Chapter 1 TB Flashcards
A firm is a business organization that sells goods and services.
T or F?
TRUE
In finance we say that the goal of the firm ought to be to maximize profits.
T or F?
FALSE
Maximize shareholder wealth
Other things being equal, it is better to receive money sooner rather than later.
T or F?
TRUE
Financial managers evaluating decision alternatives or potential actions must consider ________.
A) only risk
B) only return
C) either risk or return
D) risk, return, and the impact on share price
risk, return, and the impact on share price
If a firm earns a profit, it will necessarily also generate a positive cash flow.
T or F?
FALSE
If a firm’s stockholders are risk averse, the firm can make its stockholders better off by earning the highest possible returns on its investments
T or F?
FALSE
high returns, high risk
Which of the following is an example of a firm’s stakeholder?
A) suppliers
B) Federal Reserve
C) media
D) competitors
suppliers
In the most recent year, two different companies generated the same earnings per share. The stocks of these two companies should trade at the same price.
T or F?
FALSE
One reason that firms exist is that most investors are risk averse, so they are not willing to make the kinds of risky investments that firms typically undertake
T or F?
FALSE
Which of the following is true of stakeholders?
A) They are the owners of a firm.
B) They are groups to whom a firm has financial obligations.
C) They are groups having a direct economic link to a firm.
D) They include only the bondholders, common stockholders, and preferred stockholders
They are groups having a direct economic link to a firm.
Which of the following is true regarding cash flow?
A) Profits do not necessarily result in cash flows available to the stockholders.
B) It is guaranteed that the board of directors will increase dividends when net cash flows increase.
C) A firm’s income statement will never show a positive profit when its cash outflows exceed its cash inflows.
D) An increase in revenue will always result in an increase in cash flow.
Profits do not necessarily result in cash flows available to the stockholders.
Investors who are risk averse will make risky investments as long as they expect compensation for doing so.
T or F?
TRUE
Which of the following is true of cash flows and risk?
A) Lower cash flow and lower risk result in an increase in share price.
B) Higher cash flow and lower risk result in an increase in share price.
C) Higher cash flow and higher risk result in an increase in share price.
D) Lower cash flow and higher risk result in an increase in share price.
Higher cash flow and lower risk result in an increase in share price.
The goal of business ethics is to motivate business and market participants to adhere to both the letter and the spirit of laws and regulations in all aspects of business and professional practice.
T or F?
TRUE
The primary goal of a financial manager is ________.
A) minimizing risk
B) maximizing profit
C) maximizing wealth
D) minimizing return
maximizing wealth
Corporate owners earn a return ________.
A) by realizing gains through increases in share price and interest earnings
B) by realizing gains through increases in share price and cash dividends
C) through capital appreciation and retained earnings
D) through interest earnings and earnings per share
by realizing gains through increases in share price and cash dividends
The wealth of the owners of a corporation is represented by ________.
A) profits
B) earnings per share
C) share value
D) cash flow
share value
Wealth maximization as the goal of a firm implies enhancing the wealth of ________.
A) the auditors
B) the creditors
C) the federal reserve
D) the firm’s stockholders
the firm’s stockholders
The amount earned during the accounting period on each outstanding share of common stock is called ________.
A) dividend per share
B) earnings per share
C) net profits after taxes
D) book value per share
earnings per share
Firm A generates more cash flow while taking less risk than Firm B. The stock price of Firm A should be higher than the stock price of Firm B.
T or F?
TRUE
Which of the following is NOT a reason that a firm that maximizes profits may fail to maximize shareholder wealth.
A) The timing of profits matters. Shareholders might prefer lower profits that arrive sooner.
B) Risk matters. Shareholders are risk averse, so they prefer less risky investments that generate lower profits.
C) Shareholder wealth depends on cash flow which is not the same as profit.
D) If a firm maximizes profits by engaging in unethical business practices, it’s stock price may be adversely affected.
Risk matters. Shareholders are risk averse, so they prefer less risky investments that generate lower profits.
________ pool investment capital, make risky investment decisions, and manage risky investments on behalf of investors who would otherwise not be able to do so own their own.
A) Firms
B) Stockholders
C) Stakeholders
D) Regulators
Firms
Finance is ________.
A) the system of verifying, analyzing, and recording business transactions
B) the science of the production, distribution, and consumption of goods and services
C) the science and art of how individuals and businesses raise, allocate, and invest money
D) the art of merchandising products and services
the science and art of how individuals and businesses raise, allocate, and invest money
In March 2017, Amazon and Clorox reported nearly identical earnings per share, but the stock price of Amazon was more than six times higher than the Clorox stock price. The most likely explanation for that difference is that ________.
A) Clorox is bad for the environment
B) Amazon is a riskier company
C) investors see better long-term prospects for Amazon
D) Amazon has more shares of stock outstanding
investors see better long-term prospects for Amazon
The wealth of corporate owners is measured by the share price of the stock.
T or F?
TRUE
Risk, the magnitude and timing of cash flows are the key determinants of share price, which represent the wealth of the owners in the firm
T or F?
TRUE
A higher earnings per share (EPS) does not necessarily translate into a higher stock price.
T or F?
TRUE
The profit maximization goal ignores the timing of returns, does not directly consider cash flows, and ignores risk.
T or F?
TRUE
When considering a firm’s financial decision alternative, financial managers should accept only those actions that are expected to maximize shareholder value.
T or F?
TRUE
An increase in a firm’s risk will always result in a higher share price since the stockholder must be compensated for the greater risk.
T or F?
FALSE
An objection to managing a firm on behalf of stakeholders rather than shareholders is that ________.
A) stakeholders have no economic interest in the firm
B) stakeholders have an interest only in short-term outcomes
C) there is no clear way to satisfy all stakeholders whose economic interests may be at odds with each other
D) the goal of managing on behalf of stakeholders is too narrow
there is no clear way to satisfy all stakeholders whose economic interests may be at odds with each other
An effective ethics program ________.
A) can weaken corporate value
B) has no effect on a corporation’s value
C) can enhance a corporation’s value
D) will result in high employee attrition rat
can enhance a corporation’s value
When considering a firm’s financial decision alternative, financial managers should accept only those actions that are expected to increase the firm’s profitability
T or F?
FALSE
________ are the standards of conduct or moral judgment that apply to persons engaged in commerce.
A) Government regulations
B) The Uniform Commercial Codes
C) The rules of fair play
D) Business ethics
Business ethics
Cash flows and risk are the key determinants in share price. Increased risk, other things remaining the same, results in ________.
A) a lower share price
B) a higher share price
C) an unchanged share price
D) an undetermined share price
a lower share price
Cash flows and risk are the key determinants in share price. Increased cash flow results in ________, other things remaining the same.
A) a lower share price
B) a higher share price
C) an unchanged share price
D) an undetermined share price
a higher share price
A treasurer is responsible for the firm’s accounting activities, such as corporate accounting, tax management, financial accounting, and cost accounting
T or F?
FALSE
________ decisions focus on how a company will spend its financial resources on long-term projects that ultimately determine whether the firm successfully creates value for its owners.
A) Investment
B) Financing
C) Working capital
D) Risk management
Investment
The principle of the time value of money basically says that ________.
A) because firms pay managers a great deal, managers need to use their time very effectively
B) money received today is more valuable than money received in the future because money in the future is more risky
C) money received today is more valuable than money received in the future because firms and individuals can invest money they have today and earn a return on that money
D) because of the principal-agent problem, investors cannot trust that money firms promise to pay in the future will ever arrive
C
The primary principle that finance borrows from economics is ________.
A) generally accepted accounting principles
B) cash is king
C) marginal cost-benefit analysis
D) shareholder value maximization
marginal cost-benefit analysis
Financing decisions deal with the left-hand side of the firm’s balance sheet.
T or F?
FALSE.
Right-hand side: current liabilities and long-term funds
Which of the following activities of a finance manager determines the types of assets the firm holds?
A) budget allocation
B) investment decisions
C) financing decisions
D) analyzing and planning cash flows
investment decisions
You own a building supply store. Today you sold construction materials to a contractor for $10,000 that you acquired a week ago for $8,000. You paid for the materials in cash, but you sold them to the contractor on credit, and you expect him to pay his bill in a few months. Based on this information during the week you earned a positive profit but experienced a negative cash flow.
T or F?
TRUE
There is a tendency for CEOs of larger companies to earn more money than CEOs of smaller companies. Suppose a CEO decides to acquire another company, thus increasing the size of the CEO’s firm. Suppose also that the price of the stock of the acquiring firm falls when it learns of the upcoming acquisition. This appears to be an example of ________.
A) a CEO pursuing profit maximization rather than wealth maximization
B) the principal-agent problem
C) a CEO behaving unethically
D) the general principal that acquisitions are generally not good investments
the principal-agent problem
A corporation’s stockholders elect its CEO.
T or F?
FALSE
Board of Directors
The money that firms raise to finance their activities is called ________.
A) the capital budget
B) working capital
C) capital
D) accruals
capital
Marginal cost-benefit analysis states that financial decisions should be made and actions should be taken only when the added benefits exceed the added costs.
T or F?
TRUE
The treasurer typically manages a firm’s cash, investing surplus funds when available and securing outside financing when needed.
T or F?
TRUE
A corporate treasurer’s focus tends to be more external, while the controller’s focus is more internal.
T or F?
TRUE
The accrual method recognizes revenue at the point of sale and recognizes expenses when incurred.
T or F?
TRUE
A treasurer is commonly responsible for handling ________.
A) tax management
B) corporate accounting
C) investing surplus funds
D) cost accounting
investing surplus funds
Which of the following is true of accrual basis accounting?
A) Expenses are recognized either when they are incurred or cash is paid.
B) Revenue is recognized when a customer pays cash.
C) Expenses are recognized when they are incurred.
D) Revenue is recognized when a customer pays cash or shows interest to purchase the product or service.
Expenses are recognized when they are incurred.
Johnson, Inc. has just ended the calendar year making a sale in the amount of $10,000 of merchandise purchased during the year at a total cost of $7,000. Although the firm paid in full for the merchandise during the year, it is yet to collect at year end from the customer. The net profit and cash flow from this sale for the year are ________.
A) $3,000 and $10,000, respectively
B) $3,000 and -$7,000, respectively
C) $7,000 and -$3,000, respectively
D) $3,000 and $7,000, respectively
$3,000 and -$7,000, respectively
A firm has just ended its calendar year making a sale in the amount of $150,000 of merchandise purchased during the year at a total cost of $112,500. Although the firm paid in full for the merchandise during the year, it is yet to collect at year end from the customer. The net profit and cash flow from this sale for the year are ________.
A) $0 and $150,000, respectively
B) $37,500 and -$150,000, respectively
C) $37,500 and -$112,500, respectively
D) $150,000 and $112,500, respectively
$37,500 and -$112,500, respectively
Stockholders expect to earn higher rates of return on investments with lower risk and lower rates of return on investments with higher risk
T or F?
FALSE
As the risk of a stock investment increases, investors’ ________.
A) return will increase
B) return will decrease
C) required rate of return will decrease
D) required rate of return will increase
required rate of return will increase
The principal-agent problem arises when ________.
A) the owners of the firm are not the people managing the firm
B) the owners of the firm also manage the firm
C) managers serve on a firm’s board of directors
D) a firm is organized as a sole proprietorship
the owners of the firm are not the people managing the firm
Which of the following works as a conduit of information between the firm and its investors?
A) the treasurer
B) the controller
C) the director of internal audit
D) the director of investor relations
the director of investor relations
________ decisions refer to how a firm manages its short-term resources on a day-to-day basis.
A) Financing
B) Investment
C) Working capital
D) Managerial finance
Working capital
There is a tradeoff between risk and return (i.e., to earn higher returns you generally have to take more risk) because ________.
A) investors like risk and return and want more of both
B) investors are risk averse, so they will not accept riskier investments unless they offer higher returns
C) to earn higher returns you have to make bigger investments and bigger investments are always riskier than smaller ones
D) investors care about returns but not about risk
investors like risk and return and want more of both
The time value of money principle implies that all other things being equal, investments that produce profits faster are preferred over those that produce more distant profits.
T or F?
TRUE
The ________ has a role that focuses on budgeting, accounting, and tracking the performance of a single business unit.
A) controller
B) treasurer
C) chief financial officer
D) director of risk management
controller
When managers are trying to create value for shareholders, their primary focus should be on earnings rather than cash flow.
T or F?
FALSE
Which of the following legal forms of organization is most expensive to organize?
A) sole proprietorships
B) partnerships
C) corporations
D) limited partnership
corporations
Which of the following legal forms of organization has the ease of dissolution?
A) sole proprietorships
B) partnerships
C) limited partnerships
D) corporations
sole proprietorships
Under which of the following legal forms of organization is ownership readily transferable?
A) sole proprietorships
B) partnerships
C) limited partnerships
D) corporations
corporations
Which of the following forms of organizations is the easiest to form?
A) sole proprietorships
B) limited liability corporation
C) limited partnership
D) S-corporations
sole proprietorships
A major weakness of a partnership is ________.
A) the difficulty in maintaining owners’ control
B) the difficulty in liquidating or transferring ownership
C) the double taxation of income
D) its high organizational costs
the difficulty in liquidating or transferring ownership
Which of the following is a strength of a corporation?
A) low taxes
B) limited liability
C) low organization costs
D) less government regulation
limited liability
Which of the following legal forms of organizations is characterized by unlimited liability?
A) sole proprietorship
B) limited partnership
C) corporation
D) C-corporation
sole proprietorship
Which of the following is true of a partnership and a corporation?
A) In a corporation, income is taxed at the corporate level; whereas, in a partnership, income is taxed twice.
B) In a partnership, income is taxed once at the individual level; whereas, in a corporation, income is taxed twice.
C) Income from both forms of organizations are double-taxed.
D) In a partnership, income is exempted from tax up to $10 million; whereas, in a corporation, income is taxed twice.
In a partnership, income is taxed once at the individual level; whereas, in a corporation, income is taxed twice
Which of the following is true of sole proprietorships and corporations?
A) It is difficult to transfer ownership of corporations compared to that of sole proprietorships.
B) Income from both forms of organizations are taxed only at the corporate level.
C) Both sole proprietorships and corporations are equally scrutinized and regulated by government
bodies.
D) In sole proprietorships, owners have unlimited liability; whereas, in corporations, owners have limited liability.
In sole proprietorships, owners have unlimited liability; whereas, in corporations, owners have limited liability.
In partnerships, partners can readily transfer their wealth to other partners.
T or F?
FALSE
A sole proprietor has unlimited liability; his or her total investment in the business, but not his or her personal assets, can be taken to satisfy creditors.
T or F?
FALSE
In a limited partnership, all partners’ liabilities are limited to their investment in the partnership.
T or F?
TRUE
Under a progressive tax structure in which tax rates rise with income levels ________.
A) the marginal tax rate and the average tax rate are the same
B) the average tax rate is what really matters when an individual or business is making a financial decision
C) the marginal tax rate is usually less than the average tax rate
D) the marginal tax rate is usually greater than the average tax rate
the marginal tax rate is usually greater than the average tax rate
The term “double taxation” means that ________.
A) partnerships and sole proprietorships pay tax on the income that they earn, and then income distributed from the business to the owner is taxed again at the individual level
B) the highest federal income tax rate faced by corporations is twice the highest tax rate faced by individuals
C) corporations pay tax on the income they earn and then shareholders pay tax on income that the corporation distributes to them
D) a corporation pays tax on the interest it pays to bondholders and then bondholders pay tax again on the interest payments they receive from firms
corporations pay tax on the income they earn and then shareholders pay tax on income that the corporation distributes to them
Suppose a certain business pays 10% tax on its first $10,000 in come, 12% tax on income above $10,000 but below $40,000, and 22% tax on income above $40,000. Suppose the business earns $50,000 in income this year. It’s marginal tax rate is ________.
A) 10%
B) 12%
C) 22%
D) greater than 22%
22%
Corporate governance refers to ________.
A) the rules, processes, and laws by which companies are operated, controlled, and regulated
B) the fact that corporations heavily influence the actions of governments through their lobbying efforts
C) the notion that corporations act like a democracy in the sense that every shareholder has an equal vote on corporate decisions
D) the idea that a corporate CEO is really accountable to no one and must be constrained by government action
the rules, processes, and laws by which companies are operated, controlled, and regulated
Agency costs are ________.
A) costs that managers bear when they do not act in the interests of shareholders
B) costs that firms must pay to comply with the regulations imposed by federal government agencies
C) costs that are exempt from taxation
D) costs that shareholders bear because managers pursue their own interests rather than acting in the interests of shareholders
costs that shareholders bear because managers pursue their own interests rather than acting in the interests of shareholders
Firms are legally required to pay dividends to stockholders just as they must make interest payments to lenders
T or F?
FALSE
Suppose a certain business pays 10% tax on its first $10,000 in come, 12% tax on income above $10,000 but below $40,000, and 22% tax on income above $40,000. Suppose the business earns $50,000 in income this year. Its average tax rate is closest to ________.
A) 22%
B) 14%
C) 10%
D) 17%
14%
Dividends are periodic distributions of cash to the stockholders of a firm.
T or F?
TRUE
Under a flat tax structure, where the same tax rate applies to all income levels ________.
A) the marginal tax rate is greater than the average tax rate
B) the marginal tax rate is less than the average tax rate
C) the marginal tax rate is equal to the average tax rate
D) the marginal tax rate is irrelevant
the marginal tax rate is equal to the average tax rate
In partnerships, owners have unlimited liability and may have to cover debts of other less financially sound partners
T or F?
TRUE
The board of directors is responsible for managing day-to-day operations and carrying out the policies established by the chief executive officer.
T or F?
FALSE
CEO
Institutional investors are professional investors who work on behalf of individuals, business, and government.
T or F?
TRUE
The major purpose of the Sarbanes-Oxley Act of 2002 was to place caps on the compensation that could be paid to corporate executives.
T or F?
FALSE
The board of directors is typically responsible for ________.
A) approving strategic goals and plans
B) managing day-to-day operations
C) arranging finance for approved long-term investments
D) maintaining and controlling the firm’s daily cash balances
approving strategic goals and plans
The responsibility for managing day-to-day operations and carrying out corporate policies belongs to the ________.
A) board of directors
B) chief executive officer
C) stockholders
D) creditors
chief executive officer
Which of the following is an example of agency cost?
A) costs incurred for setting up an agency
B) failure to make an investment that would make shareholders wealthier
C) payment of income tax
D) payment of interest
failure to make an investment that would make shareholders wealthier
Which of the following is a routine way that boards try to align the interests of managers and stockholders?
A) fire managers who are inefficient
B) remove management’s perquisites
C) tie management compensation to the performance of the company’s common stock price
D) tie management compensation to the level of dividend per share
tie management compensation to the performance of the company’s common stock price
The marginal tax rate paid on a firm’s ordinary income can be calculated by dividing its taxes by its net income
T or F?
FALSE
The average tax rate paid on the firm’s ordinary income can be calculated by dividing its taxes by its taxable income.
T or F?
TRUE
The tax deductibility of various expenses such as general and administrative expenses ________.
A) increases their pretax cost
B) reduces their after-tax cost
C) has no effect on their after-tax cost
D) has an unpredictable effect on their after-tax cost
reduces their after-tax cost
If a corporation sells certain capital equipment for more than its initial purchase price, the difference between the sale price and the purchase price is called a(n) ________.
A) ordinary gain
B) revenue gain
C) capital gain
D) abnormal gain
capital gain
In general, most corporate capital gains are taxed at ________ tax rate.
A) the average
B) the regular corporate
C) the historic
D) a 30 percent
the regular corporate
The marginal tax rate represents the rate at which the next dollar of income is taxed.
T or F?
TRUE
All dividend income received by a corporation is exempted from taxation.
T or F?
FALSE
Communication skills are very important to financial and nonfinancial managers because ________.
A) they will be communicating with the investment community regularly
B) they work together in cross-functional teams and need to understand how members of their teams think
C) they will write reports that are disclosed in the firm’s financial reports
D) they are all responsible for selling the firms goods and services to customers
they work together in cross-functional teams and need to understand how members of their teams think
Developing financial computing skills, such as expertise with software like Excel, is important because ________.
A) everyone in the firm must be an Excel expert to have success
B) everyone in the firm needs to understand financial reports and models at some level, and those are usually constructed and presented in Excel
C) there are no good alternatives to Excel
D) mistakes are more likely to occur when people do financial work by hand rather than using a product like Excel
everyone in the firm needs to understand financial reports and models at some level, and those are usually constructed and presented in Excel
