FIN 3100 Chapter 1 Practice Quiz

Maximizing expected EPS will maximize shareholder value.

False

Maximizing the stock price on a specific target date will maximize shareholder value.

False

The chairperson of the board and the CEO are one and the same.

False

The primary financial objective of the firm is to maximize EPS.

False

Which of the following statements about business organizations is CORRECT? a. If a corporation elects to be taxed as a P corporation, then both it and its stockholders can avoid all federal taxes. This provision was put into the Federal Tax Code in order to encourage the formation of small businesses. b. A significant risk in starting a proprietorship is that you may be exposed to personal liability if the business goes bankrupt. This problem would be avoided if you formed a corporation to operate the business. c. It is generally easier to transfer one's ownership interest in a partnership than in a corporation. d. Tax advantages of incorporation offset the corporate shareholders' exposure to unlimited liability. e. It's unlikely for a firm to be organized as a corporation when it requires a lot of capital.

A significant risk in starting a proprietorship is that you may be exposed to personal liability if the business goes bankrupt. This problem would be avoided if you formed a corporation to operate the business.

Which of the following factors tend to encourage management to act in their stockholders' best interests? a. Firing managers who do not perform well. b. Threat of a hostile takeover. c. All of the above encourage management to act in shareholders' best interests. d. Direct intervention by shareholders. e. A reasonable compensation package sufficient to attract and retain able managers.

ALL

Which of the following statements reflects the position of most people in business? a. Firms and government agencies almost always agree with one another regarding the restrictions that should be placed on hiring and firing employees. b. A corporation's short-run profits will almost always increase if the firm takes actions that the government has determined are in the best interests of the nation. c. Although people's moral characters are probably developed before they are admitted to a business school, it is still useful for business schools to cover ethics, if only to give students an idea about the adverse consequences of unethical behavior to themselves, their firms, and the nation. d. It is not useful for large corporations to develop a formal set of rules defining ethical and unethical behavior. e. Whistleblowers are generally promoted more rapidly than other employees because of the courage it takes to blow the whistle.

Although people's moral characters are probably developed before they are admitted to a business school, it is still useful for business schools to cover ethics, if only to give students an idea about the adverse consequences of unethical behavior to themselves, their firms, and the nation.

Of the following actions, which one is most likely to reduce conflicts of interest between managers and stockholders? a. Pay managers large cash salaries and give them no stock options. b. Beef up the restrictive covenants in the firm's debt agreements. c. Eliminate a requirement that members of the board of directors must hold a high percentage of their personal wealth in the firm's stock. d. For a firm that compensates managers with stock options, reduce the time before options are vested (i.e., the time before options can be exercised and the shares that are received can be sold). e. Change the corporation's formal documents to make it easier for outside investors to acquire a controlling interest in the firm through a hostile takeover.

Change the corporation's formal documents to make it easier for outside investors to acquire a controlling interest in the firm through a hostile takeover.

Bethany is planning to start a business. Why might she choose to operate her business as a corporation rather than as a proprietorship or a partnership?

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

Which is TRUE about business organizations? a. Large corporations are taxed more favorably than proprietorships. b. Due to limited liability, unlimited lives, and ease of ownership transfer, the vast majority of international businesses (in terms of the number of businesses) are organized as corporations, all governed by the same legal statutes. c. Due to legal considerations related to ownership transfers and limited liability, which affect the ability to attract capital, most business (measured by dollar sales) is conducted by corporations in spite of large corporations' less favorable tax treatment. d. Corporate stockholders are exposed to unlimited liability. e. Most businesses (by number and total dollar sales) are organized as proprietorships or partnerships because it is easier to set up and operate one of these forms rather than as a corporation. However, if the business gets very large, it becomes advantageous to convert to a corporation, primarily because corporations have important tax advantages over proprietorships and partnerships.

Due to legal considerations related to ownership transfers and limited liability, which affect the ability to attract capital, most business (measured by dollar sales) is conducted by corporations in spite of large corporations' less favorable tax treatment.

Imagine that you are the chairman of the board of a large corporation. Which of the following mechanisms do you think the board should choose to adopt to motivate top-level managers to act in the best interests of shareholders? a. Eliminate a requirement that members of the board of directors have a substantial investment in the firm's stock. b. Increase the proportion of executive compensation that comes from stock options and reduce the proportion that is paid as cash salaries. c. Decrease the use of restrictive covenants in bond agreements. d. Take actions that reduce the possibility of a hostile takeover. e. Elect a board of directors that allows managers greater freedom of action.

Elect a board of directors that allows managers greater freedom of action

Which of the following represents a significant disadvantage to the corporate form of organization? a. Difficulty in transferring ownership. b. Level of difficulty corporations' face in obtaining large amounts of capital in financial markets. c. Degree of liability to which corporate owners and managers are exposed. d. All of the above are disadvantages to the corporate form of organization. e. Exposure to taxation of corporate earnings and stockholder dividend income.

Exposure to taxation of corporate earnings and stockholder dividend income.

Which of the following statements about legal and ethical issues is CORRECT? a. If someone deliberately understates costs and thereby causes reported profits to increase, this can cause the stock price to rise above its intrinsic value. The stock will probably fall in the future. Both those who participated in the fraud and the firm itself can be prosecuted. b. Ethics is not an important consideration in business and in business schools. c. If a lower level person in a firm does something illegal, like "cooking the books," to understate costs and thereby artificially increase profits because he or she was ordered to do so by a superior, the lower level person cannot be prosecuted but the superior can be prosecuted. d. There are many types of unethical business behavior. One example is when executives provide information that they know is incorrect to outsiders. It is illegal to provide such information to federally regulated banks, but it is not illegal to provide it to stockholders. e. Ethical behavior is not influenced by training and auditing procedures. People are either ethical or they are not, and this is what determines ethical behavior in business.

If someone deliberately understates costs and thereby causes reported profits to increase, this can cause the stock price to rise above its intrinsic value. The stock will probably fall in the future. Both those who participated in the fraud and the firm itself can be prosecuted.

The Gabriel Corporation has asked you, a consultant, to recommend an action that is likely to reduce potential conflicts between stockholders and bondholders. Which action do you propose? a. A government regulation that banned the use of convertible bonds. b. Compensating managers with more stock options and less cash income. c. The firm begins to use only long-term debt (e.g., debt that matures in 30 years or more) rather than debt that matures in less than one year. d. The passage of laws that make it harder for hostile takeovers to succeed. e. Including restrictive covenants in the company's bond indenture (which is the contract between the company and its bondholders).

Including restrictive covenants in the company's bond indenture (which is the contract between the company and its bondholders).

Which of the following statements accurately describes business organizations? a. A slow-growth company, with little need for new capital, would be more likely to organize as a corporation than would a faster growing company. b. Partnerships have more difficulty attracting large amounts of capital than corporations because of such factors as unlimited liability, the need to reorganize when a partner dies, and the illiquidity (difficulty buying and selling) of partnership interests. c. In a typical partnership, liability for other partners' misdeeds is limited to the amount of a particular partner's investment in the business. d. A major disadvantage of a partnership relative to a corporation is the fact that federal income taxes must be paid by the partners rather than by the firm itself. e. In a limited partnership, the limited partners have voting control, while the general partner has operating control over the business, and the limited partners are individually responsible, on a pro rata basis, for the firm's debts in the event of bankruptcy.

Partnerships have more difficulty attracting large amounts of capital than corporations because of such factors as unlimited liability, the need to reorganize when a partner dies, and the illiquidity (difficulty buying and selling) of partnership interests.

Of the following policy changes, which would be the most likely to REDUCE potential conflicts of interest between stockholders and managers? a. The company's outside marketing firm is given a lucrative year-by-year consulting contract with the company. b. The composition of the board of directors is changed from all inside directors to all outside directors, and the directors are compensated with stock rather than cash. c. A firm's compensation system is changed so that managers receive larger cash salaries and no long-term options to buy stock. d. The company changes the way executive stock options are handled, with all options vesting after one year rather than having 20% of the options awarded vest every two years over a 10-year period. e. Congress passes a law that severely restricts hostile takeovers

The composition of the board of directors is changed from all inside directors to all outside directors, and the directors are compensated with stock rather than cash.

Which of the following situations would most likely encourage a firm's managers to make decisions that are in the best interests of shareholders? a. The percentage of the firm's stock that is held by institutional investors such as mutual funds, pension funds, and hedge funds, rather than by small individual investors, rises from 10% to 80%. b. The state legislature passes a law that makes it more difficult to successfully complete a hostile takeover. c. The firm's founder, who is also the president and chairperson of the board, sells 85% of her shares. d. The percentage of executive compensation that comes in the form of cash is increased and the percentage coming from long-term stock options is reduced. e. The firm's board of directors gives the firm's managers greater freedom to take whatever actions they think best without obtaining board approval.

The percentage of the firm's stock that is held by institutional investors such as mutual funds, pension funds, and hedge funds, rather than by small individual investors, rises from 10% to 80%.

If you sat on the board of directors of Tyng Corporation, which of the following actions would you recommend to reduce potential conflicts of interest between Tyng's stockholders and bondholders? a. Abolishing the Securities and Exchange Commission. b. The use of covenants in bond agreements that limit the firm's use of additional debt and constrain managers' actions. c. Financing risky projects with additional debt. d. The threat of hostile takeovers. e. Compensating managers with stock options.

The use of covenants in bond agreements that limit the firm's use of additional debt and constrain managers' actions.

Imagine that a firm's board of directors wants to maximize value for all of its stockholders in general, as opposed to some specific stockholders. A smart solution would be to design an executive compensation system that aims to build the firm's long-term value.

True

In most corporations, the CFO is outranked by the CEO.

True

Maximizing the firm's expected profits for the current year does not necessarily maximize the stockholders' wealth for the current year.

True

The board of directors is the highest ranking body in a corporation. The members of the board are elected by the shareholders, and the chairperson of the board is the highest ranking member of the board. The CEO generally reports to the board and its chairperson, and the board generally has the authority to remove the CEO.

True

There are factors that influence stock price over which managers have virtually no control.

True

Calistoga Combines is a publicly-owned firm. In order to best serve shareholders, its' primary operating goal should be to:

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