47) Assume that an investor is offered a choice of a risk-free government bond or a high-risk
corporate stock. Further assume that the expected return is the same for both. According to one
of the axioms of finance, which investment would be chosen?
A) the corporate stock
B) the government bond
C) neither, the investor would be indifferent
D) none of the above
48) Assume that an investor is offered a choice of a risk-free government bond that is expected
to return 3.5% or a high-risk corporate stock. According to one of the principles of finance, what
would induce the investor to purchase the corporate stock?
A) a return that is substantially lower than 3.5%
B) cash dividends
C) a return that is substantially higher than 3.5%
D) none of the above
49) Assume that you went to Las Vegas and hit the jackpot for $5 million. Further assume that
you were offered a choice to receive the $5 million today, or receive it in two years. According
to one of the principles of finance, which would you take?
A) The $5 million in two years because you would be afraid of spending it all right away.
B) The $5 million in two years because it would be worth more than if you would receive it
today.
C) You would be indifferent as to when you would receive the $5 million.
D) The $5 million today because it would be worth more than if you would receive it in two
years.
50) Assume that you won the Lotta Dough Lotto jackpot for $20 million. Further assume that
you were offered a choice to receive the $20 million today, or receive it in equal installments of
$1 million per year for 20 years. According to one of the principles of finance, which would you
take?
A) The $20 million in equal installments of $1 million per year for 20 years because you would
be afraid of spending it all right away.
B) The $20 million today because it would be worth more than if you would receive it in equal
installments of $1 million per year for 20 years.
C) You would be indifferent as to when you would receive the $20 million since the total
number of dollars received is the same either way.
D) The $20 million in equal installments of $1 million per year for 20 years because it would be
worth more than if you would receive it today.
51) Which of the following statements best represents the “Agency Problem?”
A) Managers might attempt to benefit themselves in terms of salary and perquisites at the
expense of shareholders.
B) The agency problem results from the separation of management and the ownership of the
firm.
C) The agency problem may interfere with the implementation of maximizing shareholder
wealth.
D) all of the above
52) Short-term United States Treasury Bills are widely used as proxies for risk-free assets, yet
the returns on these T-bills are consistently greater than zero. Is this consistent with the concept
of a risk-return tradeoff?
53) John won the lottery on Monday and can take either $50,000 per year for 20 years, or
$500,000 today. Bill won the same lottery on Tuesday and has the same options for receiving
the cash. A well respected financial advisor is hired by both John and Bill. The advisor
recommends that John take the $50,000 per year for 20 years but advises Bill to take the
$500,000 up front payment. How is it possible to give different advice to two clients regarding
the exact same cash flows?
54) The manager of Golden Ray Corporation receives a bonus if company profits exceed
$1,000,000 this year. During the final week of the year, the manager changes an accounting
policy that will increase reported profits from $950,000 to $1,025,000, triggering his bonus. The
change in profits of $75,000 will reverse itself in the next year, and the accounting change has no
impact on Golden Ray’s cash flow. Discuss the above situation as it relates to both an agency
problem and efficient markets.
55) Your friend Ricky took a finance class and learned about the risk/return tradeoff. Wanting a
high return, Ricky invested in a risky, start-up technology company. A year later the company
went bankrupt and Ricky lost his entire investment. Ricky is furious with his finance professor
for misleading him, claiming he was taught that higher return goes with higher risk. Explain
how Ricky misinterpreted the risk/return tradeoff.
56) The board of directors of Wireless, Inc. is considering two compensation plans for the CEO
of the company. The first would pay the CEO a salary of $250,000 for the upcoming year. The
second would pay the CEO a salary of $100,000 and provide the CEO with a stock option to buy
100,000 shares of stock for $11 per share. The current price per share of Wireless, Inc. stock is
$10 per share. The stock option expires at the end of the year. Why might shareholders prefer
the second payment plan? As part of your answer, calculate the breakeven point for the CEO to
obtain the same compensation under option two as he or she would under option one.
1.3 Learning Objective 3
1) A corporate treasurer is typically responsible for cash management, credit management, and
raising capital.
2) Determining how a firm should raise money to fund its long-term investments is referred to as
capital structure decisions.
3) The chief financial officer (CFO) is responsible for overseeing financial planning, corporate
strategic planning, and controlling the firm’s cash flow.
4) The financial manager most directly responsible for producing the company’s financial
statements and directing its cost accounting functions is the
A) chief financial officer.
B) controller.
C) treasurer.
D) vice president – financer.
5) A corporate treasurer is typically responsible for each of the following duties except:
A) cash management.
B) credit management.
C) capital expenditures.
D) cost accounting.
6) The three basic types of issues addressed by the study of finance are
A) capital budgeting, capital structure decisions, and working capital management.
B) capital budgeting, working capital management, and investment analysis.
C) capital structure decisions, working capital management, and sustained profitability.
D) capital budgeting, investment analysis, and cash management.
7) Cash and credit management are typically the responsibility of the
A) Controller.
B) Vice President of Production and Operations.
C) Chief Executive Officer, or CEO.
D) Treasurer.
8) Working capital management is concerned with
A) how a firm can best manage its cash flows as they arise in its day-to-day operations.
B) how a firm should raise money to fund its investments.
C) what long-term investments a firm should undertake.
D) managing a firms capital stock.
9) Capital budgeting is concerned with
A) whether a company’s assets should be financed with debt or equity.
B) managing a firms cash budgeting procedures.
C) what long-term investments a firm should undertake.
D) planning sales of a corporation’s equity capital.
10) Determining the best way to raise money to fund a firm’s long-term investments is called
A) the capital budgeting decision.
B) the portfolio decision.
C) the money flow processing decision.
D) the capital structure decision.
11) Your friend, John, believes that since capital markets are efficient, he doesn’t need to read the
financial press or be involved in stock research before purchasing stocks for his portfolio. He
simply throws darts at the stock pages and buys the stocks the darts hit. Is stock research and
analysis important when buying and selling stocks in an efficient market?
1.4 Learning Objective 4
1) The sole proprietorship is for all practical purposes the absence of any formal legal business
structure.
2) A general partnership, unlike a limited partnership, is an entity that legally functions separate
and apart from its owners.
3) The best form of business entity to attract new capital is the sole proprietorship because
investors only need to deal with one owner.
4) S-type corporations and limited liability companies are taxed like partnerships, but have the
advantage of limited liability for their owners.
5) Limited liability companies are more flexible than S-type Corporations because limited
liability companies operate under state laws.
6) A limited liability company (LLC) is taxed like a partnership but provides limited liability for
its owners similar to a corporation.
7) Its ability to raise capital by selling stock makes the corporation the best form of organization
in terms of raising capital.
8) There is no legal distinction made between the assets of the business and the personal assets of
any of the owners in the limited partnership.
9) The owners of a corporation enjoy limited liability.
10) The corporation is a legal entity separate from its owners; thus it is possible for the
corporation to continue even upon the death of one or more shareholders.
11) In a sole proprietorship, the owner is personally responsible without limitation for the
liabilities incurred.
12) The procedure by which significant changes may be made to a partnership, such as
admission of a new partner or termination of the partnership, are governed by each state so no
partnership agreement is needed.
13) In a limited partnership at least one general partner must exist; that general partner has
unlimited liability.
14) A limited partnership provides limited liability to
A) all general partners.
B) only limited partners responsible for day to day management of the firm.
C) only to limited partners who do not participate in the management of the business.
D) all partners.
15) Joe is deciding whether or not to invest $10,000 in a business that has pending lawsuits
against it. If Joe invests and the business loses the lawsuits, the most Joe can lose is
A) $10,000 if Joe is a general partner.
B) $10,000 if Joe is a sole proprietor.
C) $10,000 if Joe is a limited partner.
D) $10,000 plus his share of the lawsuits if Joe is a limited partner.
16) S-type corporations have all of the following advantages except:
A) they are taxed as partnerships.
B) the owners have limited liability.
C) distributions are taxed twice, similar to corporate dividend payments.
D) all owners must be people, no corporations.
17) All of the following business organizations provide limited liability to their owners except:
A) general partnership.
B) S-type corporation.
C) corporation.
D) limited liability company.
18) Bill, a local inventor, developed a diet pill that he believes will solve the obesity problem in
the United States. Bill wants to create a new company, 50% owned by Bill and 50% owned by a
major drug company. Although he believes the pills are safe, Bill is concerned about liability if
someone becomes sick or dies. The best form of business organization for the new company is
________.
A) sole proprietorship with Bill as owner and the drug company as creditor
B) general partnership with Bill and the drug company as equal partners
C) S-type corporation with Bill and the drug company owning equal shares
D) limited liability company with Bill and the drug company owning equal shares
19) Which of the following statements about the corporate form of business organization is true?
A) The corporate form has the disadvantage of double taxation relative to a sole proprietorship.
B) The corporate form is preferred over the sole proprietorship because a corporation is easier to
form and faces less regulation.
C) Sole proprietorships are the most common form of business organization because liability is
limited to the amount invested in the business by the sole proprietor.
D) The corporate form has the advantage of unlimited liability.
20) Limited partnerships are not as prevalent as corporations because
A) limited partners can lose up to three times the amount they invested in the partnership if the
business goes bankrupt.
B) limited partnerships have the disadvantage of double taxation.
C) the general partner has no liability, making it difficult for the partnership to borrow money.
D) it is easier to transfer ownership by selling common stock than it is to sell partnership.
21) Which of the following is an advantage of the sole proprietorship?
A) limited liability for its owners
B) double taxation for its owners
C) no significant legal requirements for starting the business
D) easily transferred ownership
22) Which of the following is not true for a limited partnership?
A) limited liability for its owners
B) One general partner must exist who has unlimited liability.
C) Only the name of general partners can appear in the name of the firm.
D) Limited partners may sell their interest in the company.
23) The true owners of the corporation are the
A) holders of debt issues of the firm.
B) preferred stockholders.
C) board of directors of the firm.
D) common stockholders.
24) In terms of the costs to organize each, which of the following sequences is correct, moving
from highest to lowest cost?
A) general partnership, sole proprietorship, limited partnership, corporation
B) sole proprietorship, general partnership, limited partnership, corporation
C) corporation, limited partnership, general partnership, sole proprietorship
D) sole proprietorship, general partnership, corporation, limited partnership
25) Which of the following categories of owners enjoy limited liability?
A) all partners in a limited partnership
B) common shareholders of a corporation
C) in a partnership, only the general partners
D) only B and C above
26) Which of the following categories of owners have unlimited liability?
A) general partners in a limited partnership
B) sole proprietors
C) shareholders of a corporation
D) both A and B
27) Which of the following are characteristics of a limited partnership?
A) Limited partners may not participate in the management of the limited partnership.
B) There must be one or more general partners.
C) General partners have unlimited liability.
D) all of the above
28) Which of the following forms of organizations have earnings that are taxed twice, once as
business income and once as personal income as the earnings are distributed to the owners in the
form of dividends?
A) corporations
B) general partnerships
C) limited partnerships
D) both A and C
29) Which of the following categories of owners have limited liability?
A) general partners
B) sole proprietors
C) shareholders of a corporation
D) both A and B
30) Which of the following forms of business organizations provide limited liability to all its
owners?
A) general partnership
B) limited partnership
C) corporation
D) both B and C
31) All of the following forms of business organizations provide limited liability to all owners
except:
A) Limited Liability Company.
B) S-Type Corporation.
C) Corporation.
D) Limited Partnership.
32) Which of the statements below are true?
A) The sole proprietorship and the general partnership both feature unlimited liability.
B) A corporation is the business form that is typically the most complicated (legally) to establish.
C) The corporation and the limited partnership both provide at least some owners with limited
liability.
D) all of the above
33) Advantages of the corporate form of business organization include
A) easier transfer of ownership.
B) double taxation.
C) minimal legal requirements.
D) none of the above
34) Which form of organization is free of initial legal requirements?
A) sole proprietorship
B) general partnership
C) corporation
D) both A and B
35) Which of the following forms of business organization limits the liability of owners?
A) sole proprietorship
B) general partnership
C) corporation
D) two person partnership
36) Which of the following forms of business organization has the greatest ability to attract new
capital?
A) sole proprietorship
B) corporation
C) general partnership
D) limited partnership
37) Which of the following is not considered to be a disadvantage of the sole proprietorship form
of business organization?
A) limited ability to raise capital
B) life is limited to that of the owner
C) unlimited liability of business owners
D) fewer regulations and reporting requirements
38) Which of the following is an advantage of the general partnership form of business
organization?
A) limited liability of business owners
B) low cost of formation
C) easy ability to raise capital
D) double taxation
1.5 Learning Objective 5
1) Due to unstable world markets, most large U.S. corporations do almost all of their business in
the United States.