Finance Chapter 30 The primary goal of investor-owned firms is shareholder wealth

Ch 30 Financial Management in Not-for-Profit Businesses

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.

a.

True

b.

False

True

1

False

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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.

a.

True

b.

False

1

False

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3. Since not-for-profit firms do not pay taxes, they receive no tax benefits whatsoever from using debt financing.

a.

True

b.

False

1

False

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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.

a.

True

b.

False

True

1

False

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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 (σP/σF)rPF, where σP is the standard deviation of the project’s returns,

σF 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.

1

Difficulty: Moderate

Multiple Choice

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Risk analysis

TYPE: Multiple Choice: Conceptual

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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.

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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.

d

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Difficulty: Moderate

Multiple Choice

False

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Ownership

TYPE: Multiple Choice: Conceptual

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Difficulty: Moderate

Multiple Choice

False

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Municipal bonds

TYPE: Multiple Choice: Conceptual

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Ch 30 Financial Management in Not-for-Profit Businesses

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.

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Difficulty: Moderate

Multiple Choice

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Cost of capital

TYPE: Multiple Choice: Conceptual

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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.

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Difficulty: Moderate

Multiple Choice

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.

b

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Difficulty: Moderate

Multiple Choice

False

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Capital sources

TYPE: Multiple Choice: Conceptual

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False

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finance, and analysis of public information

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Fund capital

TYPE: Multiple Choice: Conceptual

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Ch 30 Financial Management in Not-for-Profit Businesses