Chapter 1: Overview True/False Page 1
(Difficulty Levels: Easy, Easy/Medium, Medium, Medium/Hard, and Hard)
Note that there is an overlap between the T/F and multiple-choice questions, as some of the T/F
statements are used in multiple-choice questions. See the preface for information on the AACSB
letter indicators (F, M, etc.) on the subject lines.
Multiple Choice: True/False
1. In most corporations, the CFO ranks under the CEO.
a. True
b. False
2. The Chairman of the Board must also be the CEO.
a. True
b. False
3. The board of directors is the highest ranking body in a corporation, and
the chairman of the board is the highest ranking individual. The CEO
generally works under the board and its chairman, and the board generally
has the authority to remove the CEO under certain conditions. The CEO,
however, cannot remove the board, but he or she can endeavor to have the
board voted out and a new board voted in should a conflict arise. It is
possible for a person to simultaneously serve as CEO and chairman of the
board, though many corporate control experts believe it is bad to vest
both offices in the same person.
a. True
b. False
4. Partnerships and proprietorships generally have a tax advantage over
corporations.
a. True
b. False
5. A disadvantage of the corporate form of organization is that corporate
stockholders are more exposed to personal liabilities in the event of
bankruptcy than are investors in a typical partnership.
a. True
b. False
CHAPTER 1
AN OVERVIEW OF FINANCIAL MANAGEMENT
Page 2 True/False Chapter 1: Overview
6. An advantage of the corporate form of organization is that corporations
are generally less highly regulated than proprietorships and
partnerships.
a. True
b. False
7. Some partners in a partnership may have different rights, privileges, and
responsibilities than other partners.
a. True
b. False
8. One advantage of the corporate form of organization is that it avoids
double taxation.
a. True
b. False
9. It is generally harder to transfer one’s ownership interest in a
partnership than in a corporation.
a. True
b. False
10. One danger of starting a proprietorship is that you may be exposed to
personal liability if the business goes bankrupt. This problem would be
avoided if you formed a corporation to operate the business.
a. True
b. False
11. If a corporation elects to be taxed as an S corporation, then it can
avoid the corporate tax. However, its stockholders will have to pay
personal taxes on the firm’s net income.
a. True
b. False
12. If a corporation elects to be taxed as an S corporation, then both it and
its stockholders can avoid all Federal taxes. This provision was put
into the Federal Tax Code in order to encourage the formation of small
businesses.
a. True
b. False
13. It is generally less expensive to form a corporation than a
proprietorship because, with a proprietorship, extensive legal documents
are required.
a. True
b. False
14. The more capital a firm is likely to require, the greater the probability
that it will be organized as a corporation.
a. True
b. False
15. One disadvantage of forming a corporation rather than a partnership is
that this makes it more difficult for the firm’s investors to transfer
their ownership interests.
a. True
b. False
16. Organizing as a corporation makes it easier for the firm to raise
capital. This is because corporations’ stockholders are not subject to
personal liabilities if the firm goes bankrupt and also because it is
easier to transfer shares of stock than partnership interests.
a. True
b. False
17. In order to maximize its shareholders’ value, a firm’s management must
attempt to maximize the expected EPS.
a. True
b. False
18. In order to maximize its shareholders’ value, a firm’s management must
attempt to maximize the stock price on a specific target date.
a. True
b. False
19. In order to maximize its shareholders’ value, a firm’s management must
attempt to maximize the stock price in the long run, or the stock’s
“intrinsic value.”
Page 4 True/False Chapter 1: Overview
a. True
b. False
20. If management operates in a manner designed to maximize the firm’s
expected profits for the current year, this will also maximize the
stockholders’ wealth as of the current year.
a. True
b. False
21. Globalization of business has been facilitated by improvements in
information technology.
a. True
b. False
22. As a result of the Enron scandal and other recent scandals, there has
been a strong push to improve business ethics.
a. True
b. False
23. There are many types of unethical business behavior. One example is
where executives provide information that they know is incorrect to banks
and to stockholders. It is illegal to provide such information to banks,
but it is not illegal to provide it to stockholders because they are the
owners of the firm, not outsiders.
a. True
b. False
24. A stock’s market price would equal its intrinsic value if all investors
had all the information that is available about the stock. In this case
the stock’s market price would equal its intrinsic value.
a. True
b. False
25. If a stock’s market price is above its intrinsic value, then the stock
can be thought of as being undervalued, and it would be a good buy.
a. True
b. False
26. If a stock’s intrinsic value is greater than its market price, then the
stock is overvalued and should be sold.
Chapter 1: Overview True/False Page 5
a. True
b. False
27. For a stock to be in equilibrium as the book defines it, its market price
should exceed its intrinsic value.
a. True
b. False
28. The term “marginal investor” means an investor who is active in the
market and would tend to buy a stock if its price fell and sell it if it
rose, barring any new information coming out about the stock. It is the
“marginal investor” who determines the actual stock price.
a. True
b. False
29. If a lower level person in a firm does something illegal, like “cooking
the books” to understate costs and thereby increase profits above the
correct profits because he or she was told to do so by a superior, the
lower level person cannot be prosecuted but the superior can be
prosecuted.
a. True
b. False
30. If someone deliberately understates costs and thereby increases profits,
this can cause the price of the stock to rise above its intrinsic value.
The stock price will probably fall in the future. Also, those who
participated in the fraud can be prosecuted, and the firm itself can be
penalized.
a. True
b. False
31. Managers always attempt to maximize the long-run value of their firms’
stocks, or the stocks’ intrinsic values. This is exactly what
stockholders desire. Thus, conflicts between stockholders and managers
are not possible. However, there can be conflicts between stockholders
and bondholders.
a. True
b. False
Page 6 M/C Problems Chapter 1: Overview
32. A hostile takeover is said to occur when another corporation or group of
investors gains voting control over a firm and replaces the old managers.
If the old managers were managing the firm inefficiently, then hostile
takeovers can improve the economy. However, hostile takeovers are
controversial, and legislative actions have been taken to make them more
difficult to undertake.
a. True
b. False
33. If a firm’s board of directors wants to maximize value for its
stockholders in general (as opposed to some specific stockholders), it
should design an executive compensation system whose goal is to maximize
the stock’s intrinsic value rather than the stock’s current market price.
a. True
b. False
Multiple Choice: Conceptual
Please note that some of the answer choices, or answers that are very close, are used in different
questions. This has caused us no difficulties, but please take this into account when you make up
exams.
34. Which of the following statements is CORRECT?
a. One of the disadvantages of incorporating your business is that you
could become subject to the firm’s liabilities in the event of
bankruptcy.
b. Sole proprietorships are subject to more regulations than
corporations.
c. In any partnership, every partner has the same rights, privileges, and
liability exposure as every other partner.
d. Corporations of all types are subject to the corporate income tax.
e. Sole proprietorships and partnerships generally have a tax advantage
over corporations.
35. Which of the following statements is CORRECT?
a. One of the advantages of the corporate form of organization is that it
avoids double taxation.
b. It is easier to transfer one’s ownership interest in a partnership
than in a corporation.
c. One of the disadvantages of a sole proprietorship is that the
proprietor is exposed to unlimited liability.
Chapter 1: Overview M/C Problems Page 7
d. One of the advantages of a corporation from a social standpoint is
that every stockholder has equal voting rights, i.e., “one person, one
vote.”
e. Corporations of all types are subject to the corporate income tax.
36. Which of the following statements is CORRECT?
a. One advantage of forming a corporation is that equity investors are
usually exposed to less liability than they would be in a partnership.
b. Corporations face fewer regulations than sole proprietorships.
c. One disadvantage of operating a business as a sole proprietor is that
the firm is subject to double taxation, because taxes are levied at
both the firm level and the owner level.
d. It is generally less expensive to form a corporation than a
proprietorship because, with a proprietorship, extensive legal
documents are required.
e. If a partnership goes bankrupt, each partner is exposed to liabilities
only up to the amount of his or her investment in the business.
37. Relaxant Inc. operates as a partnership. Now the partners have decided
to convert the business into a corporation. Which of the following
statements is CORRECT?
a. Relaxant’s shareholders (the ex-partners) will now be exposed to less
liability.
b. The company will probably be subject to fewer regulations and required
disclosures.
c. Assuming the firm is profitable, none of its income will be subject to
federal income taxes.
d. The firm’s investors will be exposed to less liability, but they will
find it more difficult to transfer their ownership.
e. The firm will find it more difficult to raise additional capital to
support its growth.
38. Which of the following statements is CORRECT?
a. Corporations generally face fewer regulations than sole
proprietorships.
b. Corporate shareholders are exposed to unlimited liability.
c. It is usually easier to transfer ownership in a corporation than in a
partnership.
d. Corporate shareholders are exposed to unlimited liability, but this
factor is offset by the tax advantages of incorporation.
e. There is a tax disadvantage to incorporation, and there is no way any
corporation can escape this disadvantage, even if it is very small.
39. Which of the following could explain why a business might choose to
operate as a corporation rather than as a sole proprietorship or a
partnership?
a. Corporations generally face fewer regulations.
b. Less of a corporation’s income is generally subject to federal taxes.
c. Corporate shareholders are exposed to unlimited liability, but this
factor is offset by the tax advantages of incorporation.
d. Corporate investors are exposed to unlimited liability.
e. Corporations generally find it easier to raise large amounts of
capital.
40. The primary operating goal of a publicly-owned firm interested in serving
its stockholders should be to
a. Maximize its expected total corporate income.
b. Maximize its expected EPS.
c. Minimize the chances of losses.
d. Maximize the stock price per share over the long run, which is the
stock’s intrinsic value.
e. Maximize the stock price on a specific target date.
41. Which of the following statements is CORRECT?
a. In most corporations, the CFO ranks above the CEO.
b. By law in most states, the chairman of the board must also be the CEO.
c. The board of directors is the highest ranking body in a corporation,
and the chairman of the board is the highest ranking individual. The
CEO generally works under the board and its chairman, and the board
generally has the authority to remove the CEO under certain
conditions. The CEO, however, cannot remove the board, but he or she
can endeavor to have the board voted out and a new board voted in
should a conflict arise. It is possible for a person to
simultaneously serve as CEO and chairman of the board, though many
corporate control experts believe it is bad to vest both offices in
the same person.
d. The CFO generally reports to the firm’s chief accounting officer, who
is normally the controller.
e. The CFO is responsible for raising capital and for making sure that
capital expenditures are desirable, but he or she is not responsible
for the validity of the financial statements, as the controller and
the auditors have that responsibility.
42. Which of the following statements is CORRECT?
a. One drawback of forming a corporation is that it generally subjects
the firm to additional regulations.
b. One drawback of forming a corporation is that it subjects the firm’s
investors to increased personal liabilities.
c. One drawback of forming a corporation is that it makes it more
difficult for the firm to raise capital.
d. One advantage of forming a corporation is that it subjects the firm’s
investors to fewer taxes.
Chapter 1: Overview M/C Problems Page 9
e. One disadvantage of forming a corporation is that it is more difficult
for the firm’s investors to transfer their ownership interests.
Page 10 M/C Problems Chapter 1: Overview
43. Which of the following statements is CORRECT?
a. If a corporation elects to be taxed as an S corporation, then both it
and its stockholders can avoid all Federal taxes. This provision was
put into the Federal Tax Code in order to encourage the formation of
small businesses.
b. The more capital a firm is likely to require, the smaller the
probability that it will be organized as a corporation.
c. It is generally easier to transfer one’s ownership interest in a
partnership than in a corporation.
d. One danger of starting a proprietorship is that you may be exposed to
personal liability if the business goes bankrupt. This problem would
be avoided if you formed a corporation to operate the business.
e. Corporate shareholders are exposed to unlimited liability, but this
factor is offset by the tax advantages of incorporation.
44. Which of the following statements is CORRECT?
a. Due to limited liability, unlimited lives, and ease of ownership
transfer, the vast majority of U.S. businesses (in terms of number of
businesses) are organized as corporations.
b. Most businesses (by number and total dollar sales) are organized as
proprietorships or partnerships because it is easier to set up and
operate one of these forms rather than as a corporation. However, if
the business gets very large, it becomes advantageous to convert to a
corporation, primarily because corporations have important tax
advantages over proprietorships and partnerships.
c. Due to legal considerations related to ownership transfers and limited
liability, which affect the ability to attract capital, most business
(measured by dollar sales) is conducted by corporations in spite of
large corporations’ less favorable tax treatment.
d. Large corporations are taxed more favorably than sole proprietorships.
e. Corporate stockholders are exposed to unlimited liability.
45. Which of the following statements is CORRECT?
a. A hostile takeover is the main method of transferring ownership
interest in a corporation.
b. A corporation is a legal entity created by a state, and it has a life
and existence that is separate from the lives and existence of its
owners and managers.
c. Unlimited liability and limited life are two key advantages of the
corporate form over other forms of business organization.
d. Limited liability is an advantage of the corporate form of
organization to its owners (stockholders), but corporations have more
trouble raising money in financial markets because of the complexity
of this form of organization.
e. Although the 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, i.e., bondholders can sue the
firm’s managers if the firm defaults on its debt.
Chapter 1: Overview M/C Problems Page 11
46. Which of the following statements is CORRECT?
a. In a typical partnership, liability for other partners’ misdeeds is
limited to the amount of a particular partner’s investment in the
business.
b. In a limited partnership, the limited partners have voting control,
while the general partner has operating control over the business, and
the limited partners are individually responsible, on a pro rata
basis, for the firm’s debts in the event of bankruptcy.
c. A slow-growth company, with little need for new capital, would be more
likely to organize as a corporation than would a faster growing
company.
d. Partnerships have more difficulty attracting large amounts of capital
than corporations because of such factors as unlimited liability, the
need to reorganize when a partner dies, and the illiquidity
(difficulty buying and selling) of partnership interests.
e. A major disadvantage of a partnership relative to a corporation is the
fact that federal income taxes must be paid by the partners rather
than by the firm itself.
47. The primary operating goal of a publicly-owned firm trying to best serve
its stockholders should be to
a. Maximize managers’ own interests, which are by definition consistent
with maximizing shareholders’ wealth.
b. Maximize the firm’s expected EPS, which must also maximize the firm’s
price per share.
c. Minimize the firm’s risks because most stockholders dislike risk. In
turn, this will maximize the firm’s stock price.
d. Use a well-structured managerial compensation package to reduce
conflicts that may exist between stockholders and managers.
e. Since it is impossible to measure a stock’s intrinsic value, the text
states that it is better for managers to attempt to maximize the
current stock price than its intrinsic value.