FIN 221 Chapter 1 Practice Quiz Questions

a. Cheers' shareholders (the ex-partners) will now be exposed to less liability.

Cheers Inc. operates as a partnership. Now the partners have decided to convert the business into a corporation. Which of the following statements is CORRECT? a. Cheers' shareholders (the ex-partners) will now be exposed to less liability. b. Cheers will now be subject to fewer regulations. c. Cheers' investors will be exposed to less liability, but they will find it more difficult to transfer their ownership. d. Cheers will find it more difficult to raise additional capital. e. Assuming Cheers is profitable, none of its income will be subject to federal income taxes.

c. Maximize the stock price per share over the long run, which is the stock's intrinsic value.

The primary operating goal of a publicly-owned firm interested in serving its stockholders should be to a. Maximize its expected EPS. b. Maximize its expected total corporate income. c. Maximize the stock price per share over the long run, which is the stock's intrinsic value. d. Maximize the stock price on a specific target date. e. Minimize the chances of losses.

a. The percentage of the firm's stock that is held by institutional investors such as mutual funds, pension funds, and hedge funds rather

Which of the following actions would be likely to encourage a firm's managers to make decisions that are in the best interest 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 60%. b. 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. c. The state legislature passes a law that makes it more difficult to successfully complete a hostile takeover. d. The firm's founder, who is also president and chairman of the board, sells 90% of her shares. e. The firm's board of directors gives the firm's managers greater freedom to take whatever actions they decide to take.

a. The board of directors becomes more vigilant in its oversight of the company's management.

Which of the following actions would be likely to reduce conflicts of interest between stockholders and managers? a. The board of directors becomes more vigilant in its oversight of the company's management. b. Managerial compensation is changed so that managers receive larger cash salaries but fewer long-term options to buy shares of stock. c. The company's outside auditing firm is offered a lucrative consulting contract with the company. d. The company changes the way executive stock options are handled, with all options now being vested after only 2 years rather than having 20% of the options awarded be vested every 2 years over a 10-year period. e. Congress passes a law that severely restricts hostile takeovers.

b. Change the corporate charter so as to make it easier for outside investors to acquire a controlling interest in the firm.

Which of the following actions would be most likely to reduce potential conflicts of interest between stockholders and managers? a. Beef up the restrictive covenants in the firm's debt agreements. b. Change the corporate charter so as to make it easier for outside investors to acquire a controlling interest in the firm. c. Pay managers large cash salaries but give them no stock options. 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 received can be sold. e. Eliminate a requirement that members of the board of directors must hold a high percentage of their personal wealth in the firm's stock.

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

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

c. The corporate charter is concerned with things like what business the company will engage in, whereas the bylaws are concerned with things like procedures for electing the board of directors.

Which of the following statements is CORRECT? a. Attorney fees are generally involved when a company develops its charter and bylaws, but since these documents are voluntary, a new corporation can avoid these costs by deciding not to have either a charter or bylaws. b. The corporate charter is a standard document prescribed by the state of incorporation, and its purpose is to ensure that the firm's managers run the firm in accordance with state laws. Procedures for electing corporate directors are contained in bylaws, while the declaration of the activities that the firm will pursue and the number of directors are included in the corporate charter. c. The corporate charter is concerned with things like what business the company will engage in, whereas the bylaws are concerned with things like procedures for electing the board of directors. d. Companies must establish a home office, or domicile, in a particular state, and that state must be the one in which most of their business (sales, manufacturing, and so forth) is conducted. e. The corporate bylaws are a standard set of rules that is established by the state of incorporation, and their purpose is to ensure that the firm's managers run the firm in accordance with state laws.

b. The bid price in a hostile takeover is generally above the price before the takeover attempt is announced because otherwise the takeover attempt would probably fail.

Which of the following statements is CORRECT? a. The bid price in a hostile takeover is generally below the price before the takeover attempt is announced because takeover targets are generally not very well managed companies. b. The bid price in a hostile takeover is generally above the price before the takeover attempt is announced because otherwise the takeover attempt would probably fail. c. Takeovers are more likely to be attempted if the target firm's stock price is above its intrinsic value. d. The efficiency of the U.S. economy would probably be increased if hostile takeovers were absolutely forbidden. e. Bond covenants are a good way to resolve agency conflicts between stockholders and managers.

e. The ability of firms in competitive industries to engage voluntarily in socially beneficial but costly projects is constrained by competition and the need to attract capital.

Which of the following statements is CORRECT? a. Any action that would maximize a firm's stock price must be consistent with the maximization of social welfare. b. Decisions regarding social and ethical behavior have no effect, either positive or negative, on firms' stock prices. c. If the government did not mandate some actions deemed to be socially responsible, such as those relating to fair hiring practices, most firms in competitive markets would still pursue these policies. d. In a competitive industry, if one group of firms is "socially conscious" and takes costly actions designed to improve social welfare, but other firms do not, then most investors will flock to the socially conscious firms, thus enhancing their ability to attract capital. Eventually, these firms must dominate the industry. e. The ability of firms in competitive industries to engage voluntarily in socially beneficial but costly projects is constrained by competition and the need to attract capital.

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

Which of the following statements is CORRECT? a. Corporate stockholders are exposed to unlimited liability. b. Due to legal considerations related to ownership transfers and limited liability, most business (measured by dollar sales) is conducted by corporations in spite of large corporations' less favorable tax treatment. c. Most businesses (by number and total dollar sales) are organized as proprietorships or partnerships because it is easier to set up and operate as 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. d. Due to limited liability, unlimited lives, and ease of ownership transfer, the vast majority of U.S. businesses (in terms of number of businesses) are organized as corporations. e. Large corporations are taxed more favorably than sole proprietorships.

c. One advantage of forming a corporation is that equity investors are usually exposed to less liability than in a partnership.

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

e. It is usually easier to transfer ownership in a corporation than it is to transfer ownership in a sole proprietorship.

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

d. One of the disadvantages of a sole proprietorship is that the proprietor is exposed to unlimited liability.

Which of the following statements is CORRECT? a. Corporations of all types are subject to the corporate income tax. b. One of the advantages of a corporation from a social standpoint is that every stockholder has equal voting rights, i.e., "one person, one vote." c. It is easier to transfer one's ownership interest in a partnership than in a corporation. d. One of the disadvantages of a sole proprietorship is that the proprietor is exposed to unlimited liability. e. One of the advantages of the corporate form of organization is that it avoids double taxation.

e. One example of an agency relationship is the one between stockholders and managers.

Which of the following statements is CORRECT? a. Firms in highly competitive industries are more likely to consciously exercise "social responsibility" than are firms in oligopolistic industries. b. Most business in the U.S. is conducted by corporations, and corporations' popularity results primarily from their favorable tax treatment. c. Corporations and partnerships have an advantage over proprietorships because a sole proprietor is exposed to unlimited liability, but the liability of all investors in the other types of businesses is more limited. d. A good goal for a firm's management is maximization of expected EPS. e. One example of an agency relationship is the one between stockholders and managers.

c. The entrenched managers of established, stable companies sometimes attempt to get their state legislatures to impose rules that make it more difficult for raiders to succeed with hostile takeovers.

Which of the following statements is CORRECT? a. Managers generally welcome hostile takeovers since the company seeking to do the taking over generally offers a price for the stock that is higher than the price before the takeover action started. b. The entrenched managers of established, stable companies sometimes attempt to get their state legislatures to remove rules that make it more difficult for raiders to succeed with hostile takeovers. c. The entrenched managers of established, stable companies sometimes attempt to get their state legislatures to impose rules that make it more difficult for raiders to succeed with hostile takeovers. d. One disadvantage of organizing a business as a corporation rather than a partnership is that the equity investors in a corporation are exposed to unlimited liability.

d. One drawback of forming a corporation is that it subjects the firm to additional regulations.

Which of the following statements is CORRECT? a. One advantage of forming a corporation is that it subjects the firm's investors to fewer taxes. b. One disadvantage of forming a corporation is that this makes it more difficult for the firm's investors to transfer their ownership interests. c. One drawback of forming a corporation is that it makes it more difficult for the firm to raise capital. d. One drawback of forming a corporation is that it subjects the firm to additional regulations. e. One drawback of forming a corporation is that it subjects the firm's investors to increased personal liabilities.

b. Hostile takeovers are most likely to occur when a firm's stock is selling below its intrinsic value because of its poor management.

Which of the following statements is CORRECT? a. The efficiency of the U.S. economy would probably be increased if hostile takeovers were absolutely forbidden. b. Hostile takeovers are most likely to occur when a firm's stock is selling below its intrinsic value because of its poor management. c. Stockholders in general would be better off if managers concealed good events and therefore caused the price of the firm's stock to sell at a price below its intrinsic value. d. Hostile takeovers are most likely to occur when a firm's stock sells at a price above its intrinsic value because its management has been issuing overly optimistic statements about its likely future performance.

d. Potential conflicts of interest can exist between stockholders and managers.

Which of the following statements is CORRECT? a. The proper goal of the financial manager should be to maximize the firm's expected cash flows, because this will add the most wealth to each of the individual shareholders (owners) of the firm. b. Large, publicly-owned firms like AT&T and GM, are controlled by their management teams. Ownership is generally widely dispersed, hence managers have great freedom in how they manage 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 are no effective tools that can be used to motivate them to take actions that are in the stockholders' best interests. c. 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. d. Potential conflicts of interest can exist between stockholders and managers. e. 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.

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