Test Bank for Foundations Of Finance, 5th Edition

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Foundations ofFinanceTenthEditionArthur J. KeownJohn D. MartinJ. William PettyFoundations of FinanceTest Bank (Download Only), 10eByRodrigo Hernandez

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1Foundations of Finance, 10e(Keown/Martin/Petty)Chapter 1An Introduction to the Foundations of Financial ManagementLearning Objective 1.11)Financial management deals with the maintenance and creation of economic value or wealth.Answer: TRUEDiff: 1Page Ref:3Keywords: Financial ManagementLearning Obj.: L.O. 1.1AACSB: Reflective Thinking2) Each financial decision made by a corporatemanager can be evaluated by its direct impact onthe corporation's stock price.Answer: FALSEDiff: 1Page Ref:4Keywords: Goal of the FirmLearning Obj.: L.O. 1.1AACSB: Reflective Thinking3) The fundamental goal of a business is to maximize theretained earnings available to thecorporation's shareholders.Answer: FALSEDiff: 1Page Ref:3Keywords: Goal of the FirmLearning Obj.: L.O. 1.1AACSB: Reflective Thinking4) Shareholder wealth maximization means maximizing the price of the existing common stock.Answer: TRUEDiff: 1Page Ref:3Keywords: Shareholder Wealth, Goal of the FirmLearning Obj.: L.O. 1.1AACSB: Reflective Thinking5)It is important to evaluate a corporate manager's financial decision by measuring the effect thedecisionshould haveon the corporation's stock price if everything else were held constant.Answer: TRUEDiff: 2Page Ref:4Keywords: Goal of the Firm, Maximize Shareholder WealthLearning Obj.: L.O. 1.1AACSB: Reflective Thinking

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26) Corporate managers should accept investment projects that maximize profits in the short runbecause of the time value of money.Answer: FALSEDiff: 2PageRef:4Keywords:Goal of the Firm, Profits, Time Value of MoneyLearning Obj.: L.O. 1.1AACSB: Reflective Thinking7) The goal of the firm's financial managers should be the maximization of the total value of thefirm's stock.Answer: TRUEDiff: 1Page Ref:3Keywords: Goal of the FirmLearning Obj.: L.O. 1.1AACSB: Reflective Thinking8) The payment of a dividend to current shareholders will have no impact on a corporation'sshare price because the cash paid is not available to future potential shareholders whomay wantto buy the corporation's stock.Answer: FALSEDiff: 1Page Ref:4Keywords: Goal of the FirmLearning Obj.: L.O. 1.1AACSB: Reflective Thinking9)One problem with maximization of shareholder wealth as a goal is that it ignores risk taken bythe firm's financial decisions.Answer: FALSEDiff: 1Page Ref:4Keywords: Goal of the FirmLearning Obj.: L.O. 1.1AACSB: Reflective Thinking10) The goal of profit maximization ignores the risk of financial decisions.Answer: FALSEDiff: 1Page Ref:4Keywords: Goal of the FirmLearning Obj.: L.O. 1.1AACSB: Reflective Thinking11) Only a firm's financial decisions affect its stock prices.Answer:FALSEDiff: 1Page Ref:4Keywords: Determinants of Stock PriceLearning Obj.: L.O. 1.1AACSB: Reflective Thinking

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312) Shareholders react to poor investment or dividend decisions by causing the total value of thefirm's stock to fall, and they react togood decisions by bidding the price of the stock up.Answer: TRUEDiff: 2Page Ref:4Keywords: Determinants of Stock PriceLearning Obj.: L.O. 1.1AACSB: Reflective Thinking13)The primary goal of a publicly owned corporation is toA) maximize dividends per shareB) maximize shareholder wealthC) maximize earnings per share after taxesD) minimize shareholder riskAnswer: BDiff: 1Page Ref:3Keywords: Goal of the Firm, CorporationLearning Obj.: L.O. 1.1AACSB: Reflective Thinking14) Maximization of shareholder wealthA) represents a zero sum game in which one corporation gains at the expense of others.B) provides benefits to society as scarce resources are directed totheir most productive use.C) is not a practical goal since it cannot be measured effectively.D) is achieved only if cash flows exceed accounting profits.Answer: BDiff: 1Page Ref:3Keywords: Goal of the Firm, Maximize Shareholder WealthLearning Obj.: L.O. 1.1AACSB: Reflective Thinking15) A financial manager is considering two projects, A and B. A is expected to add $2 million toprofits this year while B is expected to add $1 million to profits this year. Which of the followingstatements is MOST correct?A) The manager should select project A because it maximizesprofits.B) The manager should select the project that maximizes long-term profits, not just one year ofprofits.C) The manager should select project A or he is irrational.D) The manager should select the project that causes the stock price to increasethe most, whichcould be A or B.Answer: DDiff: 2Page Ref:4Keywords: Goal of the FirmLearning Obj.: L.O. 1.1AACSB: Analytical Thinking

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416)Shareholder wealth maximization meansA) maximizing earnings per share.B) maximizing dividends per share.C) maximizing the price of existing common stock.D) maximizing stockholders equity.Answer: CDiff: 1Page Ref:4Keywords: Goal of the Firm, Maximize Shareholder WealthLearning Obj.: L.O. 1.1AACSB: Reflective Thinking17) The goal of thefirm should beA) maximization of profits (net income per share).B) maximization of shareholder wealth.C) maximization of market share.D) maximization of sales.Answer: BDiff: 1Page Ref:3Keywords: Goal of the Firm, Maximize Shareholder WealthLearning Obj.: L.O. 1.1AACSB: Reflective Thinking18) Which of the following goals of the firm are synonymous (equivalent) to the maximizationof shareholderwealth?A) profit maximizationB) risk minimizationC) maximization of the total market value of the firm's common stockD) none of the aboveAnswer: CDiff: 1Page Ref:4Keywords:Goal of the Firm, Maximize Shareholder WealthLearning Obj.: L.O. 1.1AACSB: Reflective Thinking19) Which of the following is the most important goal that a corporation should strive for?A) maximize current profitsB) maximize market shareC) maximizerevenueD) maximize shareholder wealthAnswer: DDiff: 1Page Ref:3Keywords: Goal of the Firm, Maximize Shareholder WealthLearning Obj.: L.O. 1.1AACSB:Reflective Thinking

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520) One of the causes of the recent financial crisis in the United Stateshas been excessive risktaking due to underestimation of risk. How does this relate to shareholder wealth maximizationand financial leverage? Can overestimation of risk also be detrimental?Answer: Underestimation of risk can lead managers to borrow excessively to fund more andmore projects. High levels of debt require interest and principal payments which may becomeimpossible to make if the company's cash flows are reduced, even for short periods of time.Overestimation of risk can also be problematic. Managers who take on too little risk may bepassing up desirable projects that could increase shareholder wealth. The principle that riskrequires a reward does not mean that all risk is bad, but rather that additional risk is ok ifadditional expected returns are high enough. If all risk was bad, companies would go out ofbusiness and all investors would buy U.S. Treasury bills.Diff: 2Page Ref:4, 9Keywords: Risk Requires a Reward, Goal of the FirmLearning Obj.: L.O. 1.1AACSB: Reflective Thinking21) Documents uncovered after the Exxon Valdez oil spill in Alaska revealed that Exxon couldhave used double-hulled oil tankers that would have preventedthe spill, but the cost of refittingtheir fleet of single-hulled tankers was considered too high.Exxon determined that the cost ofcleaning up an oil spill would be less than the cost of refitting the ships, thus increasingshareholder value. Several years after the oil spill, however, Exxon was fined billions of dollarsfor the spill. How do the costs of the cleanup and the fines pertain to a discussion of maximizingshareholder value and ethical responsibility?Answer:Managers are supposed to maximizeshareholder value. Exxon's analysis of the costs ofan oil spill versus the cost of improving their tankers seems to have been a reasonable one at thetime it was undertaken. The social costs of killing birds and fish wereexpected to be low. Theoutrageat Exxon's conduct and the subsequent large fines will change the estimation of futurecosts for similar situations. Managers need to consider the impact of their decisions on theircompanies' cash flows. Socially undesirable activities may lead to boycotts, protests, lower sales,fines, etc. These costs must be included in their analyses. Society sets limits within whichcorporations must operate or the corporations, and their shareholders, will suffer. Therefore,acting inethical and socially responsibleways is congruent with the goal of shareholder wealthmaximization.Diff: 2Page Ref:4, 9, 10Keywords: Goal of the Firm, Maximizing Shareholder Value, Ethical Responsibility, Cash FlowLearning Obj.: L.O. 1.1AACSB: Reflective Thinking

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6LearningObjective 1.21) When making financial decisions, managers should always look at marginal, or incrementalcash flows.Answer: TRUEDiff: 1Page Ref:5Keywords: Marginal or Incremental Cash FlowsLearning Obj.: L.O. 1.2AACSB: Reflective Thinking2) An investment project is acceptable if the total cash received over the life of the projectexceeds the total cash spent over the life of the project.Answer: FALSEDiff: 2Page Ref:5Keywords: Cash Flow, Time Value of MoneyLearning Obj.: L.O.1.2AACSB: Reflective Thinking3) If two companies have the same net income and the same level of risk, they must also have thesame stock price or the market is not in equilibrium.Answer: FALSEDiff: 2Page Ref:4Keywords: Net Income, Risk, Timing of Cash FlowLearning Obj.: L.O. 1.2AACSB: Analytical Thinking4) Profits represent money that can be spent, and as such, form the basis for determining thevalue of financial decisions.Answer: FALSEDiff: 2Page Ref:4Keywords: Profits, Cash FlowLearning Obj.: L.O. 1.2AACSB: Reflective Thinking5) The root cause of agency problems is conflicts of interest.Answer: TRUEDiff: 1Page Ref:8Keywords: Agency Problems, Conflicts of InterestLearning Obj.: L.O. 1.2AACSB: ReflectiveThinking

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76) Investors will be indifferent between two investments if both investments have the sameexpected return.Answer: FALSEDiff: 1PageRef:5, 6Keywords: Risk-Return Trade-offLearning Obj.: L.O. 1.2AACSB: Reflective Thinking7) If the stock market is efficient, then investors do not need to read the Wall Street Journal orresearch companies before they select which stocks to buy becausemarket prices already reflectall publicly available information.Answer: FALSEDiff: 2Page Ref:6Keywords: Efficient MarketsLearning Obj.: L.O. 1.2AACSB: Analytical Thinking8) Giving the company's CEO stock options as part of his or her compensation package is anexample of an agency cost.Answer: TRUEDiff: 2Page Ref:8Keywords:Agency CostsLearning Obj.: L.O. 1.2AACSB: Reflective Thinking9)Cash flows and profits are synonymous; in other words, higher cash flows equal higherprofits.Answer: FALSEDiff: 1Page Ref:4Keywords: Cash Flow, ProfitLearning Obj.: L.O. 1.2AACSB: Reflective Thinking10) Shareholder selection committees select potential board of director nominees ensuring thatboard members will monitor management sufficiently to protect shareholder interests.Answer: FALSEDiff: 1Page Ref:9Keywords: Agency Problems, Board of DirectorsLearning Obj.: L.O. 1.2AACSB: Reflective Thinking

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811) Managers should not be concerned with business ethics because ethical behavior isinconsistent with the primary goal of maximizing shareholder value.Answer: FALSEDiff: 1Page Ref:10Keywords: Ethics, Goal of the FirmLearning Obj.: L.O. 1.2AACSB: Ethical Understanding and Reasoning12) One of the problems associated with maximization of total current stock value is that itignores the timing of aproject's return.Answer: FALSEDiff: 1Page Ref:4, 5Keywords:Maximizing Shareholder Value, Timing of ReturnsLearning Obj.: L.O. 1.2AACSB: Reflective Thinking13) The risk-return trade-off is seen in many areas of finance.Answer: TRUEDiff: 1Page Ref:6Keywords: Risk, ReturnLearning Obj.: L.O. 1.2AACSB:Reflective Thinking14) The risk-return trade-off implies that the return on a riskless asset must be zero.Answer: FALSEDiff: 1Page Ref:6Keywords: Risk-Return Trade-offLearning Obj.: L.O. 1.2AACSB: Reflective Thinking15) When employees dowhat is in their best interest, they are also doing what is the best resultfor the organization they belong.Answer: FALSEDiff: 1Page Ref:9Keywords: Agency ProblemsLearning Obj.: L.O. 1.2AACSB: Reflective Thinking16) An efficient market is onewhere the prices of the assets traded in that market fully reflect allavailable information at any instant in time.Answer: TRUEDiff: 1Page Ref:6Keywords: EfficientMarketsLearning Obj.: L.O. 1.2AACSB: Reflective Thinking

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917)The opportunity cost of any choice you make is the highest-valued alternative that you had togive up when you made the choice.Answer: TRUEDiff: 1Page Ref:5Keywords: OpportunityCost, Time Value of MoneyLearning Obj.: L.O. 1.2AACSB: ReflectiveThinking18) While many factors contributed to the financial crisis of 2007 and beyond, it is safe to saythat real estate loans were NOT much of a contributing factor.Answer: FALSEDiff: 1Page Ref:9Keywords: Current Global Financial CrisisLearningObj.: L.O. 1.2AACSB: Reflective Thinking19) The five basic principles of finance include all of the following EXCEPTA) cash flow is what matters.B) money has a time value.C)risk requires a reward.D) incremental profits determine value.Answer:DDiff: 1Page Ref:4Keywords: Basic Principles of FinanceLearning Obj.: L.O. 1.2AACSB: Reflective Thinking20)Suppose XYZ Corporation is traded on the New York Stock Exchange. XYZ's closing priceon Monday is $20 per share. After the market closes on Monday, XYZ makes a surpriseannouncement that it has obtained a major new customer. XYZ's stock will likelyA) open at $20 per share on Tuesday and then increase as more investors read the announcementin the Wall Street Journal.B) remain at $20 per share because in efficient markets the price already reflects all information.C) open above $20 because the positive news will result in a higher valuation even though thestockhas not yet traded.D) open below $20 because the surprise announcement creates more uncertainty.Answer: CDiff: 2Page Ref:6Keywords: Efficient MarketsLearning Obj.: L.O. 1.2AACSB: Analytical Thinking

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1021) A corporate manager decides to builda new store on a lot owned by the corporation thatcould be sold to a local developer for $250,000. The lot was purchased for $50,000 twenty yearsago. When determining the value of the new store project,A) the cost of the lot is zero since the corporation already owns it.B) the opportunity cost of the lot is $250,000 and should be included in calculating the value ofthe project.C) the cost of the lot for valuation purposes is $50,000 because land does not depreciate.D) the incremental cash flow should be the $50,000 original cost less accumulated amortization.Answer: BDiff: 2Page Ref:5Keywords: Opportunity CostLearning Obj.: L.O. 1.2AACSB: Analytical Thinking22) To measure value,the concept of time value of money is usedA) to determine the interest rate paid on corporate debt.B) to bring the future benefits and costs of a project, measured by its expected profits, back to thepresent.C) to bring the future benefits and costs of a project, measured by its cash flows, back to thepresent.D) to ensure that expected future profits exceed current profits today.Answer: CDiff: 1Page Ref:5Keywords: Time Value of Money, Cash FlowsLearning Obj.: L.O. 1.2AACSB:Reflective Thinking23) A financial manager is evaluating a project which is expected to generate profits of $100,000per year for the next 10 years. The project should be accepted ifA) the cost of the project is less than $1,000,000.B) the cost of theproject is less than the present value of $100,000 per year for 10 years.C) this project's expected profits are higher than any other projects the corporation has available.D) the present value of the project's cash inflows exceeds the present value ofthe project's cashoutflows.Answer: DDiff: 2Page Ref:4,5Keywords: Time Value of Money, Cash FlowsLearning Obj.: L.O. 1.2AACSB: Analytical Thinking

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1124) Investors want a return that satisfies the following expectation(s):A) A return for delaying consumptionB) An additional return for taking on riskC) An additional return for accepting dividends rather than capital gainsD) Both A and B.Answer: DDiff: 2Page Ref:5,6Keywords: Risk, ReturnLearning Obj.: L.O. 1.2AACSB: Reflective Thinking25) The expected return on a riskless asset is greater than zero due toA) an expected return for delaying consumption.B) an expected return for opportunity costs.C) an expected return for taxes.D)irrational investors who believe risk is always present.Answer: ADiff: 1Page Ref:5Keywords: Risk-Return Trade-offLearning Obj.: L.O. 1.2AACSB: Reflective Thinking26) Joe, a risk-averse investor, is trying to choose between investment A and investment B. Ifinvestment A is riskier than investment B and Joe selects investment A anyway, thenA) the actual return for investment A will be higher than the actual return for investment B.B) the actual return for investment A will be higher than the expected return for investment B.C) the expected return for investment A will be higher than the actual return for investment B.D) the expected return for investment A will be higher than the expected return for investment B.Answer: DDiff: 1Page Ref:5, 6Keywords: Risk-Return Trade-offLearning Obj.: L.O. 1.2AACSB: Analytical Thinking27) The principle of risk-return trade-off means thatA) higher risk investments must earn higher returns.B) an investor who takes more risk will earn a higher return.C) a rational investor will only take on higher risk if he expects a higher return.D) aninvestor who bought stock in a small corporation five years ago has more money than aninvestor who bought U.S. Treasury bonds five years ago.Answer: CDiff: 2Page Ref:5, 6Keywords: Risk-Return Trade-off, Expected Return, Actual ReturnLearning Obj.: L.O. 1.2AACSB: Reflective Thinking

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1228)Project A is expected to generate positive cash flow of $1 million in 10 years while Project Bis expected to generate $500,000 in 5 years. ThereforeA) Project A is preferred because shareholder value is based on cash flow.B) Project B is preferred because its cash flow is expected to be received sooner than the cashflow from Project A.C) Both projects have equal value because they average $100,000 per year.D) Project B may be preferred to Project A if the opportunity cost of money is high enough.Answer: DDiff: 2Page Ref:5Keywords: Time Value of MoneyLearning Obj.: L.O. 1.2AACSB: Analytical Thinking29) Company A reports sales of $100,000 and net income of $15,000. Company B reports salesof $100,000 and net income of $10,000. ThereforeA)Company A's cash flow may be higher or lower than Company B's cash flow even though A'snet income is higher.B) Company A's cash flow is $5,000 more than Company B's cash flow.C) Company B is creating less value for its shareholders than Company A.D) Company B's accounts receivable must be higher than Company A's accounts receivable.Answer: ADiff: 2Page Ref:4, 5Keywords: Cash Flow, Net IncomeLearning Obj.: L.O. 1.2AACSB: Analytical Thinking30) Profits are down so the controller decides to change the corporation's accounting policyrelating to inventory costing. The change will allow the corporation to report higher income andhigher assets, although the physical inventory has not changed.Which of the followingstatements is MOST correct?A)The stock price is likely to increase because income is higher.B) The stock price is likely to be unaffected because the stock market is efficient.C) The stock price is likely to decrease because reported inventory is higher.D) If the stock price increases, the stock market is efficient.Answer: BDiff: 2Page Ref:6Keywords: Efficient MarketsLearning Obj.: L.O. 1.2AACSB: Analytical Thinking

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1331)All of the following statements about agency problems are true EXCEPTA) agency problems interfere with the goal of maximizing shareholder value.B) agency costs are paid by the managers who do not act in the shareholders' best interest.C) agency problems result from the separation of management and the ownership of a firm.D) the root cause of agency problems is conflicts of interest.Answer: BDiff: 2Page Ref:8Keywords: Agency ProblemsLearning Obj.: L.O. 1.2AACSB: Reflective Thinking32) A corporate financial manager trying to maximize shareholder valueA) is not concerned with ethics but rather with writing iron-clad contracts.B) can safely ignore ethics as long as no laws are broken.C) must behave ethically in order to stay out of jail.D) is concerned with ethics because unethical behavior destroys trust, and businesses cannotfunction without a certain degree of trust.Answer: DDiff: 1Page Ref:9, 10Keywords: Ethics, Maximizing Shareholder ValueLearning Obj.: L.O. 1.2AACSB: Ethical Understanding and Reasoning33) John invested $1,000 in a risky investment and Bill invested $1,000 in a less riskyinvestment. One year later, Bill's investment is worth $1,030. Which of the following statementsis MOST correct?A) If John's investment is worth less than $1,030, then John was irrational to invest in the riskyproject.B)John's investment must be worth more than $1,030 because of the risk-return trade-off, giventhat John's investment was more risky.C) If John's investment is worth more than $1,030, then Bill wasirrational to invest in the lessrisky investment.D) Theworth of John's investment cannot be determined with the information given.Answer: DDiff: 2Page Ref:5, 6Keywords: Risk-Return Trade-off, Expected Return, Actual ReturnLearning Obj.: L.O. 1.2AACSB: Analytical Thinking

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1434) In order to reduce agency problems, managers may be provided compensation that includesA) a fixed salary so managers' pay is not at risk, allowing managers to focus on the company'sbusiness.B) a bonus based on the level of profit achieved during the year.C) an option to buy the company's stock.D) incentive pay for achieving higher sales than last year.Answer: CDiff: 2Page Ref:8, 9Keywords: Agency Problems, Stock Option, Incentive CompensationLearning Obj.: L.O. 1.2AACSB: Reflective Thinking35) An investor isconsidering two equally risky investments. Investment A is expected to return$1,000 per year for the next 5 years. Investment B is expected to return $6,000 at the end of 5years. Which ofthe following statements is MOST correct if both investments A andB have thesame cost?A) A risk averse investor will select investment B because it is expected to provide the most cash($6,000 > $5,000).B) A risk averse investor will select investmentA because it provides cash earlier thaninvestment B.C) The investor will select investment A only if the cost is less than $1,000.D) The investor may select investment A or investment B depending on the opportunity cost ofmoney.Answer: DDiff: 2Page Ref:4, 5Keywords: Time Value of Money, Cash FlowsLearning Obj.: L.O. 1.2AACSB: Analytical Thinking36)The CEO of High Tech International decides to change an accounting method at the end ofthe current year. The change results in reported profits increasing by 5%, but the company's cashflows are not changed. If capital markets are efficient, thenA) thestock price will not be affected by the accounting change.B) the stock price will increase due to higher profits.C) the stock price willincrease only if the accounting change will also result in higher profits inthe next year.D) the stock price will decrease because accounting method changes are not permitted undergenerally accepted accounting principles.Answer: ADiff: 1Page Ref:4, 6Keywords: Efficient MarketsLearning Obj.: L.O. 1.2AACSB: Analytical Thinking

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