2 – 15 Test Bank for Introduction to Corporate Finance, Fourth Canadian Edition
38. Which of the following is an example of an indirect agency cost?
a) A company buys the latest computer equipment for its employees.
b) Senior management use company money to pay their children’s education.
c) Managers can use the company float plane to fly to their cottages on weekends.
d) Managers may take risky projects when the company is not doing well.
39. Agency problems are best defined as
a) difficulties arising in dealings with real estate agencies.
b) problems arising due to potential misalignment between the interests of owners, creditors,
and managers.
c) problems arising due to the complete alignment of the interests of owners, creditors, and
managers.
d) issues surrounding whether or not to outsource production to an external agency.
40. Which of the following will help shareholders mitigate agency problems? Shareholders can
I. elect directors.
II. challenge management through proxy fights.
III. tender their shares to outsiders in a hostile takeover.
IV. sell their shares on the stock market.
a) I, II, and IV
b) II, III, and IV
c) I, II, and III
d) I, II, III, and IV
41. Which of the following illustrates a situation that would encourage a manager to work in the
interests of a company’s shareholders?
a) The manager’s salary depends largely on increasing quarterly accounting profits.
b) The manager’s salary depends largely on his/her ability to keep costs low.
c) The manager’s total compensation depends on maximizing the share price.
d) The manager has access to many perks, which improves his/her personal work environment.
42. Which one of the following is NOT a criterion that managers prefer to be judged upon?
a) return on assets
b) return on equity
c) share price
d) market share
43. Why do shareholders have a greater preference for risk than do managers?
a) Shareholders are always richer than managers, and can afford to take more risk.
b) Shareholders can diversify risk by holding many securities, while a manager’s career is tied up
with the firm.
c) Because they are investing in the stock market, shareholders must naturally prefer taking more
risk than managers.
d) Managers do not like risk because it hurts the value of the company.
44. What is the main purpose behind share incentive plans?
a) The plans encourage managers to invest in the stock market.
2 – 17 Test Bank for Introduction to Corporate Finance, Fourth Canadian Edition
b) The plans are meant to align the interests of management and shareholders.
c) The plans encourage managers to give shares as incentives for employees.
d) all of the above
45. Share incentive plans may NOT produce the desired results. Why?
a) the retooling of option grants and share incentive schemes
b) Compensation schemes are generally designed to reward management, not to provide
incentives.
c) fraud
d) all of the above
46. Which one of the following is NOT a way to improve the efficiency in Canadian wealth
management?
a) Encourage takeovers.
b) Expand management’s defence mechanisms with regards to takeovers.
c) Hold managers personally accountable.
d) Increase measures of corporate governance.
47. Ten years ago a company spent $10 million on a large machine. It is expected that the
machine will be useful for two more years. What should the company’s financial managers do?
a) They should consider the value of the machine today and in two years, and the potential cost
and benefit to extend the machine’s life.
b) They should scrap the machine on schedule – the plan was made, so stick to the plan.
c) They should sell the machine now. It always makes more sense to upgrade to new
Business (Corporate) Finance 2 – 18
technology than to keep older technology running.
d) They should hand this decision off to the company’s accountants. This is an accounting
decision, not a finance decision.
48. When a company faces uncertainty it is common for managers to attempt to build up cash
reserves. Which of the following is an important advantage of having large cash balances on
hand?
a) Cash balances pay significant interest, enabling a company to receive additional revenue.
b) Having large cash balances enables a company to pay its bills even when sales are
dropping.
c) A cash account will increase in value when equity markets go up in value.
d) Corporate shareholders generally approve of large corporate cash balances, believing that
corporate managers are acting prudently.
49. Which of the following is an example of a capital structure decision?
a) issuing new shares
b) buying a new factory
c) reducing inventory levels
d) increasing purchases on credit
50. The framework for analyzing investment or asset decisions is known as
a) income management analysis.
b) capital budgeting analysis.
c) capital aligning analysis.
2 – 19 Test Bank for Introduction to Corporate Finance, Fourth Canadian Edition
d) asset allocation analysis.
51. Capital budgeting refers to
a) the decision to raise capital from the market.
b) the decision to invest.
c) the decision to budget the administrative expenses of the firm.
d) the decision to budget compensation within the firm.
52. What does it mean to “go public”?
a) to sell goods and services to the public
b) to raise money from the stock market
c) to borrow money from the debt market
d) to do business with governmental firms
53. If a controller is responsible for liquidity management, which of the following accounts is she
NOT interested in?
a) Long-term Debt
b) Cash
c) Accounts Payable
d) Inventory
54. Another term for the “paper” market is
a) debt market.
b) equity market.
c) money market.
d) options market.
55. Which of the following statements is NOT true?
a) Cash and cash equivalents are defined as deposits in banks plus short-term investments.
b) A firm’s accounts receivable is debt owed to them by other firms.
c) Another term for accounts receivable is trade credit.
d) A firm’s mortgages would appear on the asset side of its balance sheet.
56. Which one of the following is NOT part of financial management?
a) deciding on sources of capital financing
b) deciding on debt versus equity
c) deciding on buying property
d) deciding on changing company image
57. Which of the following is NOT a source of corporate financing?
a) equity
b) retained earnings
c) bonds
d) increase in inventory
58. Typical duties of the financial manager include
I. raising funds.
II. product line evaluation.
III. controlling the disbursement of funds.
IV. dividend policy.
V. auditing financial statements.
VI. shareholder relations.
VII. setting personnel policy.
VIII. pricing of the company’s products.
a) I, III, IV, V, and VI
b) I, III, IV, and VI
c) III, IV, VI, and VII
d) II, III, VI, and VIII
59. If your job requires you to monitor the valuations of the companies you follow and make
recommendations to buy or sell a company’s shares, you are most likely a(n)
a) banker to retail clients.
b) investment dealer security analyst.
c) valuation insurance agent.
d) mutual fund private client sales representative.
60. What is the primary responsibility of a portfolio manager?
a) to oversee the financial investments within a portfolio
b) to take care of the financial needs of a portfolio of clients, as a personal representative
c) to make forecasts for a portfolio of economic and financial variables
d) to buy and sell bonds
61. Which of the following is the least important of the financial manager’s responsibilities?
a) Keep an up-to-date record on past operations.
b) Contain costs and foster productivity improvements.
c) Raise funds to support the ongoing operations and planned investments.
d) Control the disbursement of funds to ensure efficiency and adequate returns.
62. All of the following are the responsibility of the controller EXCEPT
a) financial planning.
b) liquidity management.
c) mergers and acquisitions.
d) dividend policy.
63. The primary objective of the financial manager is to
a) maximize earnings.
b) maximize dividend payments.
c) maximize shareholder wealth.
d) minimize expenses.
64. If you are working for a company and your job description includes accounting, budgeting,
internal audit, systems management/MIS, and tax management, you are most likely a(n)
a) treasurer.
b) tax accountant.
c) auditor.
d) controller.
65. In major financial institutions, people generally start out their careers as
a) consultants.
b) analysts.
c) account managers.
d) banking associates.
Business (Corporate) Finance 2 – 24
PRACTICE PROBLEMS
66. Give three potential advantages that explain why corporations represent a small percentage
of the total number of businesses in Canada, but dominate in terms of assets and dollar
volumes of sales.
67. Which is a better economic objective for financial managers: maximizing profit or maximizing
share price? Why? Give three reasons.
68. Explain the concept of “too-big-to–fail” and how it relates to the latest financial crisis.
69. Describe what is meant by agency relationships, and outline the potential conflicts of interest
that may arise.
70. Do agency costs only occur in a corporation, or can you have agency costs in a sole
proprietorship?
71. The management of Prairie Resources Limited (PRL) has just recommended to the board
that the company should purchase an expensive corporate jet in order to improve
management’s ability to oversee the company’s operations. PRL’s operations are
geographically remote. Are company jets always a waste of shareholder wealth? How should
the board decide if the purchase is appropriate?
Business (Corporate) Finance 2 – 26
72. Frank Wood, the owner of Cozy Corner Cabinets (CCC), has just hired Joe Boss to manage
his company. Instead of using a flat salary, the two men have agreed that Joe will be paid 15
percent of the profits at the end of each year. CCC currently has three project opportunities to
choose from, and can only choose one of them. Project A will generate profits of $75,000 per
year, and will increase the value of CCC by $145,000. Project B will generate profits of $63,000
per year, and will increase the value of CCC by $153,000. Project C will generate profits of
$68,000 per year, and will increase the value of CCC by $138,000. Which project is Joe Boss
likely to choose and why? As the owner of CCC, which project would Frank prefer?
73. Define the term finance. What are the three broad functional categories associated with
finance?
2 – 27 Test Bank for Introduction to Corporate Finance, Fourth Canadian Edition
74. Give two reasons for the importance and scope of finance.
Business (Corporate) Finance 2 – 28
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