fin chapter 1 mindtap

Which of the following statements about business organizations is CORRECT? -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. -Tax advantages of incorporation offset the corporate shareholders' exposure to unlimited liability. -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. It is generally easier to transfer one's ownership interest in a partnership than in a corporation.

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? -Threat of a hostile takeover. -Firing managers who do not perform well. -Direct intervention by shareholders. -A reasonable compensation package sufficient to attract and retain able managers. -All of the above encourage management to act in stockholders' best interests.

All of the above encourage management to act in stockholders' best interests.

Which of the following statements reflects the position of most people in business? -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. -Firms and government agencies almost always agree with one another regarding the restrictions that should be placed on hiring and firing employees. -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. -Whistleblowers are generally promoted more rapidly than other employees because of the courage it takes to blow the whistle. It is not useful for large corporations to develop a formal set of rules defining ethical and unethical behavior.

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. Compliance may hurt short-term profits, and companies rarely welcome new regulations, but having rules in place and ethics training helps people understand what is expected of them and reminds them of the consequences of their actions.

Of the following actions, which one is most likely to reduce conflicts of interest between managers and stockholders? -Eliminate a requirement that members of the board of directors must hold a high percentage of their personal wealth in the firm's stock. -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). -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. -Beef up the restrictive covenants in the firm's debt agreements. Pay managers large cash salaries and give them no stock options.

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. Corporate takeovers are most likely to occur when a firm is underperforming. Managers who fear losing their jobs will try to maximize shareholder wealth.

Sabastian, the CEO of a beverage company, is required to certify the accuracy of information provided in the company's quarterly reports.

Corporation

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

Corporations generally find it easier to raise large amounts of capital. Outsiders who are thinking about investing in a business are generally not willing to be subjected to unlimited liability, and they also want to be able to sell their shares should they choose to do so. Corporations provide these advantages; hence, firms that need large amounts of capital that must be raised in capital markets generally choose to incorporate.

Which is TRUE about business organizations? -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. -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. -Large corporations are taxed more favorably than proprietorships. -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. -Corporate stockholders are exposed to unlimited liability.

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. The unfavorable tax treatment of corporations keeps most businesses, which are small, from incorporating. This is offset by ease of ownership transfer and limited liability, which are important to large businesses.

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

Exposure to taxation of corporate earnings and stockholder dividend income. Corporations' earnings are taxed, and then earnings paid out as dividends to shareholders are taxed again, generally at a rate of 15%.

investments

Fall under the area of Security analysis, portfolio theory, market analysis, and behavioral finance Security analysis deals with analyzing the value of securities, which include stocks, bonds, and hybrids of both stocks and bonds. Based on the results of security analysis, analysts decide whether they should buy, hold, or sell the security.

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

False

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

False The primary financial objective is stockholder wealth maximization, which is the maximization of stock price.

Maximizing expected EPS will maximize shareholder value. True False

False The primary operating goal should be to maximize the long-run stock price, or the intrinsic value.

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

False The primary operating goal should be to maximize the long-run stock price, or the intrinsic value.

Which of the following statements about legal and ethical issues is CORRECT? -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. -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. -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. -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. Ethics is not an important consideration in business and in business schools.

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? -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. -The passage of laws that make it harder for hostile takeovers to succeed. -Including restrictive covenants in the company's bond indenture (which is the contract between the company and its bondholders). -A government regulation that banned the use of convertible bonds. Compensating managers with more stock options and less cash income.

Including restrictive covenants in the company's bond indenture (which is the contract between the company and its bondholders). Bondholders want to be paid. Financing risky projects with additional debt increases the potential for conflicts between stockholders and bondholders. Adding covenants to bond agreements will reduce conflicts between stockholders and bondholders.

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 stockholders? -Elect a board of directors that allows managers greater freedom of action. -Decrease the use of restrictive covenants in bond agreements. -Increase the proportion of executive compensation that comes from stock options and reduce the proportion that is paid as cash salaries. -Take actions that reduce the possibility of a hostile takeover. -Eliminate a requirement that members of the board of directors have a substantial investment in the firm's stock.

Increase the proportion of executive compensation that comes from stock options and reduce the proportion that is paid as cash salaries. The goal of management should be to maximize long-run shareholder wealth, and paying executives with stock and stock options can help reduce incentives for short-term performance.

Selena and Mario run a law firm in Chicago. The firm has debt of $100,000, but Selena and Mario will not be held personally liable for the law firm's debt.

LLC/LLP

Which of the following statements accurately describes business organizations? -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. -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. -In a typical partnership, liability for other partners' misdeeds is limited to the amount of a particular partner's investment in the business. -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. -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. The limited liability and ease of transfer make the corporate structure superior to the partnership structure to those interested in making investments.

Purple Consulting has five consultants in the firm. The company's annual revenue is around $500,000. Income is distributed among all consultants, and each is personally liable for claims if the company goes under.

Patnership

William founded and operated a wedding planning agency, which specialized in celebrity weddings. When he died, his business was dissolved because there was no plan for control after his death.

Sole Proprietorship

Of the following policy changes, which would be the most likely to REDUCE potential conflicts of interest between stockholders and managers? -Congress passes a law that severely restricts hostile takeovers. -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. -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. -The company's outside marketing firm is given a lucrative year-by-year consulting contract with the company. A firm's compensation system is changed so that managers receive larger cash salaries and no long-term options to buy stock.

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. The goal of management should be to maximize long-run shareholder wealth, and having outside directors with significant stock can help reduce incentives for short-term performance.

Which of the following situations would most likely encourage a firm's managers to make decisions that are in the best interests of stockholders? -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%. -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. -The firm's founder, who is also the president and chairperson of the board, sells 85% of her shares. -The state legislature passes a law that makes it more difficult to successfully complete a hostile takeover.

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%. Small stockholders have little clout with management, while large institutional investors are better able to force managers to operate in stockholders' interests.

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? -The use of covenants in bond agreements that limit the firm's use of additional debt and constrain managers' actions. -Compensating managers with stock options. -Abolishing the Securities and Exchange Commission. -The threat of hostile takeovers. -Financing risky projects with additional debt.

The use of covenants in bond agreements that limit the firm's use of additional debt and constrain managers' actions. Stock options and the threat of takeovers reduce conflicts between managers and shareholders. Financing risky projects with additional debt increases the potential for conflicts between stockholders and bondholders. Adding covenants to bond agreements will reduce conflicts between stockholders and bondholders.

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

True Managers have no control over factors such as (1) external constraints, (2) the general level of economic activity, (3) taxes, (4) interest rates, and (5) conditions in the stock market.

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

True Risky transactions that generate short-term profits sometimes fail, thus eliminating wealth.

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

True The CFO generally reports to the CEO, who oversees all executives.

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 False

True The board represents the shareholders, and the interests of shareholders may be very different from the interests of the CEO and other managers.

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 False

True The primary operating goal should be to maximize the long-run stock price, or the intrinsic value.

Calistoga Combines is a publicly-owned firm. In order to best serve shareholders, its' primary operating goal should be to: -Minimize the firm's risks because most stockholders dislike risk. In turn, this will maximize the firm's stock price. -Maximize managers' own interests, which are by definition consistent with maximizing shareholders' wealth. -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. -Maximize the firm's expected EPS, which must also maximize the firm's price per share. -Use a well-structured managerial compensation package to reduce conflicts that may exist between stockholders and managers.

Use a well-structured managerial compensation package to reduce conflicts that may exist between stockholders and managers. The goal of management should be to maximize long-run shareholder wealth, and good compensation packages can reduce a manager's incentives to focus on the short term instead.

The CFO is usually in charge of

accounting, treasury, credit, legal, capital budgeting, investor relations, security analyst relations, and investment decisions.

The COO is in charge of the

firm's operations, which include marketing, production, human resources, administration, and research and development.

Corporate finance

focuses on financial decisions that corporations need to make to run the firm. The objective of these decisions is to achieve the primary goal of the corporation: maximize shareholder wealth.

The capital market

includes the stock market and the bond market. These markets come under the supervision of financial regulators such as the Securities and Exchange Commission (SEC). Capital markets include entities—such as banks, investment banks, stockbrokers, mutual funds, insurance companies, governmental organizations such as the Federal Reserve Bank, and individuals—that deal with capital for different purposes. Here, bank managers make loans to customers and charge a certain interest rate. They consolidate the capital collected from bank depositors and make loans to entities who require capital. The interest rate charged on these loans depends on various factors, one of which is the federal funds rate that banks charge each other for overnight loans.