Chapter 1—The Scope of Corporate Finance
MULTIPLE CHOICE
1. One of the tasks for financial managers when identifying projects that increase firm value is to identify
those projects where
a.
benefits are at least equal to the project’s costs.
b.
taking the project will increase the book value of the firm’s common stock.
c.
taking the project will decrease the book value of the firm’s debt outstanding.
d.
none of the above
2. Which finance career classification involves analyzing a firm’s business processes and strategies as
well as recommending a change in practice in order to make a firm more competitive?
a.
corporate finance
b.
commercial banking
c.
investment banking
d.
consulting
3. If you would like to work in finance by trading debt and equity securities for customers, then which
finance career classification should you target?
a.
corporate finance
b.
commercial banking
c.
investment banking
d.
money management
4. Which form of invested capital is subject to most of the firm’s business and financial risk?
a.
debt capital
b.
equity capital
c.
borrowed capital
d.
intellectual capital
5. Which of the following is not a true capital-raising event for the firm?
a.
primary market transaction
b.
secondary market transaction
c.
initial public offering
d.
a corporate loan from a bank
6. Which of the following is not one of the five basic corporate finance functions?
a.
external financing function
b.
capital budgeting function
c.
risk management
d.
auditing
7. William and Theodore have decided to start a travel business called Excellent Adventures. Since their
business primarily involves time-travel their clients may be harmed during a small but significant
portion of the travels. Consequently, William and Theodore would like a business form that will shield
their personal wealth from any legal claims that the firm might be subject to after one of the travel
mishaps. If William and Theodore are the only investors in this U.S. domiciled firm, which legal form
of organization would be best for Excellent Adventures to protect both William and Theodore?
a.
sole proprietorship
b.
partnership
c.
limited partnership
d.
corporation
8. Within a limited partnership context, what are the conditions on a limited partner?
a.
There is a limit to the amount of capital that a limited partner can contribute, as mandated
by law.
b.
There is a limit to the number of limited partners that the firm may take on as investors.
c.
The limited partner must remain a low level employee and cannot ever serve in a
managerial role in the firm.
d.
A limited partner may not take any active role in the operation of the business.
9. The rules dictating voting procedures and other aspects of corporate governance for a corporation are
a.
the minutes of the board of directors meeting.
b.
the corporate charter.
c.
the Institute for Corporate Governance corporate governance procedures.
d.
the Securities and Exchange Commission rules for corporate governance.
10. The ultimate owner(s) of an ongoing corporation are
a.
the federal government.
b.
the debt holders.
c.
the equity holders.
d.
the executive staff of the corporation.
11. Agency costs refer to
a.
the costs associated with managing the demands of federal agencies.
b.
the costs involved when converting an entity from a proprietorship to a corporation.
c.
the costs that arise due to conflicts of interest between shareholders and managers.
d.
none of the above.
12. Since the Tax Relief Act of 2003, if a corporation has pre-tax earnings of $110,000 while the
corporation is subject to a 35% income tax rate and an investor is subject to a 35% personal tax rate
and a 15% capital gains tax rate, then what is the after-tax income that the investor could capture if all
of the firm’s earnings are paid out in dividends?
a.
$93,500
b.
$71,500
c.
$60,775
d.
$46,475
13. Since the Tax Relief Act of 2003, if a corporation or partnership has pre-tax earnings of $110,000
while the corporation is subject to a 35% income tax rate and an investor is subject to a 35% personal
tax rate and a 15% capital gains tax rate, then what is the advantage to being a partnership (compared
to a corporation) if all of the proceeds are paid out to investors in either legal form?
a.
($22,500)
b.
$0
c.
$10,725
d.
$24,725
14. Which of the following characteristics would disqualify a firm from being an S Corporation?
a.
a firm with 51 different individual shareholders
b.
the controlling majority shareholder is a Fortune 500 corporation
c.
one of the shareholders of the proposed S Corporation is an elected official
d.
none of the above would disqualify a firm from qualifying as an S Corporation
15. Which of the following is a valid criticism concerning the goal of firms to maximize profits?
a.
profit maximization ignores expenses
b.
profit maximization is completely unrelated to shareholder wealth
c.
profit maximization may ignore the timing of those profits
d.
there are no valid criticisms of profit maximizing firms
16. Managers of firms should only take actions that
a.
increase the value of the firm’s future cash flows.
b.
they expect will increase the firm’s share price.
c.
have benefits which are at least as great as the cost of those actions.
d.
all of the above
17. Which of the following parties have the proper incentives to make risky, value increasing investments
for the firm?
a.
suppliers
b.
creditors
c.
shareholders
d.
managers who are only compensated with a salary
18. An agent of a firm could be any of the following:
a.
100% owner of the firm
b.
the IRS agent in charge of auditing the firm’s tax return
c.
an employee who does not own any proportion of the firm
d.
a supplier of the firm
19. Shareholders can attempt to overcome agency problems by all BUT ONE of the following:
a.
incurring costs to monitor managers
b.
paying managers a good salary
c.
relying on market forces to exert managerial discipline
d.
paying the manager a proportion of the profits that the firm generates
20. The Sarbanes-Oxley Act of 2002
a.
established the Securities and Exchange Commission.
b.
requires CEO and CFOs of all large companies to personally certify their firms’ financial
statements.
c.
defined ethical behavior.
d.
established that a CFO must be a member of the firm’s audit committee of the board of
directors.
21. Which of the following is the best bonding expenditure to help limit agency costs?
a.
auditing the managers work on a monthly basis
b.
a contract whereby the manager will forfeit a portion of his deferred compensation in the
event of poor performance
c.
granting the manager a large number of options that will become valuable if the firm
performs well
d.
paying the manager a bonus if the firm performs well
22. A root cause of firm agency costs is
a.
managerial carelessness.
b.
a manager owning too much of his firm’s stock.
c.
a managers concern for his personal well-being.
d.
federal agency filing requirements.
23. Which of the following is a weakness of a sole proprietorship?
a.
Unlimited life
b.
Easy to form
c.
Limited liability
d.
Limited access to capital
24. Which of the following is a strength of a sole proprietorship?
a.
Unlimited life
b.
Easy to form
c.
Limited liability
d.
Limited access to capital
25. Which of the following is a strength of the corporate form of business?
a.
Limited life of the business
b.
Unlimited access to capital
c.
Unlimited liability
d.
Double taxation of income
26. Which of the following is NOT a strength of the corporate form of business?
a.
Unlimited life of the business
b.
Unlimited access to capital
c.
Unlimited liability
d.
Individual contracting
27. What type of corporation allows shareholders to be taxed as partners while retaining their limited
liability status?
a.
J Corporation
b.
LLP Corporation
c.
S Corporation
d.
Series 6 Corporation
28. Shareholders are said to have a residual claim on the firm’s assets. What does this mean?
a.
Shareholders have limited liability in their investment.
b.
Shareholders do not receive any payoff from the firm until all creditors are paid.
c.
Shareholders are allowed to recover their investment first if the firm experiences financial
distress.
d.
Shareholders have priority in electing the board of directors for the firm.
29. What market is where transactions that generate new cash flow for the firm occur?
a.
Primary market transactions
b.
Secondary market transactions
c.
Commodities market transactions
d.
Initial public offering transactions
30. Which type of finance position focuses on preparing firm financial plans and the evaluation of the
firm’s financial ratios?
a.
Financial analyst
b.
Capital budgeting analyst
c.
Cash manager
d.
Portfolio manager
31. What of the following is FALSE regarding debt capital?
a.
Debt holders receive interest payments at fixed intervals.
b.
Debt holders receive the amount of their loan (called principal) at the debt’s maturity date.
c.
Debt holders can force the firm into bankruptcy if interest payments are not made.
d.
Debt holders have voting rights for the firm’s board of directors.
32. Which of the following is FALSE regarding equity capital?
a.
Common stock holders bear most of the firm’s business and financial risk.
b.
Preferred stock holders receive a fixed annual payment on their invested capital.
c.
Common stock holders have ownership in the firm by voting for the firm’s management.
d.
Preferred stockholders can force the firm into bankruptcy if dividend payments are not
paid.
33. What was the key impact to the Jobs and Growth Tax Reconciliation Act of 2003?
a.
It greatly reduced the risk and liability of owning a small business.
b.
It provided tax credits and incentives for corporations to maintain their operations in the
United States.
c.
It reduced the effect of double taxation on corporate earnings by lowering the tax rate on
corporate dividends.
d.
It reduced taxes in an effort to keep Social Security solvent through 2040.
34. What is a fiduciary?
a.
Someone who performs ratio analysis for a corporation.
b.
Someone who invest and manages money on someone else’s behalf.
c.
Someone who manages the release of a initial public offering.
d.
Someone who evaluates the performance of individual bonds.
35. Calculate the tax disadvantage to organizing a U.S. business today, after passage of the Jobs and
Growth Tax Reconciliation Act of 2003, as a corporation versus a partnership, given the following
assumptions. All earnings will be paid out as dividends, and operating income before taxes will be
$200,000. The effective corporate tax rate is 35%, and the tax rate on corporate dividends is 15%. The
average personal tax rate for partners in the business is 35%.
a.
$17,500
b.
$19,500
c.
$20,000
d.
$22,250
36. Calculate the tax disadvantage to organizing a U.S. business today, after passage of the Jobs and
Growth Tax Reconciliation Act of 2003, as a corporation versus a partnership, given the following
assumptions. All earnings will be paid out as dividends, and operating income before taxes will be
$750,000. The effective corporate tax rate is 35%, and the tax rate on corporate dividends is 15%. The
average personal tax rate for partners in the business is 35%.
a.
$63,125
b.
$64,250
c.
$66,000
d.
$73,125
37. Calculate the tax disadvantage to organizing a U.S. business today, after passage of the Jobs and
Growth Tax Reconciliation Act of 2003, as a corporation versus a partnership, given the following
assumptions. All earnings will be paid out as dividends, and operating income before taxes will be
$1,500,000. The effective corporate tax rate is 35%, and the tax rate on corporate dividends is 15%.
The average personal tax rate for partners in the business is 35%.
a.
$146,250
b.
$152,250
c.
$166,850
d.
$170,375
38. Before passage of the Jobs and Growth Tax Reconciliation Act of 2003, some argued to completely
eliminate the tax rate on dividends. Calculate the tax disadvantage to organizing a U.S. business today
if the Jobs and Growth Tax Reconciliation Act of 2003 passed with this provision. Consider the
following firm: All earnings will be paid out as dividends, and operating income before taxes will be
$1,500,000. The effective corporate tax rate is 35%, and the tax rate on corporate dividends is 0%. The
average personal tax rate for partners in the business is 35%. What is the tax disadvantage?
a.
$0
b.
$75,000
c.
$100,000
d.
$125,000
39. What is meant by the term “double taxation” as applied to the corporate form of business
organization?
a.
Corporate income as taxed at twice the rate of partnership income.
b.
Corporate income is taxed, and then corporate dividends are taxed as well.
c.
Corporations pay both Federal income tax and state income tax on their earnings.
d.
Corporations pay both income tax and sales taxes on their goods.
40. What is the proper goal for management of a firm?
a.
Maximize shareholder wealth
b.
Maximize net income or earnings
c.
Maximize sales revenue
d.
Minimize expenses
41. What is a basic guide for financial decision making?
a.
Make decisions where the benefits exceed the costs.
b.
Make decisions where the total benefits exceed the total costs.
c.
Make decisions where the average benefits exceed the fixed costs.
d.
Make decisions where the average benefits exceed the average costs.
42. What recent act has attempted to reduce the possibility of more accounting scandals in our economy?
a.
Tax Relief Act of 2003
b.
Internal Accounting Standards Act of 2002
c.
McCain-Feingold Act of 2003
d.
Sarbanes-Oxley Act of 2002
43. What is a key provision regarding CEOs in the Sarbanes-Oxley Act of 2002?
a.
CEOs cannot hold options in the firms they direct.
b.
CEOs total compensation cannot exceed a limit set by the SEC.
c.
CEOs are personally liable for any mistakes on company financial filings.
d.
CEOs are prohibited from commenting on company filings to the SEC.
44. Which of the following describes the “collective action problem”?
a.
When a CEO fails to represent the interest of shareholders in daily decisions of the firm.
b.
When the shareholders of a firm fail to act in their own best interests.
c.
When the managers of a firm lack incentive to maximize shareholder wealth.
d.
When an individual stockholder spends time and resources monitoring managers, bearing
the cost, while the benefits go to all the shareholders in the firm.
45. To maximize the value of a business, a firm needs access to capital and to minimize risk for investors.
Given these guidelines, which business form should maximize value for a firm?
a.
Sole proprietorship
b.
Limited partnership
c.
General partnership
d.
Corporation
46. What is the term applied to a firm that offers shares to the general public for the first time?
a.
Initial Public Offering
b.
Initial Placed Offering
c.
Investment Plan Offer
d.
Investment of Public Offers
47. Which statement best describes the capital structure decision process for a firm?
a.
The firm finds the least expensive debt to finance its projects.
b.
The firm finds the mix of debt and equity to maximize firm value.
c.
The firm purchases the mix of debt and equity to match the guidelines of the company
charter.
d.
The firm makes the necessary filings for an initial public offering.
48. Which is not a duty of a financial manager?
a.
Budgeting
b.
Financial forecasting
c.
Product research
d.
Investment analysis
49. A business with a single owner is called a
a.
partnership.
b.
sole proprietorship.
c.
corporation.
d.
limited liability company.
50. Which form of business organization allows shareholders to be taxed as partners while still retaining
their limited liability status?
a.
Corporation
b.
Partnership
c.
S Corporation
d.
Sole Proprietorship
51. A corporation is a separate legal entity. What consequences does that have for the corporation?
a.
It can sue and be sued.
b.
They can own property.
c.
a only
d.
a and b
52. In order to be eligible for S status, a firm must
a.
have 100 or fewer shareholders.
b.
be a financial intermediary.
c.
have been incorporated for more than 5 years.
d.
not have more than one line of business.
53. Which of the following represents career opportunities in finance?
a.
Corporate finance
b.
Investment banking
c.
Consulting
d.
All of the above
54. Which of the following is NOT a career opportunity in corporate finance?
a.
Financial analyst
b.
Mortgage banker
c.
Cash manager
d.
Controller
55. Which of the following DOES NOT represent a career opportunity in money management?
a.
Portfolio manager
b.
Securities analyst
c.
Financial planner
d.
Capital budgeting analyst
56. What are the broad types of capital?
a.
Equity
b.
Debt
c.
Assets
d.
both (a) and (b)
57. What is considered a primary market transaction?
a.
Corporations sell securities to investors in exchange for cash.
b.
Investor A buys stock from investor B.
c.
A company declares a dividend.
d.
A company makes a bank deposit.
58. Capital budgeting is the single most important activity of the firm’s financial manager. Which of the
following is not a part of the capital budgeting process?
a.
Identifying potential investments.
b.
Identifying investments that create shareholder value.
c.
Developing new products.
d.
Implementing and monitoring the selected investments.
59. Of the five basic corporate finance functions, which deals with developing company-wide structures
that force managers to act ethically and to make decisions that further the interests of the firm’s
stockholders?
a.
Financing
b.
Corporate governance
c.
Financial management
d.
Risk management
60. Which of the following is NOT considered a weakness of the sole proprietorship?
a.
Limited life
b.
Unlimited personal liability
c.
Simplicity
d.
Limited access to capital
61. Which of the following does NOT apply to a partnership?
a.
Limited life
b.
Limited access to capital
c.
A single owner
d.
Unlimited personal liability
62. What are the responsibilities of the board of directors in a corporation?
a.
Hire and fire managers.
b.
Manage day-to-day operations.
c.
Amend the firm’s corporate charter when necessary.
d.
Hire and fire entry level employees.
63. Which of the following is NOT true about common stockholders and preferred stockholders?
a.
Preferred stockholders receive a fixed dividend each year.
b.
Common stockholders vote to elect the members of the board of directors.
c.
Preferred stockholders have a more senior claim on the firm’s assets in the event of
bankruptcy.
d.
Preferred stockholders are considered the firm’s ultimate owners.
64. What is the goal of financial management?
a.
Maximize corporate profits.
b.
Maximize shareholder wealth.
c.
Minimize costs.
d.
Maximize earnings.
65. You were just hired as the CEO of a company. Your primary objective should be
a.
to maximize the company’s earnings.
b.
to maximize profits.
c.
to maximize the company’s price of common stock.
d.
to eliminate the company’s competitors.
66. What should be the objective of a focus on stakeholders?
a.
Maximize the stakeholders’ interests.
b.
In situations of conflict pick stakeholders’ interests over shareholders’ interests.
c.
Preserve stakeholders’ interests.
d.
Disregard shareholders’ interests all together.
67. In which form of business organization is a agency problem most likely to occur?
a.
Sole proprietorship
b.
Corporation
c.
Partnership
d.
Limited liability company
68. Which of the following scenarios could be considered an example of an agency problem.
a.
Management decides to close a plant to lower operating costs.
b.
Management decides to go ahead with an expansion that is expected to benefit the
company’s value.
c.
The board of directors rewards management for the company’s last year performance.
d.
Management decides to purchase a Boeing 747 as a corporate plane.
69. Which of the following encourages managers to act in the shareholders’ interests?
a.
Performance based compensation.
b.
Audits.
c.
Threat of hostile takeovers.
d.
All of the above.
70. Which law did Congress pass in 2002 to enforce ethical behavior in corporate finance?
a.
The Jobs and Growth Relief Reconciliation Act
b.
The Financial Services Modernization Act
c.
The Patriot Act
d.
The Sarbanes-Oxley Act
71. Why do shareholders bear most of the risk of running a firm?
a.
They only have a residual claim on the firm’s cash flows.
b.
They receive a salary from the company.
c.
They are guaranteed a fixed payout each quarter.
d.
Shares can be taken away at any time without notice.
72. What do we call the possible conflict of interests between shareholders and management?
a.
Agency problem.
b.
Stakeholder problem
c.
Double taxation
d.
Shareholders’ dilemma
73. Virtually all finance jobs require:
a.
Teamwork
b.
Good communication skills
c.
Proficiency with computers
d.
All of the above
e.
Both (a) and (c)
74. Which of the following is true?
a.
If a company files for bankruptcy, preferred stockholders’ claims are paid prior to
creditors’ claims.
b.
If a company files for bankruptcy, preferred stockholders’ claims are paid prior to
common stockholders’ claims.
c.
In the event of bankruptcy and subsequent liquidation, preferred stockholders only receive
funds after creditors and common stockholders.
d.
Both (a) and (b)
e.
None of the above
75. Career opportunities in commercial banking do NOT include:
a.
Corporate loan officer
b.
Credit analyst
c.
Investment banker
d.
Mortgage banker
e.
All of the above are career opportunities in commercial banking
76. A financial intermediary is an institution that:
a.
Lends money to borrowers and raises that capital by issuing equity
b.
Lends money to borrowers and raises that capital by issuing liabilities against itself
c.
Issues stocks and sells shares in itself to generate cash for investing for the stockholders
d.
None of the above
77. Banks perform which of the following functions:
a.
Collecting payments on checks sent to their corporate customers
b.
Making payment on the checks written by their customers to other parties
c.
Providing information-processing services to small- and medium-sized businesses
d.
Handling large-volume transactions, such as payroll disbursements
e.
All of the above
78. Venture capitalists:
a.
Are banks that provide capital only for low-risk corporations
b.
Will only make investments if there is no risk involved
c.
Are professional investors who provide capital for high risk/high return rapidly-growing
entrepreneurial business
d.
None of the above
79. Capital budgeting:
a.
Is the area in which managers have the greatest scope to create (or destroy) value for
shareholders
b.
Involves identifying potential investments, analyzing those investments and identifying
which of those will create shareholder value and implement and monitor those investments
c.
Involves identifying potential investments, analyzing those investments and identifying
which of those are expected to increase net income and implement and monitor those
investments
d.
Both (a) and (b)
e.
None of the above
80. Working capital management:
a.
Involves managing the firm’s long-term assets, such as plant and equipment
b.
Requires very little in terms of people skills as it mostly involves analyzing numbers
c.
Deals with the firm’s seasonal financing, inventory needs, collecting accounts receivable
and investing surplus cash
d.
All of the above
e.
None of the above
81. Diversifying among different suppliers is an example of:
a.
Capital budgeting
b.
Financial management
c.
External financing
d.
Risk management
e.
Corporate governance
82. Modern risk management:
a.
Focuses primarily on easily-insured losses such as those from fires or theft
b.
Deals with the use of derivatives to hedge various risks
c.
Has evolved to cover more sophisticated risk reduction, including that which may arise
from changes in interest rates and the prices of commodities and currencies
d.
Both (b) and (c)
e.
None of the above
83. A limited liability company:
a.
Combines the pass-through taxation feature of a partnership with the limited liability
feature of an S corporation
b.
Will probably decline as a form of organization due to its undesirable features
c.
Are allowed in only a very few states in the U.S.
d.
Results in personal liability for all partners if one (or more) partner(s) commit malpractice
e.
Can only be formed if more than one person is a partner (i.e., no one-person LLCs are
allowed)
84. Maximizing profit as the manager’s goal has several flaws, including:
a.
Earnings figures focus on past performance rather than current or future performance
b.
The timing of the profits may be ignored
c.
Focusing on earnings does not mean that the firm will necessarily have enough cash on
hand to pay its bills
d.
Risk is ignored
e.
All of the above
85. In recent years some firms have
a.
Become more focused on maximizing profits rather than stockholder wealth
b.
Become more focused on keeping a broader group of stakeholders happy rather than just
the stockholders
c.
Become less interested in managing risks arising from fluctuations in interest rates,
commodity prices and currency prices
d.
Both (b) and (c)
e.
None of the above
86. A stock purschased on the New York Stock Exchange is an example of
a.
a primary, money market transaction
b.
a secondary, money market transaction
c.
a primary, captial market transaction
d.
a secondary, captial market transaction
87. When a corporation offers shares to the public for the first time that is an:
a.
IPO
b.
PPO
c.
NPO
d.
LBO
88. Hedging is
a.
Buying derivatives to take advantage of likely changes in the market
b.
Buying stocks firm’s own stock
c.
Insuring against risks a firm likely faces
d.
Making sure that the hedges are not too high at the firm’s headquarters
89. Which agency oversees fair reporting of financial information to investors of publicly traded stocks?
a.
SEC
b.
IRS
c.
NYSE
d.
NASDAQ
90. Would it be reasonable for a successful manufacturing firm, started as a sole proprietorship or
partnership to eventually adopt the corporate organizational form?
a.
No, the tax burden (double taxation) is too costly
b.
No, the reporting burdens are too costly
c.
No, once started as a sole proper ship or partnership, firms are not allowed to change their
form
d.
Yes, the competitive disadvantages to sole proprietorship or partnership are too
burdensome
91. Which of the following would disqualify a corporation from electing the S Corporate form?
a.
There are 82 shareholders
b.
The corporation only has one class of stock
c.
The corporation is a holding company
d.
The corporation eventually expects to be a C Corporation
92. Which of the following is NOT a stakeholder?
a.
Competitors
b.
Tax collection agencies
c.
Suppliers
d.
Customers
