WEB CHAPTER 30—FINANCIAL MANAGEMENT IN NOT–FOR-PROFIT
BUSINESSES
TRUE/FALSE
1. The primary goal of investor-owned firms is shareholder wealth maximization, while the primary goal
of not-for-profit firms is typically stated in terms of some mission; for example, to provide health care
services to the communities served.
2. Not-for-profit firms have fund capital in place of equity capital. Since fund capital does not have to
provide a return to stockholders, the appropriate cost of fund capital in a cost of capital estimate is
zero.
3. Since not-for-profit firms do not pay taxes, they receive no tax benefits whatsoever from using debt
financing.
4. The net present social value model formally recognizes that not-for-profit firms must consider the
social value along with the financial value of proposed new projects.
MULTIPLE CHOICE
5. Which of the following statements about project risk analysis in not-for-profit firms is incorrect?
a.
A project’s corporate beta measures the contribution of the project to the overall corporate
risk of the firm.
b.
A project’s corporate beta is found (at least conceptually) by regressing returns on the
project against returns on the market portfolio.
c.
A project’s corporate beta is defined as (P/F)rPF, where P is the standard deviation of the
project’s returns, F is the standard deviation of the firm’s returns, and rPF is the correlation
among the two sets of returns.
d.
In practice, it is usually difficult, if not impossible, to directly measure a project’s
corporate risk, so project risk analysis typically focuses on stand-alone risk.
e.
The market risk of a project is not relevant to not-for-profit firms.
6. Which of the following statements about municipal bond financing is most correct?
a.
Whereas the vast majority of Treasury and corporate bonds are held by institutions, no
municipal bonds are held by individual investors.
b.
The primary attraction of municipal bonds to individual investors is their high before-tax
yields.
c.
Municipal bonds usually pay higher coupon rates than corporate bonds with similar
ratings.
d.
Municipal bonds are risk-free.
e.
In contrast to corporate bonds, municipal bond issues are not required to be registered with
the Securities and Exchange Commission.
7. Which of the following statements about a not-for-profit firm’s ownership is most correct?
a.
The residual earnings (profits) of not-for-profit firms can be distributed to the firm’s top
managers.
b.
Not-for-profit firms are exempt from federal taxes, but they must pay state and local taxes,
including property taxes.
c.
Upon liquidation of a not-for-profit firm, the proceeds from the sale of its assets are
distributed, on a pro rata basis, to the firm’s employees.
d.
None of the profits are used for private inurement.
e.
Not-for-profit firms are governed by a board of trustees whose members are elected by the
community at large.
8. Which of the following statements about a not-for-profit firm’s cost of capital estimate is most correct?
a.
The capital structure weights for a not-for-profit firm are set at 50/50, because such firms
can raise $1 of debt financing for each dollar of retained earnings.
b.
The cost of tax-exempt debt issued by not-for-profit firms is increased (“grossed up”) by 1
− T in the WACC estimate to reflect the fact that such firms do not pay taxes.
c.
Equity (fund) capital has a cost that is roughly equivalent to the cost of retained earnings
to similar investor-owned companies.
d.
Not-for-profit firms have a zero cost of capital.
e.
Since a not-for-profit firm has no shareholders, its WACC estimate does not include a cost
of equity (fund capital) estimate.
9. Which of the following statements about a not-for-profit firm’s fund capital is most correct?
a.
The sole source of fund capital is the excess of revenues over expenses.
b.
Fund capital has a zero opportunity cost.
c.
Fund capital can only come from donations.
d.
Fund capital does not change over time.
e.
Fund capital is equivalent to equity capital in investor-owned firms.
10. Which of the following statements about a not-for-profit firm’s sources of capital is most correct?
a.
Fund capital is obtained by retaining earnings⎯if all earnings are paid out as dividends,
no fund capital is created.
b.
Preferred stock is never used by not-for-profit firms.
c.
Not-for-profit firms are not allowed to raise capital by borrowing.
d.
Not-for-profit firms usually have high dividend payouts.
e.
Since not-for-profit firms are tax exempt, there is no tax advantage to debt capital.