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Fundamentals Of Corporate Finance, Sixth Canadian Edition Test Bank

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    Exam Name___________________________________ MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) Which of the following is correct regarding board membership in a corporation? 1) A) in a private corporation, shareholders are also board members. B) all corporations have board of directors. C) in a public corporation, shareholders are not board members. D) All of the choices are correct. Answer: D Explanation: A) B) C) D) 2) Which of the following appears to be the most appropriate goal for corporate management? 2) A) maximizing the company's market share. B) minimizing the company's liabilities. C) maximizing market value of the company's shares. D) maximizing the current profits of the company. Answer: C Explanation: A) B) C) D) 3) The term "corporate stakeholder" typically refers to: 3) A) the management and board of directors of the firm. B) a company's customers. C) the equity holders of the firm. D) anyone with a financial interest in the firm. Answer: D Explanation: A) B) C) D) 1

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    4) Ethical decision making in business: 4) A) is not in the best interests of shareholders. B) is less important than good capital budgeting decisions. C) reduces the firm's profits. D) requires adherence to implied rules as well as written rules. Answer: D Explanation: A) B) C) D) 5) In a large corporation, budget preparation would most likely be conducted by the: 5) A) financial manager. B) treasurer. C) chief financial officer. D) controller. Answer: D Explanation: A) B) C) D) 6) Sole proprietorships resolve the issue of agency problems by: 6) A) avoiding excessive expense accounts. B) allowing owners to share the cost of their actions with others. C) discharging those who violate the rules. D) forcing owners to bear the full cost of their actions. Answer: D Explanation: A) B) C) D) 7) Which of the following is least likely to represent an agency problem? 7) A) executive incentive compensation plans. B) lavish spending on expense accounts. C) excessive investment in "safe" projects. D) plush remodeling of the executive suite. Answer: A Explanation: A) B) C) D) 2

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    8) "Double taxation" refers to: 8) A) the fact that marginal tax rates are doubled for corporations. B) paying taxes on profits at the corporate level and on dividends at the personal level. C) all partners paying equal taxes on profits. D) corporations paying taxes on both dividends and retained earnings. Answer: B Explanation: A) B) C) D) 9) A manager's compensation plan that offers financial incentives for increases in quarterly profitability may create agency problems in that: 9) A) the managers are not motivated by personal gain. B) investors desire stable profits. C) the board of directors may claim the credit. D) short-term, not long-term, profits become the focus. Answer: D Explanation: A) B) C) D) 10) The financial manager has to determine a value to uncertain cash flows. The variables involved in this determination are: 10) A) risk B) timing C) amount D) All of the choices are correct. Answer: D Explanation: A) B) C) D) 11) A corporate board of directors should provide support for the top management team: 11) A) under all circumstances. B) in all decisions related to cash dividends. C) if shareholders are pleased with the firm's performance. D) only when the board has confidence in management's actions. Answer: D Explanation: A) B) C) D) 3

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    12) The legal "life" of a corporation is: 12) A) permanent, as long as shareholders don't change. B) permanent, regardless of current ownership. C) equal to the life of the board of directors. D) coincident with that of its CEO. Answer: B Explanation: A) B) C) D) 13) Which of the following is not an advantage to incorporating a business? 13) A) limited liability. B) profits taxed at the corporate level and the shareholder level. C) easier access to financial markets. D) becoming a permanent legal entity. Answer: B Explanation: A) B) C) D) 14) Long-term financing arrangements occur in the: 14) A) money markets. B) primary markets. C) capital markets. D) secondary markets. Answer: C Explanation: A) B) C) D) 15) Which of the following represents a financing decision? 15) A) a decision to pay $1 million of accounts payable. B) a decision to buy a new mainframe computer. C) a decision to borrow $10 million through a bank loan. D) a decision to invest in the common stock of another corporation. Answer: C Explanation: A) B) C) D) 4

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    16) When a corporation fails, the maximum that can be lost by an investor protected by limited liability is: 16) A) the amount necessary to pay the corporation's debts. B) the amount of the investor's personal wealth. C) the amount of the profit on the investment. D) the amount of the initial investment. Answer: D Explanation: A) B) C) D) 17) Which of the following statements generally cannot be correct for an investor who faces unlimited liability on an investment? 17) A) the investor has no partners. B) the investor is responsible for managing the firm. C) the investor is subject to double taxation. D) the investor owns stock in the firm. Answer: C Explanation: A) B) C) D) 18) Whom of the following is not a financial manager? 18) A) the chief financial officer (CFO). B) the marketing manager. C) the controller. D) the treasurer. Answer: B Explanation: A) B) C) D) 19) When the management of a business is conducted by individuals other than the owners, the business is more likely to be a: 19) A) sole proprietorship. B) corporation. C) partnership. D) general partner. Answer: B Explanation: A) B) C) D) 5

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    20) Corporations are referred to as public companies when their: 20) A) shares are widely traded. B) products or services are available to the public. C) shareholders have no tax liability. D) shares are held by the federal or state government. Answer: A Explanation: A) B) C) D) 21) Which of the firm's financial managers is most likely to be involved with obtaining financing for the firm? 21) A) board of directors B) chief executive officer C) treasurer D) controller Answer: C Explanation: A) B) C) D) 22) Within the realm of ethical decision making, managers should attempt to maximize: 22) A) their compensation plans. B) the market value of the shareholders' wealth. C) their firm's market share. D) the profits of the firm. Answer: B Explanation: A) B) C) D) 23) In a partnership form of organization, income tax liability, if any, is incurred by: 23) A) the partners individually. B) the partnership itself. C) Both the partnership and the partners. D) Neither the partnership nor the partners. Answer: A Explanation: A) B) C) D) 6

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    24) The primary goal of corporate management should be to: 24) A) maximize the firm's profit. B) maximize the number of shareholders. C) minimize the firm's costs. D) maximize the shareholders' wealth. Answer: D Explanation: A) B) C) D) 25) Profit-sharing plans may be beneficial when used to: 25) A) reduce the payment of cash dividends. B) reduce the impact of corporate income taxes. C) improve managers' incentives for effective decision making. D) divert financial resources from shareholders. Answer: C Explanation: A) B) C) D) 26) Which of the following would be considered a capital budgeting decision? 26) A) a decision to expand into a new line of products, at a cost of $5 million B) repurchasing shares of common stock C) issuing debt in the form of long-term bonds D) planning to issue common stock rather than issuing preferred stock Answer: A Explanation: A) B) C) D) 27) Which of the following is least likely to be discussed in the articles of incorporation? 27) A) the number of members of the board of directors. B) the maximum number of shares that can be issued. C) the price range of the shares of stock. D) the purpose of the business. Answer: C Explanation: A) B) C) D) 7

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    28) Which of the following groups is least likely to be considered a stakeholder of the firm? 28) A) bondholders B) employees C) government D) competitors Answer: D Explanation: A) B) C) D) 29) A corporation's board of directors: 29) A) has a lifetime appointment to the board. B) is selected by and can be removed by management. C) can be voted out of power by the shareholders. D) is selected by a vote of all corporate stakeholders. Answer: C Explanation: A) B) C) D) 30) Which of the following would be considered an advantage of the sole proprietorship form of organization? 30) A) wide access to capital markets B) unlimited liability C) profits taxed at only one level D) a pool of expertise Answer: C Explanation: A) B) C) D) 31) Which of the following statements best distinguishes the difference between real and financial assets? 31) A) real assets are tangible; financial assets are not. B) financial assets appreciate in value; real assets depreciate in value. C) financial assets represent claims to income that are generated by real assets. D) real assets have less value than financial assets. Answer: C Explanation: A) B) C) D) 8

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    32) When managers' compensation plans are tied in a meaningful manner to the profits of the firm, agency problems: 32) A) will be created. B) are eliminated entirely from the firm. C) can be reduced. D) are shifted to other stakeholders. Answer: C Explanation: A) B) C) D) 33) A firm decides to pay for a small investment project through a $1 million increase in short-term bank loans. This is best described as an example of a(n): 33) A) investment decision. B) financing decision. C) capital market decision. D) capital budgeting decision. Answer: B Explanation: A) B) C) D) 34) How may a reduction in cash dividends be in the best interests of current shareholders? 34) A) dividends are taxed at twice the rate of other gains. B) a reduction of cash dividends cannot be in the best interests of current shareholders. C) reduced dividends increase managerial compensation, thus increasing their motivation. D) the firm will have available cash to increase current investment and future profits. Answer: D Explanation: A) B) C) D) 35) The overall goal of capital budgeting projects should be to: 35) A) decrease the firm's reliance upon debt. B) increase the firm's outstanding shares of stock. C) increase the wealth of the firm's shareholders. D) increase the firm's sales. Answer: C Explanation: A) B) C) D) 9

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    36) What are the two critical decisions that have to be made by the financial manager? 36) A) debt and equity. B) investment and financing. C) short term and long term. D) All of the choices are correct. Answer: B Explanation: A) B) C) D) 37) The term "capital structure" refers to: 37) A) the manner in which a firm obtains its long-term sources of funding. B) which specific assets the firm should invest in. C) the length of time needed to repay debt. D) whether the firm invests in capital budgeting projects. Answer: A Explanation: A) B) C) D) 38) The best criterion for success in a capital budgeting decision would be to: 38) A) finance all capital budgeting projects with debt. B) maximize the difference between cash inflows and cost. C) maximize the number of capital budgeting projects. D) minimize the cost of the investment. Answer: B Explanation: A) B) C) D) 39) Unlimited liability is faced by the owners of: 39) A) sole proprietorships and partnerships. B) all forms of business organization. C) corporations. D) partnerships and corporations. Answer: A Explanation: A) B) C) D) 10

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    40) One common reason for partnerships to convert to a corporate form of organization is that the partnership: 40) A) faces rapidly growing financing requirements. B) has issued all of its allotted shares. C) wishes to avoid double taxation of profits. D) agreement expires after ten years of use. Answer: A Explanation: A) B) C) D) 41) A corporation is characterized by: 41) A) non-profitable. B) simplicity of decision making. C) a legal entity unto itself (may sue or be sued, engage in contracts, acquire property). D) sufficient funds to fulfill their needs. Answer: C Explanation: A) B) C) D) 42) A common problem for closely held corporations is: 42) A) the separation of ownership and management. B) an abundance of agency problems. C) that shareholders receive only one vote each. D) lack of access to substantial amounts of capital. Answer: D Explanation: A) B) C) D) 43) One continuing problem with managerial incentive-compensation plans is that: 43) A) the plans increase agency problems. B) effectiveness of the plans is difficult to evaluate. C) the plans do not reward shareholders. D) managers prefer guaranteed salaries. Answer: B Explanation: A) B) C) D) 11

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    44) In which of the following organizations would the existence of agency problems be least likely? 44) A) a partnership B) a closely held corporation C) a corporation D) a sole proprietorship Answer: D Explanation: A) B) C) D) 45) A financial manager facing a capital budgeting decision must decide whether to: 45) A) issue stock or debt securities. B) buy new machinery or repair the old. C) use primary markets or secondary markets. D) use the money market or capital market. Answer: B Explanation: A) B) C) D) 46) A corporation is considered to be closely held when: 46) A) management also serves as the board of directors. B) the market value of the shares is stable. C) it operates in a small geographic area. D) only a few shareholders exist. Answer: D Explanation: A) B) C) D) 47) Which of the following would not be considered a real asset? 47) A) a factory B) a corporate bond C) a patent D) a machine Answer: B Explanation: A) B) C) D) 12

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    48) Ethical decision making by management has a payoff for shareholders in terms of: 48) A) higher dividend payments. B) increased managerial benefits. C) enhanced reputation value. D) improved capital structure. Answer: C Explanation: A) B) C) D) 49) When a corporation decides to issue long-term debt in order to pay for the acquisition of real assets, it has made a: 49) A) money market decision. B) secondary market decision. C) capital budgeting decision. D) financing decision. Answer: D Explanation: A) B) C) D) 50) A chief financial officer would typically: 50) A) report to both the treasurer and controller. B) report to the controller, but supervise the treasurer. C) supervise both the treasurer and controller. D) report to the treasurer, but supervise the controller. Answer: C Explanation: A) B) C) D) 51) A first step in determining managerial objectives is to: 51) A) eliminate agency problems. B) serve the needs of the customer. C) develop appropriate compensation policies. D) select an appropriate capital structure. Answer: B Explanation: A) B) C) D) 13

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    52) In a firm having both a treasurer and a controller, which of the following would most likely be handled by the controller? 52) A) insurance B) internal auditing C) banking relationships D) credit management Answer: B Explanation: A) B) C) D) 53) One corporate activity that is specifically reserved for the board of directors is the: 53) A) custody of records. B) preparation of budgets. C) day-to-day operation of the firm. D) declaration of dividends. Answer: D Explanation: A) B) C) D) 54) A managerial objective to increase market share is more likely to be successful in the long run if the firm is: 54) A) managed by the board of directors. B) investing in capital budgeting projects. C) selling shares in the secondary market. D) the low-cost producer in the industry. Answer: D Explanation: A) B) C) D) 55) An example of a firm's financing decision would include: 55) A) whether or not to increase the price of its products. B) the issuance of ten-year versus twenty-year bonds. C) acquisition of a competitive firm. D) how much to pay for a specific asset. Answer: B Explanation: A) B) C) D) 14

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    56) The shareholders in a sole proprietorship are represented by: 56) A) the owner of the firm. B) the board of directors of the firm. C) no one; sole proprietorships have no shareholders. D) the general partner of the firm. Answer: C Explanation: A) B) C) D) 57) By organizing itself as a corporation, a business may be able to attract: 57) A) proprietors. B) agents. C) investors. D) partners. Answer: C Explanation: A) B) C) D) 58) For small firms, shareholders and management may be one and the same. But for large companies, separation of ownership and management is: 58) A) a fraudulent move. B) not a necessity. C) a practical necessity. D) a liability. Answer: C Explanation: A) B) C) D) 59) Agency problems can best be characterized as a: 59) A) friction between the primary and secondary markets. B) spending corporate resources. C) differing incentives between managers and owners. D) dislike of firm's bondholders by its equity holders. Answer: C Explanation: A) B) C) D) 15

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    60) Firms can alter their capital structure by: 60) A) issuing stock to repay debt. B) investing in non-tangible assets. C) becoming a limited liability company. D) not accepting any capital budgeting projects. Answer: A Explanation: A) B) C) D) 61) Corporate managers are expected to make corporate decisions that are in the best interest of: 61) A) the corporation's shareholders. B) top corporate management. C) the corporation's board of directors. D) all corporate employees. Answer: A Explanation: A) B) C) D) 62) Which of the following would correctly differentiate general partners from limited partners in a limited partnership? 62) A) general partners are subject to double taxation. B) general partners have more job experience. C) general partners have an ownership interest. D) general partners have unlimited personal liability. Answer: D Explanation: A) B) C) D) 63) The short-term decisions of financial managers are comprised of: 63) A) capital structure decisions. B) investment decisions. C) both investment and financing decisions. D) financing decisions. Answer: C Explanation: A) B) C) D) 16

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    64) In the case of a professional corporation, ________ has/have limited liability. 64) A) only the business B) only the professionals C) Both the professionals and the business D) Neither the professionals nor the business Answer: A Explanation: A) B) C) D) 65) A board of directors is elected as a representative of the corporation's: 65) A) stakeholders. B) customers. C) top management. D) shareholders. Answer: D Explanation: A) B) C) D) SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 66) Discuss why corporations typically exhibit separation of ownership and management, as distinguished from sole proprietorships or partnerships. 66) Answer: One reason corporations typically exhibit a separation of ownership and management is that ownership often includes a diverse amount of relatively small investors. Thus, it would be nearly impossible to coordinate these owners into decision makers. Also, many small investors are pleased in being relieved of management responsibilities. Therefore, the quality of management is likely to be better if those managers have been hired specifically for that function. Finally, the separation minimizes managerial disruptions that would occur with changing or deceased investors. Most sole proprietorships and partnerships are smaller firms that do not need, may not be able to afford, and may not desire even if they could afford, the existence of a separate management. Explanation: 17

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    67) Explain why managers should use ethical decision making as a way to increase the profitability of a firm. 67) Answer: Ethical decision making can have an important impact on employee attitudes, investor actions, and customer retention. Further, all of these factors can have a large impact on the bottom line. The list of potential benefits for a firm that has developed a reputation for ethical operations can be long-easier employee recruitment, lower employee turnover, easier issue of primary securities, repeat business, good word of mouth, et cetera. In other words, the actions of all stakeholders can be positively affected when they perceive the firm to be ethical in its decisions. Explanation: 68) What are the two major decisions made by a financial manager? 68) Answer: Financial management can be broken down into (1) the investment, or capital budgeting decision, and (2) the financing decision. The firm has to decide on how much to invest and which real assets to invest in, and secondly, how to raise the necessary cash. Explanation: 69) What specific arrangements can be used to ensure management is working towards shareholders' goals? 69) Answer: Compensation Plans, board of directors, takeover threats, specialist monitoring, legal and regulatory requirements. Explanation: 70) Describe agency problems in general, and offer at least three examples from corporations. 70) Answer: Whenever the firm's managers are different from the firm's owners, the potential exists for agency problems. Management may be taking advantage of the fact that corporate ownership is often quite diverse, such that none of the owners appears to be "minding the store." In those cases, it may be easy for top management to vote itself an excessive raise, or to redecorate the corporate suite, or to be lax on the justification of expense reports, or even to invest in projects that are "too safe." Why might managers choose safe projects? For example, the executive may have one year remaining on an employment contract and be more concerned with stable profits than with rising profits. Explanation: 18

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    71) Discuss the interrelationship between a firm's financing and capital structure decisions. 71) Answer: Although the capital budgeting decision considers what to invest in and specifically how much to invest, this decision is importantly related to how the necessary funds should be raised. For example, if many other firms of similar risk have recently issued bonds, the supply of loanable funds may be low, which could affect the interest rate on such funds. Or, the current market value of common stock may be so low that management would prefer not to issue additional shares at this time. Alternatively, the existence of loan or bond covenants could restrict certain forms of borrowing. Finally, although certain forms of financing may appear attractive, they may not represent the targeted capital structure. Thus, elements of the financing decision need to be considered simultaneously with the capital budgeting decision. Explanation: 72) What general factors may influence the decision of whether to organize as a sole proprietorship, a partnership, or a corporation? 72) Answer: Factors that may influence the decision concerning organizational form would include: amount of capital needed in relation to amount of capital that can be raised, estimated sales volume, the extent of managerial expertise, the willingness to share profits, the importance of limited liability, a desire for the permanence of the organization, the issue of double taxation. Explanation: 19

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    73) Briefly discuss income trusts. 73) Answer: An income trust is an investment fund, legally known as a mutual fund trust. Mutual fund trusts sell units to investors to raise money to purchase shares and debt of operating businesses. Mutual fund trusts are not operating companies but flow-through entities, in which the earnings on the investments are not taxed at the fund level, but rather are taxed in the hands of the unit holders. Unlike typical investment funds, which invest in many different companies, an income trust invests in only one company, making a unit similar to a share. Clever lawyers and financial experts were able to structure income trusts to dramatically reduce the taxes paid by the underlying business enterprise. One way this was accomplished was by having the income trust own both the debt and the equity of the underlying corporation. This allowed the corporation to be financed with a lot of debt, reducing its taxes. Income trusts became very popular, with some corporations converting to the trust structures and other business going public as trusts. On October 31, 2006, the Canadian federal government, fearing significant loss of tax revenue, changed the rules for the taxation of income trusts, taking away their tax advantage, and the income trust boom came to a sudden end. Explanation: 74) Why is limited liability such an important aspect to investors? 74) Answer: Many investors would not be willing to commit their investment funds into projects if it were known they were risking more than those specific funds. Specifically in the case of separated ownership and management, shareholders may be unwilling to remain liable for decisions they did not have a hand in making. With the aversion to risk that is witnessed in general for many investors, it is questionable whether investors would direct their funds into financial assets that did not offer limited liability. Thus, the existence of limited liability may greatly affect the demand for corporate shares. Explanation: 75) Tabulate and compare the differences among corporations, proprietorships and partnerships. 75) Answer: Explanation: 20

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    76) Are all investment decisions made by the financial manager multi-billion dollar investment? 76) Answer: No. Most investment decisions are smaller and simpler, such as purchase of trucks, machine tools or computer systems. But the objective is to add value to the firm. Explanation: 77) Distinguish between a firm's capital budgeting decision and financing decision. 77) Answer: Examples of the capital budgeting decision for a firm could include: a decision to replace all of the firm's personal computers, a decision to expand the size of the production facility, a decision to buy a corporate jet, a decision to expand production into two new product lines, et cetera. Examples of the financing decision for a firm could include: a decision to issue corporate bonds rather than expand a bank loan, a decision to float a new issue of common stock, a decision to denominate a loan in Japanese yen rather than Canadian dollars, a decision to roll over short-term financing rather than borrow for a longer term, et cetera. Explanation: 78) Provide at least three examples each of real and financial assets that might appear on the balance sheet of General Motors. 78) Answer: Examples of real assets for General Motors: cash, raw materials inventory, production facilities, tools and machines, finished inventory of automobiles. Examples of financial assets that could have been issued by General Motors: common stock (different classes), preferred stock, corporate bonds, bank loans, et cetera. Of course, GM could show financial assets on the left side of their balance sheet also, such as: short-term investments in government securities, contracts receivable from the financing of their automobiles, or possibly residential mortgages (GM, through its subsidiaries, is a large originator of residential mortgages, although most would eventually be sold in the secondary market). Explanation: 79) How do corporations ensure that managers' and shareholders' interests coincide? 79) Answer: Conflicts of interest between managers and shareholders can lead to agency problems. These problems are kept in check by compensation plans that link the well-being of employees to that of the firm; by monitoring of management by the board of directors, security holders, and creditors; and by the threat of takeover. Explanation: 21

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    80) What does "real asset" mean? What is a "financial asset"? 80) Answer: Real assets include all assets used in the production or sale of the firm's products or services. Real assets can be tangible or intangible. Financial assets are securities such as shares, sold by the firm to raise money, and represent claims on the firm's real assets and the cash generated by those assets. Explanation: 81) Provide examples of managerial goals other than the maximization of market value. 81) Answer: Managers may attempt to maximize profits, or to maximize market share, or even to maximize their own benefits! Problems with maximizing profits can include the method of maximizing (i.e., is it in the long-run or short-run best interests of the firm?), the maintenance of product quality, ethical decision making, customer satisfaction, et cetera. Problems with market share can include economies of scale (i.e., low average cost of production), maintained profitability, increased liabilities, et cetera. Agency problems that relate to managerial compensation or perquisites that are not in the long-run interest of shareholders are another example of misguided goals. Explanation: TRUE/FALSE. Write 'T' if the statement is true and 'F' if the statement is false. 82) The agency problem is mitigated in practice through several devices. 82) Answer: True False Explanation: 83) A successful investment is one that increases the value of the firm. 83) Answer: True False Explanation: 84) General partners have limited personal liability for business debts in a limited partnership. 84) Answer: True False Explanation: 85) The corporate form of business organization is often accompanied by separation of ownership and management. 85) Answer: True False Explanation: 86) Managers are spurred on by incentive schemes that provide big returns if shareholders gain but are valueless if they do not. 86) Answer: True False Explanation: 22

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    87) Capital budgeting decisions are used to determine how to raise the cash necessary for investments. 87) Answer: True False Explanation: 88) If employee compensation plans are not designed properly, they can create incentives for errant behaviour by management. 88) Answer: True False Explanation: 89) As your firm grows, you may decide to form a corporation. You may incorporate your firm federally, under the Canadian Business Corporation Act, or provincially, under the relevant provincial laws. 89) Answer: True False Explanation: 90) Agency problems act as a hindrance to the goal of maximizing firm value. 90) Answer: True False Explanation: 91) To obtain the necessary money a company sells financial assets or securities. 91) Answer: True False Explanation: 92) A major disadvantage of partnerships is that they have "double taxation" of profits. 92) Answer: True False Explanation: 93) The duties of a corporate controller typically include the preparation of financial statements. 93) Answer: True False Explanation: 94) Managers are subject to the scrutiny of specialists. Their actions are monitored by the security analyst who advises investors to buy, hold, or sell the company's shares. 94) Answer: True False Explanation: 95) The primary goal of any company should be to maximize current period profit. 95) Answer: True False Explanation: 96) The liability of sole proprietors is limited to the amount of their investment in the company. 96) Answer: True False Explanation: 23

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    97) Maximizing profits is the same as maximizing the value of the firm. 97) Answer: True False Explanation: 98) Ethical decision making in business can be viewed as a long-term investment in reputation. 98) Answer: True False Explanation: 99) Poorly performing companies are also more likely to be taken over by another firm. After the takeover, the old management team may find itself out on the street. 99) Answer: True False Explanation: 24

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    Answer Key Testname: C1 1) D 2) C 3) D 4) D 5) D 6) D 7) A 8) B 9) D 10) D 11) D 12) B 13) B 14) C 15) C 16) D 17) C 18) B 19) B 20) A 21) C 22) B 23) A 24) D 25) C 26) A 27) C 28) D 29) C 30) C 31) C 32) C 33) B 34) D 35) C 36) B 37) A 38) B 39) A 40) A 41) C 42) D 43) B 44) D 45) B 46) D 47) B 48) C 49) D 50) C 25

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    Answer Key Testname: C1 51) B 52) B 53) D 54) D 55) B 56) C 57) C 58) C 59) C 60) A 61) A 62) D 63) C 64) A 65) D 66) One reason corporations typically exhibit a separation of ownership and management is that ownership often includes a diverse amount of relatively small investors. Thus, it would be nearly impossible to coordinate these owners into decision makers. Also, many small investors are pleased in being relieved of management responsibilities. Therefore, the quality of management is likely to be better if those managers have been hired specifically for that function. Finally, the separation minimizes managerial disruptions that would occur with changing or deceased investors. Most sole proprietorships and partnerships are smaller firms that do not need, may not be able to afford, and may not desire even if they could afford, the existence of a separate management. 67) Ethical decision making can have an important impact on employee attitudes, investor actions, and customer retention. Further, all of these factors can have a large impact on the bottom line. The list of potential benefits for a firm that has developed a reputation for ethical operations can be long-easier employee recruitment, lower employee turnover, easier issue of primary securities, repeat business, good word of mouth, et cetera. In other words, the actions of all stakeholders can be positively affected when they perceive the firm to be ethical in its decisions. 68) Financial management can be broken down into (1) the investment, or capital budgeting decision, and (2) the financing decision. The firm has to decide on how much to invest and which real assets to invest in, and secondly, how to raise the necessary cash. 69) Compensation Plans, board of directors, takeover threats, specialist monitoring, legal and regulatory requirements. 70) Whenever the firm's managers are different from the firm's owners, the potential exists for agency problems. Management may be taking advantage of the fact that corporate ownership is often quite diverse, such that none of the owners appears to be "minding the store." In those cases, it may be easy for top management to vote itself an excessive raise, or to redecorate the corporate suite, or to be lax on the justification of expense reports, or even to invest in projects that are "too safe." Why might managers choose safe projects? For example, the executive may have one year remaining on an employment contract and be more concerned with stable profits than with rising profits. 26

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    Answer Key Testname: C1 71) Although the capital budgeting decision considers what to invest in and specifically how much to invest, this decision is importantly related to how the necessary funds should be raised. For example, if many other firms of similar risk have recently issued bonds, the supply of loanable funds may be low, which could affect the interest rate on such funds. Or, the current market value of common stock may be so low that management would prefer not to issue additional shares at this time. Alternatively, the existence of loan or bond covenants could restrict certain forms of borrowing. Finally, although certain forms of financing may appear attractive, they may not represent the targeted capital structure. Thus, elements of the financing decision need to be considered simultaneously with the capital budgeting decision. 72) Factors that may influence the decision concerning organizational form would include: amount of capital needed in relation to amount of capital that can be raised, estimated sales volume, the extent of managerial expertise, the willingness to share profits, the importance of limited liability, a desire for the permanence of the organization, the issue of double taxation. 73) An income trust is an investment fund, legally known as a mutual fund trust. Mutual fund trusts sell units to investors to raise money to purchase shares and debt of operating businesses. Mutual fund trusts are not operating companies but flow-through entities, in which the earnings on the investments are not taxed at the fund level, but rather are taxed in the hands of the unit holders. Unlike typical investment funds, which invest in many different companies, an income trust invests in only one company, making a unit similar to a share. Clever lawyers and financial experts were able to structure income trusts to dramatically reduce the taxes paid by the underlying business enterprise. One way this was accomplished was by having the income trust own both the debt and the equity of the underlying corporation. This allowed the corporation to be financed with a lot of debt, reducing its taxes. Income trusts became very popular, with some corporations converting to the trust structures and other business going public as trusts. On October 31, 2006, the Canadian federal government, fearing significant loss of tax revenue, changed the rules for the taxation of income trusts, taking away their tax advantage, and the income trust boom came to a sudden end. 74) Many investors would not be willing to commit their investment funds into projects if it were known they were risking more than those specific funds. Specifically in the case of separated ownership and management, shareholders may be unwilling to remain liable for decisions they did not have a hand in making. With the aversion to risk that is witnessed in general for many investors, it is questionable whether investors would direct their funds into financial assets that did not offer limited liability. Thus, the existence of limited liability may greatly affect the demand for corporate shares. 75) 76) No. Most investment decisions are smaller and simpler, such as purchase of trucks, machine tools or computer systems. But the objective is to add value to the firm. 27

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    Answer Key Testname: C1 77) Examples of the capital budgeting decision for a firm could include: a decision to replace all of the firm's personal computers, a decision to expand the size of the production facility, a decision to buy a corporate jet, a decision to expand production into two new product lines, et cetera. Examples of the financing decision for a firm could include: a decision to issue corporate bonds rather than expand a bank loan, a decision to float a new issue of common stock, a decision to denominate a loan in Japanese yen rather than Canadian dollars, a decision to roll over short-term financing rather than borrow for a longer term, et cetera. 78) Examples of real assets for General Motors: cash, raw materials inventory, production facilities, tools and machines, finished inventory of automobiles. Examples of financial assets that could have been issued by General Motors: common stock (different classes), preferred stock, corporate bonds, bank loans, et cetera. Of course, GM could show financial assets on the left side of their balance sheet also, such as: short-term investments in government securities, contracts receivable from the financing of their automobiles, or possibly residential mortgages (GM, through its subsidiaries, is a large originator of residential mortgages, although most would eventually be sold in the secondary market). 79) Conflicts of interest between managers and shareholders can lead to agency problems. These problems are kept in check by compensation plans that link the well-being of employees to that of the firm; by monitoring of management by the board of directors, security holders, and creditors; and by the threat of takeover. 80) Real assets include all assets used in the production or sale of the firm's products or services. Real assets can be tangible or intangible. Financial assets are securities such as shares, sold by the firm to raise money, and represent claims on the firm's real assets and the cash generated by those assets. 81) Managers may attempt to maximize profits, or to maximize market share, or even to maximize their own benefits! Problems with maximizing profits can include the method of maximizing (i.e., is it in the long-run or short-run best interests of the firm?), the maintenance of product quality, ethical decision making, customer satisfaction, et cetera. Problems with market share can include economies of scale (i.e., low average cost of production), maintained profitability, increased liabilities, et cetera. Agency problems that relate to managerial compensation or perquisites that are not in the long-run interest of shareholders are another example of misguided goals. 82) TRUE 83) TRUE 84) FALSE 85) TRUE 86) TRUE 87) FALSE 88) TRUE 89) TRUE 90) TRUE 91) TRUE 92) FALSE 93) TRUE 94) TRUE 95) FALSE 96) FALSE 97) FALSE 98) TRUE 28

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    Answer Key Testname: C1 99) TRUE 29

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    Exam Name___________________________________ MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) If Apple Computer Inc. is used as the model, then new firms should expect to raise capital in which one of these orders? Start with the first money raised. 1) A) owners, public investors, venture capitalists, suppliers B) owners, venture capitalists, suppliers, public investors C) venture capitalists, owners, public investors, suppliers D) owners, suppliers, venture capitalists, public investors Answer: D Explanation: A) B) C) D) 2) One reason suggesting that banks may be better than individuals at matching lenders to borrowers is that banks: 2) A) do not have any income tax liability. B) are motivated by the potential for profit. C) have information to evaluate creditworthiness. D) can shift loan risk to their deposit customers. Answer: C Explanation: A) B) C) D) 3) Financing for public corporations flows through: 3) A) the financial markets only. B) the financial markets, financial intermediaries, or both. C) derivatives markets. D) financial intermediaries only. Answer: B Explanation: A) B) C) D) 1

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