up the
necessary papers), it is less expensive to form a corporation than to form a proprietorship or partnership.
ANSWER:
c
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-2 – Application
Business Program-6 – Reflective Thinking
DISC-FIN-07 – Finance Function
Time Estimate-a – 5 min.
TOPICS:
Firm Organization
22. Which of the following statements is correct?
a.
The optimal dividend policy is the one that satisfies the shareholders because they supply the firm’s capital.
b.
The use of debt financing has no effect on earnings per share (EPS) or stock price.
c.
The riskiness of projected EPS depends upon how the firm is financed.
d.
Stock price is dependent on the projected EPS and the use of debt but not on the timing of the earnings stream.
e.
Dividend policy is one aspect of the firm’s financial policy that is determined directly by the shareholders.
ANSWER:
c
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-2 – Application
Business Program-6 – Reflective Thinking
DISC-FIN-07 – Finance Function
Time Estimate-a – 5 min.
TOPICS:
Financial Policy and Earnings
23. Which of the following statements is correct?
a.
The proper goal of the financial manager should be to maximize the firm’s expected cash flow, because this
will add the most wealth to each of the individual shareholders (owners) of the firm.
b.
One way to state the decision framework most useful for carrying out the firm’s objective is as follows: “The
financial manager should seek that combination of assets, liabilities, and capital which will generate the largest
expected projected after-tax income over the relevant time horizon.”
c.
The riskiness inherent in a firm’s earnings per share (EPS) depends on the characteristics of the projects the
firm selects, which means it depends upon the firm’s assets, but EPS does not depend on the manner in which
those assets are financed.
Principles of Finance, 6e
Besley/Brigham
Chapter 06
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distributed with a certain product or service or otherwise on a password-protected website for classroom use.
d.
Because large, publicly-owned firms are controlled by their management teams, and typically, ownership is
widely dispersed, managers have great freedom in managing the firm. Managers may operate in the
stockholders’ best interest, but they may also operate in their own personal best interests. As long as managers
stay within the law, there simply aren’t any effective controls over managerial decisions in such situations.
e.
Agency problems exist between stockholders and managers, and between stockholders and creditors.
ANSWER:
e
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-2 – Application
Business Program-6 – Reflective Thinking
DISC-FIN-07 – Finance Function
Time Estimate-a – 5 min.
TOPICS:
Corporate Goals and Control
24. Jane Doe, who has substantial personal wealth and income, is considering the possibility of opening a new business in
the chemical waste management field. She will be the sole owner. The business will have a relatively high degree of risk,
and it is expected that the firm will incur losses for the first few years. However, the prospects for growth and positive
future income look good, and Jane expects to realize substantial cash flows from dividends the firm will eventually pay
out. Which of the legal forms of business organization would probably best suit her needs?
a.
Proprietorship, because of ease of entry.
b.
Regular corporation, because of the limited liability.
c.
Partnership, if she needs additional capital.
d.
S corporation, to enjoy tax advantages and gain limited liability.
e.
In this situation, the various forms of organization seem equally desirable.
ANSWER:
d
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-2 – Application
Business Program-6 – Reflective Thinking
DISC-FIN-07 – Finance Function
Time Estimate-a – 5 min.
TOPICS:
Business Organization
25. Allen Corporation can (1) build a new plant which should generate a before-tax return of 11 percent, or (2) invest the
same funds in the preferred stock of FPL, which should provide Allen with a before-tax return of 9%, all in the form of
dividends. Assume that Allen’s marginal tax rate is 25 percent, and that 70 percent of dividends received are excluded
from taxable income. If the plant project is divisible into small increments, and if the two investments are equally risky,
what combination of these two possibilities will maximize Allen’s effective return on the money invested?
a.
All in the plant project.
b.
All in FPL preferred stock.
c.
60% in the project; 40% in FPL.
d.
60% in FPL; 40% in the project.
e.
50% in each.
ANSWER:
b
Principles of Finance, 6e
Besley/Brigham
Chapter 06
Cengage Learning Testing, Powered by Cognero
Page 16
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
35. In 2014, Craig and Kathy Koehler owned a small business which was held as a proprietorship in Kathy’s name. They
were thinking of incorporating if that would lower their total tax liability. The Koehlers expected the company to earn
$100,000 before taxes next year. They planned to take out salaries of $45,000, and to reinvest the rest in the business.
Their personal deductions total $8,150 and they will file a joint return for their personal income. (1) What is their
expected total tax liability as a proprietorship? (2) As a corporation? (3) Based on current taxes, should they incorporate?
a.
$23,304.50; $14,675.00; Yes
b.
$14,675.00; $13,427.50; Yes
c.
$23,304.50; $13,427.50; Yes
d.
$15,212.50; $23,450.00; No
e.
$20,778.00; $23,450.00; No
ANSWER:
b
RATIONALE:
As a sole proprietorship:
Taxable income
EBT
$100,000
Personal deductions
(8,150)
$ 91,850
Tax liability
= $10,162.50 + (0.25)($91,850 − $73,800)
= $10,162.50 + $4,512.50 = $14,675.00
As a corporation:
Taxable income
Salary
$45,000
Personal deductions
(8,150)
1) Personal taxable income
$36,850
2) Company EBT
$55,000
1) Personal tax liability
= $1,700 + (0.15)($36,850 – $17,000) = $4,677.50
2) Corporate tax liability
+ $7,500 + 0.25($55,000 − $50,000) = $8,750
Total tax liability
= $8,750 + $4,677.50 = $13,427.50
Yes, the Koehlers should incorporate.
POINTS:
1
DIFFICULTY:
Hard
ACCREDITING STANDARDS:
Blooms Taxonomy-2 – Application
Business Program-3 – Analytic
DISC-FIN-07 – Finance Function
Time Estimate-a – 5 min.
TOPICS:
Business Organization and Taxes
36. Which of the following is not a limitation of the proprietorship form of business?
a.
Unlimited personal liability
b.
Difficulty raising capital
c.
Double taxation
d.
Difficulty in transferring ownership
e.
Limited life
ANSWER:
c
POINTS:
1
