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Test Bank for Foundations Of Finance, 5th Edition

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    Foundations of Finance Tenth Edition Arthur J. Keown John D. Martin J. William Petty Foundations of Finance Test Bank (Download Only), 10e By Rodrigo Hernandez

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    1 Foundations of Finance, 10e (Keown/Martin/Petty) Chapter 1 An Introduction to the Foundations of Financial Management Learning Objective 1.1 1) Financial management deals with the maintenance and creation of economic value or wealth. Answer: TRUE Diff : 1 Page Ref: 3 Keywords: Financial Management Learning Obj.: L.O. 1.1 AACSB: Reflective Thinking 2) Each financial decision made by a corporate manager can be evaluated by its direct impact on the corporation's stock price. Answer: FALSE Diff: 1 Page Ref: 4 Keywords: Goal of the Firm Learning Obj.: L.O. 1.1 AACSB: Reflective Thinking 3) The fundamental goal of a business is to maximize the retained earnings available to the corporation's shareholders. Answer: FALSE Diff: 1 Page Ref: 3 Keywords: Goal of the Firm Learning Obj.: L.O. 1.1 AACSB: Reflective Thinking 4) Shareholder wealth maximization means maximizing the price of the existi ng common stock. Answer: TRUE Diff: 1 Page Ref: 3 Keywords: Shareholder Wealth, Goal of the Fi rm Learning Obj.: L.O. 1.1 AACSB: Reflective Thinking 5) It is important to evaluate a corporate manager's financial decision by measuring the effect the decision should have on the corporation's stock price if everything else were held constant. Answe r: TRUE Diff: 2 Page Ref: 4 Keywords: Goal of the Firm, Ma ximize Shareholder Wealth Learning Obj.: L.O. 1.1 AACSB: Reflective Thinking

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    2 6) Corporate managers should accept investment projects that maximize profits in the short run because of the ti me value of money. Answer: FALSE Diff: 2 Page Ref: 4 Keywords: Goal of the Firm, Profits, Time Value of Money Learning Obj.: L.O. 1.1 AACSB: Reflective Thinking 7) The goal of the firm's financial managers should be the maximization of the total v alue of the firm's stock. Answer: TRUE Diff: 1 Page Ref: 3 Keywor ds: Goal of the Firm Learning Obj.: L.O. 1.1 AACSB: Reflective Thinking 8) The payment of a dividend to current shareholders will have no impact on a corporation's share price becaus e the cash paid is not available to future potential shareholders who may want to buy the corporation's stock. Answer: FALSE Diff: 1 Page Ref: 4 Keywords: Goal of the Firm Learning Obj.: L.O. 1.1 AACSB: Reflective Thinking 9) One problem with maxi mization of shareholder wealth as a goal is that it ignores risk taken by the firm's financial decisions. Answer: FALSE Diff: 1 Page Ref: 4 Keywords: Goal of the Firm Learning Obj.: L.O. 1.1 AACSB: Reflective Thinking 10) The goa l of profit maximi zation ignores the risk of financial decisions. Answer: FALSE Diff: 1 Page Ref: 4 Keywords: Goal of the Firm Learning Obj.: L.O. 1.1 AACSB: Reflective Thinking 11) Only a firm's financial decisions affect its stock prices. Answer: FALSE Diff: 1 Page Ref: 4 Keywords: Determinants of Stock Price Learning Obj.: L.O. 1.1 AACSB: Reflective Thinking

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    3 12) Shareholders react to poor investment or dividend decisions by causing the total value of the firm's stock to fall, and they react to good decisi ons by bidding the price of the stock up. Answer: TRUE Diff: 2 Page Ref: 4 Keywords: Determinants of Stock Price Learning Obj.: L.O. 1.1 AACSB: Reflective Thinking 13) The primary goal of a publicly owned corporation is to A) maximize dividends p er share B) maximize shareholder wealth C) maximize earnings per share after taxes D) minimize shareholder risk Answer: B Diff: 1 Page Ref: 3 Keywords: Goal of the Firm, Cor poration Learning Obj.: L.O. 1.1 AACSB: Reflective Thinking 14) Maximizat ion of shareholder wealth A) 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 to their most productive use. C) is not a practical goal since it cannot be me asured effectively. D) is achieved only if cash flows exceed accounting profits. Answer: B Diff: 1 Page Ref: 3 Keywords: Goal of the Firm, Maximize Shareholder Wealth Learning Ob j.: L.O. 1.1 AACSB: Reflective Thinking 15) A financial manager is con sidering two projects, A and B. A is expected to add $2 million to profits this year while B is expected to add $1 million to profits this year. Which of the following statements is M OST correct? A) The manager should select project A because it maximizes profits. B) The manager should select the project that maximizes long - term profits, not just one year of profits. C) The manager should select project A or he is irrational. D) The m anager should select the project that causes the stock price to increase the most, which could be A or B. Answer: D Diff: 2 Page Ref: 4 Keywords: Goal of the Firm Learning Obj.: L.O. 1.1 AACSB: Analytical Thinking

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    4 16) Shareholder wealth maximization means A) maximizing earnings per share. B) maximizing dividends per s hare. C) maximizing the price of existing common stock. D) maximizing stockholders equity. Answer: C Diff: 1 Page Ref: 4 Keywords: Goal of the Firm, Maxi mize Shareholder Wealth Learning Obj.: L.O. 1.1 AACSB: Reflective Thinking 17) The goal of the firm should be A) maximization of profits (net income per share). B) maximization of shareholder wealth. C) maximization of market share. D) maximization of s ales. Answer: B Diff: 1 Page Ref: 3 Keywords: Goal of the Firm, Maximize Shareholder Wealth L earning Obj.: L.O. 1.1 AACSB: Reflective Thinking 18) Which of the following goals of the firm are synonymous (equivalent) to the maximization of shareholder wealth? A) profit maximization B) risk minimization C) maximization of the total market value o f the firm's common stock D) none of the above Answer: C Diff: 1 Page Ref: 4 Keywords: Goal of the Firm, Maximize Shareholder Wealth Learning Obj.: L.O. 1.1 AACSB: Reflective Thinking 19) Which of the following is the most important goal that a cor poration should strive for? A) maximize current profits B) maximize market share C) maximize revenue D) maximize shareholder wealth Answer: D Diff: 1 Page Ref: 3 Keywords: Goal of the Firm, Maximize Shareholder Wealth Learning Obj.: L.O. 1.1 AACSB: Reflective Thinking

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    5 20) One of the causes of the recent financial crisis in the United States has been excessive risk taking due to underestimation of risk. How does this relate to shareholder wealth maximization and financial leverage? Can overestimatio n of risk also be detrimental? Answer: Underestimation of risk can lead managers to borrow exc essively to fund more and more projects. High levels of debt require interest and principal payments which may become impossible to make if the company's cash f lows are reduced, even for short periods of time. Overestimation of risk can also be problematic . Managers who take on too little risk may be passing up desirable projects that could increase shareholder wealth. The principle that risk requires a reward do es not mean that all risk is bad, but rather that additional risk is ok if additional expected r eturns are high enough. If all risk was bad, companies would go out of business and all investors would buy U.S. Treasury bills. Diff: 2 Page Ref: 4, 9 Keywo rds: Risk Requires a Reward, Goal of the Firm Learning Obj.: L.O. 1.1 AACSB: Reflective Thinking 21) Documents uncovered after the Exxon Valdez oil spill in Alaska revealed that Exxon could have used double - hulled oil tankers that would have prevented the spill, but the cost of refitting their fleet of single - hulled tankers was considered too high. Exxon determined that the cost of cleaning up an oil spill would be less than the cost of refitting the ships, thus increasing shareholder value. Several yea rs after the oil spill, however, Exxon was fined billions of dollars for the spill. How do the cost s of the cleanup and the fines pertain to a discussion of maximizing shareholder value and ethical responsibility? Answer: Managers are supposed to maximize shareholder value. Exxon's analysis of the costs of an oil spill versus the cost of improving their tankers seems to have been a reasonable one at the time it was undertaken. The social costs of killing birds and fish were expected to be low. The outrage at Exxon's conduct and the subsequent large fines will change the estimation of future costs for similar situations. Managers need to consider the impact of their decisions on their companies' cash flows. Socially undesirab le activities may lead to boycott s, protests, lower sales, fines, etc. These costs must be included in their analyses. Society sets limits within which corporations must operate or the corporations, and their shareholders, will suffer. Therefore, acting in ethical and socially responsible ways is congruent with the goal of shareholder wealth maximization. Diff: 2 Page Ref: 4, 9, 10 Keywords: Goal of the Firm, Maximizing Shareholder Value, Ethical Responsibility, Cash Flow Learning Obj.: L.O. 1.1 AACSB: R eflective Thinking

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    6 Learning Objective 1.2 1) When making financial decisions, managers should always look at marginal, or incremental cash flows. Answer: TRUE Diff: 1 Page Ref: 5 Keywords: Marginal or Incremental Cash Flows Learning Obj.: L.O. 1.2 AA CSB: Reflective Thinking 2) An investment project is acceptable if the total cash received over the life of the project exceeds the total cash spent over the life of the project. Answer: FALSE Diff: 2 Page Ref: 5 Keywords: Cash Flow, Time Value of Mon ey Learning Obj.: L.O. 1.2 AACSB: Reflective Thinking 3) If two companies have the same net income and the same level of risk, they must also have the same stock price or the market is not in equilibrium. Answer: FALSE Diff: 2 Page Ref: 4 Keywords: Ne t Income, Risk, Timi ng of Cash Flow Learning Obj.: L.O. 1.2 AACSB: Analytical Thinking 4) Profits represent money that can be spent, and as such, form the basis fo r determining the value of financial decisions. Answer: FALSE Diff: 2 Page Ref: 4 Keywords: Profits, Cas h Flow Learning Obj.: L.O. 1.2 AACSB: Reflective Thinking 5) The root cause of agency problems is conflicts of interest. Answer: TRUE Diff: 1 Page Ref: 8 Keywords: Agency Problems, Conflicts of Interest Learning Obj.: L.O. 1.2 AACSB: Reflective Thinking

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    7 6) Investors will be indifferent between two investments if both investments have the same expected return. Answer: FALSE Diff: 1 Page Ref: 5, 6 Keywords: Risk - Return Trade - off Learning Obj.: L.O. 1.2 AACSB: Reflective Thinking 7) If th e stock market is efficient, then investors do not need to read the Wall Street Journal or research companies before they select which stocks to buy because market prices already reflect all publicly available information. Answer: FALSE Diff: 2 Page R ef: 6 Keywords: Efficient Markets Learning Obj.: L.O. 1.2 AACSB: Analytical Thinking 8) Giving the company's CEO stock options as part of his or her compen sation package is an example of an agency cost. Answer: TRUE Diff: 2 Page Ref: 8 Keywords: Agency Costs Learning Obj.: L.O. 1.2 AACSB: Reflective Thinking 9) Cash flows and profits are synonymous; in other words, higher cash flows equal higher profits. Answer: FALSE Diff: 1 Page Ref: 4 Keywords: Cash Flow, Profit Learning Obj.: L.O. 1. 2 AACSB: Reflective Thinking 10) Shareholder selection committees selec t potential board of director nominees ensuring that board members will monitor management sufficiently to protect shareholder interests. Answer: FALSE Diff: 1 Page Ref: 9 Keywor ds: Agency Problems, Board of Directors Learning Obj.: L.O. 1.2 AACSB: Re flective Thinking

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    8 11) Managers should not be concerned with business ethics because ethical behavior is inconsistent with the primary goal of maximizing shareholder value. Answe r: FALSE Diff: 1 Page Ref: 10 Keywords: Ethics, Goal of the Firm Learning O bj.: L.O. 1.2 AACSB: Ethical Understanding and Reasoning 12) One of the problems associated with maximization of total current stock value is that it ignores the timing of a project's return. Answer: FALSE Diff: 1 Page Ref: 4, 5 Keywords: Maximizing Shareholder Value, Timing of Returns Learning Obj.: L.O. 1.2 AACSB: Reflective Thinking 13) The risk - return trade - off is seen in many areas of finance. Answer: TRUE Diff : 1 Page Ref: 6 Keywords: Risk, Return Learning Obj.: L.O. 1.2 AACSB: Reflective Thinking 14) The risk - return trade - off implies that the return on a riskless asset must be zero. Answer: FALSE Diff: 1 Page Ref: 6 Keywords: Risk - Return Trade - off Learning Obj.: L.O. 1.2 AACSB: Reflective Thinking 15) When employees do what is in their best interest, they are also doing what is the best result for the organization they belong. Answer: FALSE Diff: 1 Page Ref: 9 Keywords: Agency Problems Lear ning Obj.: L.O. 1.2 AACSB: Reflective Thinking 16) An efficient market is one where the prices of the assets traded in that market fully reflect all available information at any instant in time. Answer: TRUE Diff: 1 Page Ref: 6 Keywords: Efficient Markets Learning Obj.: L.O. 1.2 AACSB: Reflective Thinking

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    9 17) The opportunity cost of any choice you make is the highest - valued alternative that you had to give up when you made the choice. Answer: TRUE Diff: 1 Page Ref: 5 Keywords: Opportunity Cost, Time Value of Money Learning Obj.: L.O. 1.2 AACSB: Reflective Thinking 18) While many factors contributed to the financial crisis of 2007 and beyond, it is safe to say that real estate loans were NOT much of a contributing factor. Answer: FALSE Diff: 1 Page Ref: 9 Keywords: Current Global Financial Crisis Learning Obj.: L.O. 1.2 AACSB: Reflective Thinking 19) The five basic principles of finance include all of the following EXCEPT A) cash flow is what matters. B) money has a time value. C) risk requires a reward. D) incremental profits determine value. Answer: D Diff: 1 Page Ref: 4 Keywords: Basic Principles of Finance Learning Obj.: L.O. 1.2 AACSB: Reflective Thinking 20) Suppose XYZ Corporation is traded on the New York Stock Exch ange. XYZ's closing price on Monday is $20 per share. After the market closes on Monday, XYZ makes a surprise announcement that it has obtained a major new customer. XYZ's stock will likely A) ope n at $20 per share on Tuesday and then increase as more inve stors read the announcement in 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 n ews will result in a higher valuation even though the stock has not yet traded. D) open below $20 because the surprise announcement creates more uncertainty. Answer: C Diff: 2 Page Ref: 6 Keywords: Efficient Markets Learning Obj.: L.O. 1.2 AACSB: Analy tical Thinking

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    10 21) A corporate manager decides to build a new store on a lot owned by the corporation that could be sold to a local developer for $250,000. The lot was purchased for $50,000 twenty years ago. When determining the value of the new store pro ject, A) the cost of the lot is zero since the corporati on already owns it. B) the opportunity cost of the lot is $250,000 and should be included in calculating the value of the project. C) the cost of the lot for valuation purposes is $50,000 because lan d does not depreciate. D) the incremental cash flow sho uld be the $50,000 original cost less accumulated amortization. Answer: B Diff: 2 Page Ref: 5 Keywords: Opportunity Cost Learning Obj.: L.O. 1.2 AACSB: Analytical Thinking 22) To measure value, the concept of time value of money is used A) to dete rmine 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 the present. C) to bring the future benefits and costs o f a project, measured by its cash flows, back to the present. D) to ensure that expected future profits exceed current profits today. Answer: C Diff: 1 Page Ref: 5 Keywords: Time Value of Money, Cash Flows Learning Obj.: L.O. 1.2 AACSB: Reflective Thinking 23) A financial manager is evaluating a pr oject which is expected to generate profits of $100,000 per year for the next 10 years. The project should be accepted if A) the cost of the project is less than $1,000,000. B) the cost of the project is less than the present value of $100,000 per year fo r 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 of the project's cash outflows. Answer: D Diff: 2 Page Ref: 4, 5 Keywords: Time Value of Money, Cash Flows Learning Obj.: L.O. 1.2 AACSB: Analytical Thinking

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    11 24) Investors want a return that satisfies the following expectation(s): A) A return for delayin g consumption B) An additional return for taking on risk C) An additional return for accepting dividends rather than capital gains D) Both A and B. Answer: D Diff: 2 P age Ref: 5,6 Keywords: Risk, Return Learning Obj.: L.O. 1.2 AACSB: Reflective Thin king 25) The expected return on a riskless asset is gre ater than zero due to A) 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: A Diff: 1 P age Ref: 5 Keywords: R isk - Return Trade - off Learning Obj.: L.O. 1.2 AACSB: Reflective Thinking 26) Joe, a risk - averse investor, is trying to choose between investment A and inv estment B. If investment A is riskier than investment B and Joe selects investment A anyway, then A ) 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 e xpected return for investment B. C) the expected return for investment A will be higher than the act ual return for investment B. D) the expected return for investment A will be higher than the expected return for investment B. Answer: D Diff: 1 Page Ref: 5, 6 Keywords: Risk - Return Trade - off Learning Obj.: L.O. 1.2 AACSB: Analytical Thinking 27) T he principle of risk - return trade - off means that A) higher risk investments must earn higher returns. B) an investor who takes more risk will earn a higher re turn. C) a rational investor will only take on higher risk if he expects a higher return. D) an investor who bought stock in a small corporation five years ago has more money than an investor who bought U.S. Treasury bonds five years ago. Answer: C Diff: 2 Page Ref: 5, 6 Keywords: Risk - Return Trade - off, Expected Return, Actual Return Learning O bj.: L.O. 1.2 AACSB: Reflective Thinking

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    12 28) Project A is expected to generate positive cash flow of $1 million in 10 years while Project B is expected to generate $500,000 in 5 years. Therefore A) Project A is preferred because shareholder value is ba sed on cash flow. B) Project B is preferred becau se its cash flow is expected to be received sooner than the cash flow 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 t he opportunity cost of money is high enough. Ans wer: D Diff: 2 Page Ref: 5 Keywords: Time Value of Money Learning Obj.: L.O. 1.2 AACSB: Analytical Thinking 29) Company A reports sales of $100,000 and net income of $15,000. Company B reports sales of $100,000 and net income of $10,000. Therefore A) Company A's cash flow may be higher or lower than Company B's cash flow even though A's net income is higher. B) Company A's cash flow is $5,000 more than Company B's cash flow. C) Company B is creating l ess value for its shareholders than Company A. D) Co mpany B's accounts receivable must be higher than Company A's accounts receivable. Answer: A Diff: 2 Page Ref: 4, 5 Keywords: Cash Flow, Net Income Learning Obj.: L.O. 1.2 AACSB: Analytical Thinkin g 30) Profits are down so the controller decides to ch ange the corporation's accounting policy relating to inventory costing. The change will allow the corporation to report higher income and higher assets, although the physical inventory has not changed. Which of the following statements 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 re ported inventory is higher. D) If the stock price incre ases, the stock market is efficient. Answer: B Diff: 2 Page Ref: 6 Keywords: Efficient Markets Learning Obj.: L.O. 1.2 AACSB: Analytical Thinking

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    13 31) All of the following statements about agen cy problems are true EXCEPT A) 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 proble ms result from the separation of managemen t and the ownership of a firm. D) the root cause of agency problems is conflicts of interest. Answer: B Diff: 2 Page Ref: 8 Keywords: Agency Problems Learning Obj.: L.O. 1.2 AACSB: Reflective Thinking 32) A c orporate financial manager trying to ma ximize shareholder value A) 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 u nethical behavior destroys trust, and businesses cannot function without a certain degree of trust. Answer: D Diff: 1 Page Ref: 9, 10 Keywords: Ethics, Maximizing Shareholder Value Learning Obj.: L.O. 1.2 AACSB: E thical Understanding and Reasoning 33) John invested $1,000 in a risky investment and Bill invested $1,000 in a less risky investment. One year later, Bill's investment is worth $1,030. Which of the following statements is MOST correct? A) If John's inve stment is worth less than $1,030, th en John was irrational to invest in the risky project. B) John's investment must be worth more than $1,030 because of the risk - return trade - off, given that John's investment was more risky. C) If John's investment is worth more than $1,030, then Bill was irrational to invest in the less risky investment. D) The worth of John's investment cannot be determined with the information given. Answer: D Diff: 2 Page Ref: 5, 6 Keywords: Risk - Return Trade - off, Expected Return, Actual Return Learning Obj.: L .O. 1.2 AACSB: Analytical Thinking

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    14 34) In order to reduce ag ency problems, managers may be provided compensation that includes A) a fixed salary so managers' pay is not at risk, allowing managers to focus on the company's business. B) a bonus based on t he level of profit achieved during the year. C) an option to bu y the company's stock. D) incentive pay for achieving higher sales than last year. Answer: C Diff: 2 Page Ref: 8, 9 Keywords: Agency Problems, Stock Option, Incentive Compensation Learnin g Obj.: L.O. 1.2 AACSB: Reflective Thinking 35) An investor is considering 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 5 years. Which of the following statements is MOST correct if both investments A and B have the same 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 investment A because it provides cash earlier than investment B. C) The inve stor 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 of money. Answer: D Diff: 2 Page Ref: 4, 5 Keywords: Time Value of Money, Cash Flows Learning O bj.: L.O. 1.2 AACSB: Analytical Thinking 36) The CEO of High Tech International decides to change an accounting method at the end of the current year. The change results in reported pr ofits increasing by 5%, but the company's cash flows are not changed. If capital markets are efficient, then A) the stock price will not be affected by the accounting change. B) the stock price will increase due to higher profits. C) the stock price will increase only if the accounting change will also result in higher profits in the next year. D) the stock price will d ecrease because accounting method changes are not permitted under generally accepted accounting principles. Answer: A Diff: 1 Page Ref: 4, 6 Keywords: Efficient Markets Learning Obj.: L.O. 1.2 AACSB: Analytical Thinking

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