Chapter 1 Sample Problems

Managers do not always attempt to maximize the long-run value of their firms' stocks, or the stocks' intrinsic values. Thus, conflicts between stockholders and managers can exist. Additionally, there can be conflicts between stockholders and bondholders. a. True b. False

a. True

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 shareholder wealth, which is equivalent to maximizing the firm's stock 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 maximize 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.

b. Maximize shareholder wealth, which is equivalent to maximizing the firm's stock price per share.

Which of the following statements is CORRECT? a. One disadvantage of forming a corporation is that equity investors are usually exposed to more liability than they would be in a partnership. b. Corporations face fewer regulations than sole proprietorships. c. One disadvantage of operating a business as a corporation is that the firm is subject to double taxation, because taxes are levied at both the firm level and the individual shareholder level. d. It is generally less expensive to form a corporation than a proprietorship because, with a proprietorship, extensive legal documents are required. e. If a partnership goes bankrupt, each partner is exposed to liabilities only up to the amount of his or her investment in the business.

c. One disadvantage of operating a business as a corporation is that the firm is subject to double taxation, because taxes are levied at both the firm level and the individual shareholder level.

Which of the following statements is most correct? a. One of the advantages of the corporate form of organization is that there is no double taxation. b. The partnership form of organization has easy transferability of ownership. c. One of the disadvantages of the sole proprietorship form of organization is that there is unlimited liability. d. Statements b and c are correct. e. None of the statements above is correct.

c. One of the disadvantages of the sole proprietorship form of organization is that there is unlimited liability.

Which of the following statements is most correct? a. A hostile takeover is the main method of transferring ownership interest in a corporation. b. The corporation is a legal entity created by the state and is a direct extension of the legal status of its owners and managers, that is, the owners and managers are the corporation. c. Unlimited liability and limited life are two key advantages of the corporate form over other forms of business organization. d. In part due to limited liability and ease of ownership transfer, corporations have less trouble raising money in financial markets than other organizational forms. e. Although stockholders of the corporation are insulated by limited legal liability, the legal status of the corporation does not protect the firm's managers in the same way.

d. In part due to limited liability and ease of ownership transfer, corporations have less trouble raising money in financial markets than other organizational forms.

Which of the following mechanisms would be most likely to help motivate managers to act in the best interests of shareholders? a. Decrease the use of restrictive covenants in bond agreements. b. Take actions that reduce the possibility of a hostile takeover. c. Elect a board of directors that allows managers greater freedom of action. d. Increase the proportion of executive compensation that comes from stock options and reduce the proportion that is paid as cash salaries. e. Eliminate a requirement that members of the board of directors have a substantial investment in the firm's stock.

d. Increase the proportion of executive compensation that comes from stock options and reduce the proportion that is paid as cash salaries.

The primary goal of a publicly-owned firm interested in serving its stockholders should be to a. Maximize expected total corporate profit. b. Maximize expected EPS. c. Minimize the chances of losses. d. Maximize the stock price per share. e. Maximize expected net income.

d. Maximize the stock price per share.

Which of the following statements is CORRECT? a. 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. b. Relative to sole proprietorships, corporations generally face fewer regulations, and they also find it easier to raise capital. c. 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. d. 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. e. 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.

d. 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 statements is most correct? a. The proper goal of the financial manager should be to maximize the firm's expected cash flow, because this will add the most wealth to each of the individual shareholders (owners) of the firm. b. One way to state the decision framework most useful for carrying out the firm's objective is as follows: "The financial manager should seek that combination of assets, liabilities, and capital that will generate the largest expected projected after-tax income over the relevant time horizon." c. The riskiness inherent in a firm's earnings per share (EPS) depends on the characteristics of the projects the firm selects, which means it depends upon the firm's assets, but EPS does not depend on the manner in which those assets are financed. d. Since large, publicly-owned firms are controlled by their management teams, and typically, ownership is widely dispersed, managers have great freedom in managing the firm. Managers may operate in stockholders' best interests, but they may also operate in their own personal best interests. As long as managers stay within the law, there simply aren't any effective controls over managerial decisions in such situations. e. Agency problems exist between stockholders and managers, and between stockholders and creditors.

e. Agency problems exist between stockholders and managers, and between stockholders and creditors.

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

e. 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.

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

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

Which of the following could explain why a business might choose to operate as a corporation rather than as a sole 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.

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