Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
Chapter 2: Business (Corporate) Finance
Multiple Choice Questions
1. Section: 2.1 Types of Business Organizations
Learning Objective 2.1
2. Section: 2.1 Types of Business Organizations
Learning Objective 2.1
3. Section: 2.1 Types of Business Organizations
Learning Objective 2.1
4. Section: 2.1 Types of Business Organizations
Learning Objective 2.1
5. Section: 2.1 Types of Business Organizations
Learning Objective 2.1
6. Section: 2.2 The Goals of the Corporation
Learning Objective 2.2
Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
7. Section: 2.3 The Role of Management and Agency Issues
Learning Objective 2.4
Level of difficulty: Intermediate
8 Section: 2.3 The Role of Management and Agency Issues
Learning Objective 2.4
Level of difficulty: Intermediate
9. Section: 2.3 The Role of Management and Agency Issues
10. Section: 2.4 Corporate Finance
Learning Objective 2.5
11. Section: 2.5 Finance Careers and the Organization of the Finance Function
Learning Objective 2.6
12. Section: 2.5 Finance Careers and the Organization of the Finance Function
Learning Objective 2.6
Practice Problems
Basic
13. Section: 2.1 Types of Business Organizations
Learning Objective 2.1
Level of difficulty: Basic
Solution:
The four major forms of business organization are:
i) Sole proprietorship – a business owned and operated by one person
Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
Intermediate
14. Section: 2.1 Types of Business Organizations
Learning Objective 2.1
Level of difficulty: Intermediate
Solution: The differences are as follows:
15. Section: 2.1 Types of Business Organizations
Learning Objective 2.1
Level of difficulty: Intermediate
16. Section: 2.1 Types of Business Organizations
Learning Objective 2.1
Level of difficulty: Intermediate
Solution: Every director and officer of a corporation in exercising their powers and discharging
17. Section: 2.1 Types of Business Organizations
Learning Objective 2.1
Level of difficulty: Intermediate
Solution:
18. Section: 2.1 Types of Business Organizations
Learning Objective 2.1
Level of difficulty: Intermediate
Solution:
Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
When operating as a sole proprietorship, all of the assets of the company belong to the owner;
19. Section: 2.1 Types of Business Organizations
Learning Objective 2.1
Level of difficulty: Intermediate
Solution:
The debtholders will receive the entire $93,000 obtained from selling the assets. The remaining
20. Section: 2.3 The Role of Management and Agency Issues
Learning Objective 2.4
Level of difficulty: Intermediate
Solution: They differ in these four areas.
21. Section: 2.3 The Role of Management and Agency Issues
Learning Objective 2.4
Level of difficulty: Intermediate
Solution:
Dan is likely to prefer Project A because it will result in a $5,000 annual bonus for him, whereas
22. Section: 2.3 The Role of Management and Agency Issues
Learning Objective 2.4
Level of Difficulty: Intermediate
Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
Solution:
The idea behind a stock option plan is simply to have the best interests of CEOs and senior
23. Section: 2.4 Corporate Finance
Learning Objective 2.5
Level of Difficulty: Intermediate
Solution:
Capital budgeting considers some basic questions:
24. Section: 2.4 Corporate Finance
Learning Objective 2.5
Level of Difficulty: Intermediate
Solution:
Financial management includes the following areas.
25. Section: 2.4 Corporate Finance
Learning Objective 2.5
Level of Difficulty: Intermediate
Solution:
Corporate financing considers the following basic questions.
Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
26. Section: 2.5 Finance Careers and the Organization of the Finance Function
Learning Objective 2.6
Level of Difficulty: Intermediate
Solution:
The major jobs available in the financial industry include analysts, associates, managers, account
27. Section: 2.5 Finance Careers and the Organization of the Finance Function
Learning Objective 2.6
Level of difficulty: Intermediate
Solution: The most senior person is the chief financial officer (CFO), or in more traditional
internal auditing, and budgeting.
28. Section: 2.5 Finance Careers and the Organization of the Finance Function
Learning Objective 2.6
Level of Difficulty: Intermediate
Solution:
The controller’s numbers indicate that the computer system will add ($60,000 – $50,000) =
Challenging
29. Section: 2.3 The Role of Management and Agency Issues
Learning Objective 2.4
Level of Difficulty: Challenging
Solution:
Referring to Table 2-2, the major components of income are straight salary, annual bonus, share
Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
Answers to Concept Review Questions
2.1 Types of Business Organizations
Concept review questions
1. Describe the main advantages and disadvantages of sole proprietorships and partnerships.
The big advantage of a sole proprietorship is that setting one up is easy – there is no paperwork
involved and all you really have to do is start the business. However, the critical thing is
unlimited liability, because you are liable not only to the extent of what you have invested in the
business, but also for any other assets you own.
The two main partnership forms are limited liability partnerships (LLP) and limited and general
2. How are trusts distinct from corporations?
Trusts are used whenever you want to separate ownership from control. The use of trusts has
3. What are the main advantages and disadvantages of the corporation structure?
2.2 The Goals of the Corporation
Concept review questions
1. What is the primary goal of the corporation?
2. What role does the board of directors serve?
3. Explain the cost imposed on society if firms become too big to fail, and discuss whether the
government should break up large firms when they pose such risks.
If firms become too big to fail, it will become the responsibility of the Government to bail firms
4. Should the Government allow one of the Big Six Canadian banks to fail if it loses money on
its loan portfolio?
The creation of shareholder value has been widely accepted, not just by academic theorists but
also by regulators. In 1994, the TSX issued a report entitled Where Were the Directors,
2.3 The Role of Management and Agency Issues
Concept review questions
1. Describe the nature of the basic owner-manager agency relationship.
For smaller firms, managers and owners are often the same people, so there is no problem. Even
for some quite large Canadian companies, there is often a controlling shareholder to make sure
2. Define agency costs and describe both types.
The costs associated with agency problems are referred to as agency costs. There are two major
3. How have management compensation schemes been designed to better align owner-manager
interests? How well have these schemes performed in this regard?
Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
4. What is moral hazard and why did it become the buzz word of the 2008 financial crisis?
In 1998, the U.S. government bailed out a hedge fund called Long-Term Capital Management
2.4 Corporate Finance
Concept review questions
1. Describe the two key decision areas with respect to the financial management of assets?
2. What are some of the key corporate financing decisions made by firms?
• How does a firm decide between raising money through debt or equity?
3. What are the two key topics covered in the study of corporate finance?