Chapter 1 - Financial Management Overview

Question 1

What is the system that includes the circulation of money, the granting of credit, making of investments, and provision of banking facilities?

Answer 1

Finance

Question 2

List the 3 areas of finance

Answer 2

1. Financial Management
2. Capital Markets
3. Investments

Question 3

Which area of finance focuses on decisions relating to how much and what types of assets to acquire, how to raise the capital needed to purchase assets, and how to run the firm so as to maximize its value?

Answer 3

Financial Management

Question 4

Which area of finance is related to markets where interest rates, along with stock and bond prices, are determined?

Answer 4

Capital Markets

Question 5

Which area of finance is related to decisions concerning stocks and bonds include a number of activities?

Answer 5

Investments

Question 6

List the 3 forms of business organization

Answer 6

1. Proprietorship
2. Partnership
3. Corporation

Question 7

List 3 advantages of a proprietorship and partnership

Answer 7

1. Easy to form
2. Fewer regulations
3. No corporate income taxes

Question 8

List 3 disadvantages of a proprietorship and partnership

Answer 8

1. Difficult to raise capital
2. Unlimited liability
3. Limited life

Question 9

List 4 advantages of a corporation

Answer 9

1. Unlimited life
2. Easy transfer of ownership
3. Limited liability
4. Easy to raise capital

Question 10

List 2 disadvantages of a corporation

Answer 10

1. Double taxation

2. Cost of setup and report filing

Question 11

What should a stock price be equal to in equilibrium?

Answer 11

It’s intrinsic value

Question 12

Which actions should managers avoid?

Answer 12

Actions that reduce the intrinsic value

Question 13

What motivates managers to act in their stockholders’ best interest?

Answer 13

Effective executive compensation plans

Question 14

What’s the difference between debtholders and stockholders?

Answer 14

Debtholders receive fixed payments regardless of how well the company does while stockholder receive more when the company does better

Question 15

True or False:

Partnerships and proprietorships generally have a tax advantage over corporations

Answer 15

True

Question 16

True or False:

A disadvantage of the corporate form of organization is that corporate stockholders are more exposed to personal liabilities in the event of bankruptcy than are investors in a typical partnership

Answer 16

False

Question 17

True or False:

An advantage of the corporate form of organization is that corporations are generally less highly regulated than proprietorships and partnerships

Answer 17

False

Question 18

True or False:

One advantage of the corporate form of organization is that it avoids double taxation

Answer 18

False

Question 19

True or False:

In order to maximize its shareholders’ value, a firm’s management must attempt to maximize the stock price in the long run, or the stock’s “intrinsic value”

Answer 19

True

Question 20

True or False:

In order to maximize its shareholders’ value, a firm’s management must attempt to maximize the expected EPS

Answer 20

False

Question 21

True or False:

If a stock’s market price is above its intrinsic value, then the stock can be thought of as being undervalued, and it would be a good buy

Answer 21

False

Question 22

True or False:

If a stock’s intrinsic value is greater than its market price, then the stock is overvalued and should be sold

Answer 22

False

Question 23

True or False:

If a firm’s board of directors wants to maximize value for its stockholders in general (as opposed to some specific stockholders), it should design an executive compensation system whose focus is on the firm’s long-term value

Answer 23

True

Question 24

Which of the following statements is CORRECT?

A. One of the advantages of the corporate form of organization is that it avoids double taxation.
B. It is easier to transfer one’s ownership interest in a partnership than in a corporation.
C. One of the disadvantages of a proprietorship is that the proprietor is exposed to unlimited liability.
D. One of the advantages of a corporation from a social standpoint is that every stockholder has equal voting rights, i.e., “one person, one vote.”
E. Corporations of all types are subject to the corporate income tax.

Answer 24

C. One of the disadvantages of a proprietorship is that the proprietor is exposed to unlimited liability.

Question 25

Which of the following statements is CORRECT?

A. One of the disadvantages of incorporating your business is that you could become subject to the firm’s liabilities in the event of bankruptcy.
B. Proprietorships are subject to more regulations than corporations.
C. In any partnership, every partner has the same rights, privileges, and liability exposure as every other partner.
D. Corporations of all types are subject to the corporate income tax.
E. Proprietorships and partnerships generally have a tax advantage over corporations.

Answer 25

E. Proprietorships and partnerships generally have a tax advantage over corporations.

Question 26

Which of the following statements is CORRECT?

A. Corporations generally face fewer regulations than proprietorships.
B. Corporate shareholders are exposed to unlimited liability.
C. It is usually easier to transfer ownership in a corporation than in a partnership.
D. Corporate shareholders are exposed to unlimited liability, but this factor is offset by the tax advantages of incorporation.
E. There is a tax disadvantage to incorporation, and there is no way any corporation can escape this disadvantage, even if it is very small.

Answer 26

C. It is usually easier to transfer ownership in a corporation than in a partnership.

Question 27

Which of the following could explain why a business might choose to operate as a corporation rather than as a proprietorship or a partnership?

A. Corporations generally face fewer regulations.
B. Less of a corporation’s income is generally subject to federal taxes.
C. Corporate shareholders are exposed to unlimited liability, but this factor is offset by the tax advantages of incorporation.
D. Corporate investors are exposed to unlimited liability.
E. Corporations generally find it easier to raise large amounts of capital.

Answer 27

E. Corporations generally find it easier to raise large amounts of capital.

Question 28

The primary operating goal of a publicly-owned firm interested in serving its stockholders should be to:

A. Maximize its expected total corporate income.
B. Maximize its expected EPS.
C. Minimize the chances of losses.
D. Maximize the stock price per share over the long run, which is the stock’s intrinsic value.
E. Maximize the stock price on a specific target date.

Answer 28

D. Maximize the stock price per share over the long run, which is the stock’s intrinsic value.

Question 29

The primary operating goal of a publicly-owned firm trying to best serve its stockholders should be to:

A. Maximize managers’ own interests, which are by definition consistent with maximizing shareholders’ wealth.
B. Maximize the firm’s expected EPS, which must also maximize the firm’s price per share.
C. Minimize the firm’s risks because most stockholders dislike risk. In turn, this will maximize the firm’s stock price.
D. Use a well-structured managerial compensation package to reduce conflicts that may exist between stockholders and managers.
E. Since it is impossible to measure a stock’s intrinsic value, the text states that it is better for managers to attempt to maximize the current stock price than its intrinsic value.

Answer 29

D. Use a well-structured managerial compensation package to reduce conflicts that may exist between stockholders and managers.

Question 30

Which of the following statements is CORRECT?

A. One of the ways in which firms can mitigate or reduce potential conflicts between bondholders and stockholders is by increasing the amount of debt in the firm’s capital structure.
B. The threat of takeover generally increases potential conflicts between stockholders and managers.
C. Managerial compensation plans cannot be used to reduce potential conflicts between stockholders and managers.
D. The threat of takeovers tends to reduce potential conflicts between stockholders and managers.
E. The creation of the Securities and Exchange Commission (SEC) has eliminated conflicts between managers and stockholders.

Answer 30

D. The threat of takeovers tends to reduce potential conflicts between stockholders and managers.

Question 31

Which of the following statements is CORRECT?

A. Corporations are taxed more favorably than proprietorships.
B. Corporations have unlimited liability.
C. Because of their size, large corporations face fewer regulations than smaller corporations and proprietorships.
D. Reducing the threat of corporate takeover increases the likelihood that managers will act in shareholders’ interests.
E. Bond covenants are designed to protect bondholders and to reduce potential conflicts between stockholders and bondholders.

Answer 31

E. Bond covenants are designed to protect bondholders and to reduce potential conflicts between stockholders and bondholders.

Question 32

Which of the following statements is CORRECT?

A. A good goal for a firm’s management is the maximization of expected EPS.
B. Most business in the U.S. is conducted by corporations, and corporations’ popularity results primarily from their favorable tax treatment.
C. Conflicts can exist between stockholders and managers, but potential conflicts are reduced by the possibility of hostile takeovers.
D. Corporations and partnerships have an advantage over proprietorships because a proprietor is exposed to unlimited liability, but the liability of all investors in the other types of businesses is more limited.
E. For a stock to be in equilibrium, its intrinsic value must be greater than the actual market price.

Answer 32

C. Conflicts can exist between stockholders and managers, but potential conflicts are reduced by the possibility of hostile takeovers.