Finance Test 1 CHP 1

New Business is just being formed by 10 investors, each of whom will own 10% of the business. The firm is expected to earn $1,000,000 before taxes each year. The corporate tax rate is 34% and the personal tax rate for the firm's investors is 35%. The firm does not need to retain any earnings, so all of its after-tax income will be paid out as dividends to its investors. The investors will have to pay personal taxes on whatever they receive. How much additional spendable income will each investor have if the business is organized as a partnership rather than as a corporation? $22,100 $21,225 $21,658 $20,384 $20,800

$22,100

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

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

Which of the following statements is CORRECT? Reducing the threat of corporate takeover increases the likelihood that managers will act in shareholders' interests. -Bond covenants are designed to protect bondholders and to reduce potential conflicts between stockholders and bondholders. -Because of their size, large corporations face fewer regulations than smaller corporations and proprietorships. -Corporations are taxed more favorably than proprietorships. -Corporations have unlimited liability.

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

Which of the following legal forms of organization is characterized by limited liability? -General Partnership -Professional Partnership -C - Corporation -Sole Proprietor

C - Corporation

All of the following are key strengths of a corporation EXCEPT -Access to capital -limited liability -Low organizational costs -Readily transferable ownership

ow organizational costs

Wealth maximization as the goal of the firm implies enhancing the wealth of the Board of Directors the federal government the firm's employees the firm's stockholders

the firm's stockholders

The goal of profit maximization would result in priority for -cash flows available to stockholders -timing of the returns -risk of the investment -earnings per share

earnings per share

Which of the following actions would be most likely to reduce potential conflicts of interest between stockholders and managers? -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. -Beef up the restrictive covenants in the firm's debt agreements. -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. -Eliminate a requirement that members of the board of directors must hold a high percentage of their personal wealth in the firm's stock. 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.

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

False

If management operates in a manner designed to maximize the firm's expected profits for the current year, this will also maximize the stockholders' wealth as of the current year. True False

False

In order to maximize its shareholders' value, a firm's management must attempt to maximize the expected EPS. False True

False

The Chairman of the Board must also be the CEO. True False

False

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

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

Which of the following statements is CORRECT? -One disadvantage of operating as a corporation rather than as a partnership is that corporate shareholders are exposed to more personal liability than are partners. -Bondholders should generally be happier than stockholders to have managers invest in risky projects with high potential returns as opposed to safe projects with lower expected returns. -Relative to proprietorships, corporations generally face fewer regulations, and they also find it easier to raise capital. -There is no good reason to expect a firm's stockholders and bondholders to react differently to the types of assets in which it invests. -Stockholders should generally be happier than bondholders to have managers invest in risky projects with high potential returns as opposed to safe projects with lower expected returns.

Stockholders should generally be happier than bondholders to have managers invest in risky projects with high potential returns as opposed to safe projects with lower expected returns.

Which of the following actions would be most likely to reduce potential conflicts of interest between stockholders and bondholders? -The use of covenants in bond agreements that limit the firm's use of additional debt and constrain managers' actions. -The threat of hostile takeovers. -Abolishing the Security and Exchange Commission. -Financing risky projects with additional debt. -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.

As a result of financial scandals occurring during the past decade, there has been a strong push to improve business ethics. False True

True

Among solutions to the agency problem in publicly held corporations are all of the following EXCEPT -cash bonuses tied to goal achievement -stock options -performance shares -bonuses based on short-term results

bonuses based on short-term results