Financial Management Exam 1 chp 1
If an investor had a choice of receiving $1,000 today, or $1,000 in five ye ars, which would the average investor prefer?
$1,000 today because it will be worth more than $1,000 received in five years.
What are the three basic questions addressed by the study of investments?
1. What investments should the firm undertake? 2. How should the firm fund these investments? 3. How c an the firm best manage cash flows in its day - to - day operations?
Which of the following types of business forms is least risky to investors
A public corporation
A corporation is owned by
B) the shareholders who hold the company's stock
Which of the following is most likely to motivate executives to maximize shareholder wealth? A) Tying bonuses to cost reductions and meeting budget goals B) Offering them relatively high salaries C) Tying annual bonuses to increases in annual profits D) Compensating them with stock options that can only be exercised after five years
Compensating them with stock options that can only be exercised after five years
Assume that you are starting a business. Further assume that the business is expected to grow very quickly and a great deal of capital will be needed soon. What type of business organization would you choose?
Corporation
Profit maximization does not adequately describe the goal of the firm because A) profit maximization does not require the consideration of risk. B) profit maximization ignores the timing of a project's return. C) maximization of dividend payout ratio is a better description of the goal of the firm. D) A and B.
D) A and B
Maximization of shareholder wealth as a goal is superior to accounting profit maximization because A) it considers the time value of the money. B) following the shareholder wealth maximization goal will ensure high stock prices. C) accounting profits are not the same as cash flows. D)A and C
D) A and C
Which of the following should be considered when assessing the financial impact of business decisions? A) The amount of projected earnings B) The risk - return tradeoff C) The tim ing of projected earnings; i.e., when they are expected to occur D) All of the above
D) All of the above
Which of the following is a characteristic of a limited partnership? A) It allows one or more partners to have limited liability. B) It requires one o r more of the partners to be a general partner to whom the privilege of limited liability does not apply. C) It prohibits the limited partners from participating in the management of the partnership. D) All of the above.
D) All of the above.
For thes e types of organization, no distinction is made between business and personal assets. A) Sole proprietorship B) General partnership C) Limited partnership D) Both A and B
D) Both A and B
Which forms of organization are free of initial legal requirements? A) Sole proprietorship B) General partnership C) Corporation D) Both A and B
D) Both A and B
Profit maximization is not an adequate goal of the firm when making financial decisions because A) it does not necessarily reflect shareholder wealth maximization. B) it ignores the risk inherent in different projects that will generate the profits. C) it ignores the timing of a project's returns. D) all of the above a re correct
D) all of the above
Which of the following is a significant disadvantage of a general partnership? A) The cost of forming it is high. B) Each partner is fully responsible for the liabilities incurred by the partnership. C) There is a risk associated with the industry in which it operates. D) Forming the business is very complex.
Each partner is fully responsible for the liabilities incurred by the partnership
Briefly discuss the incentives for financial managers to conduct their business in an ethical manner
Extreme ethical lapses s uch as those evident in the Madoff Ponzi scheme may also break laws and result in fines or imprisonment. In less extreme cases, deceptive accounting practices or sales techniques once exposed lead to a loss of trust. Because individuals and firms are rel uctant to do business with those they mistrust, a reputation for unethical behavior over the long run leads to adversarial relations with business partners, a loss of customers, and destruction of the firm's value
Business financial decisions are fundamentally different from personal financial d ecisions.
FALSE
How could you compensate an investor for taking on a significant amount of risk?
Increase the expected rate of return
Briefly discuss why f inancial decision makers must focus on incremental cash flows when evaluating new projects
Incremental cash flows describe the total cash effect on the company, looking at the difference between total cash flow to the company with the cash flow, and without the cash flow. The company can then value these cash flows and see if the company is worth more with the project or without the project
) Consider the following equally likely project outcomes: Profit X Y Pessimistic prediction $ 0 $500 Expected outcome $ 500 $500 Optimistic prediction $1000 $500 A) Investors will prefer project X because it potentially of fers a higher profit. B) Investors will reject both projects because the profit is too low. C) Investors will prefer project Y because the expected return is the same as for project X but the outcome is certain. D) Since Projects X and Y have the same expe cted outcomes of $500, investors will view them as identical in value.
Investors will prefer project Y because the expected return is the same as for project X but the outcome is certain.
) Which of the following is NOT an advantage of the sole proprietorship? Limited liability B) No time limit impose d on its existence C) No legal requirements for starting the business D) None of the above
Limited liability
Which of the following f orms of organization blends elements of partnerships and corporations?
Limited liability companies (LLC's)
Which of the following is NOT true for limited partnerships? 5 A) Limited partners can only manage the b usiness. B) One general partner must exist who has unlimited liability. C) Only the name of general partners can appear in the name of the firm. D) Limited partners may sell their interest in the company
Limited partners can only manage the b usiness.
The price of Netflix stock dropped sharply after customers responded negatively to a change in pricing policies. The change in stock price illustrates which principle?
Market prices reflect information
Which of the following goals of the firm is equivalent to the maximization of shareholder wealth? A) Profit maximization B) Risk minimization C) Maximization of the total market value of the firm's common stock D ) None of the above
Maximization of the total market value of the firm's common stock
Which of the following goals is in the best long - term interest of stockholders?
Maximizing of the market value of the existing shareholders' common stock
Why do investors prefer receiving cash sooner rather than later, according to financ e theory?
Money received earlier can be reinvested and returns can be increased.
What is the chief disadvantage of the sole proprietorship as a form of business organization when compared to the corporate form?
Owners have unlimited liability.
Consider the timing of the profits of the following certain investment projects: Profit L S Year 1 $ 0 $ 3000 Year 2 $ 3000 $ 0 A) Project S is preferred to Project L. B) Project L is preferred to Project S. C) Projects S and L are equally desirable. D) A goal of profit maximization would favor Project S only.
Project S is preferred to Project L.
Which of the following is a characteristic of an efficient market?
Security prices reflect fair value of the firm.
Which one of the following categories of owners enjoys limited liability? A) General partners in a limited partnership or limited liability company B) Shareholders (common stock) of a corporation C) Sole proprietors D) Both A and B
Shareholders (common stock) of a corporation
In terms of organizational costs, which of the following sequences is generally correct, moving from lowest to highe st cost?
Sole proprietorship, general partnership, limited partnership, corporation
Capital structure refers to the financing of long - term investments.
TRUE
The sole proprietorship is the same as the individu al for liability purposes.
TRUE
Which of the following factors is most important in investment decisions?
The change in after - tax cash flow.
Which of th e following forms of business organization is the dominant economic force in the United States?
The corporation
Which of the following best describes the goal of the fir m? A) The maximization of the total market value of the firm's common stock B) Profit maximization C) Risk minimization D) None of the above
The maximization of the total market value of the firm's common stock
What does the agency problem refer to?
The problem that results from potential conflicts of interest between the manager of a business and the stockholders.
Which of the following statements best represents what finance is about?
The study of how people and businesses make investment decisions and how to finance those decisions
If one security has a greater risk than another security, how will investors respond?
They will require a higher rate of return for the investment that has greater risk.
Finance managers need to interact constantly with A) marketing managers. B) accounti ng staff. C) management information systems staff. D) all of the above.
all of the above.
From a financial point of view, a company that decides to develop new product is making
an investment decision.
Discuss the risk/return tradeoff and how it relates t o finance
as people are risk averse, they need a higher return as the risk gets higher. This means that investors will need a higher return on bonds that they do not consider to be as safe as other bonds, and they will need a higher return on st ock when the company in question's stock seems to be riskier than the stock of other companies
In finance, we assume that investors are generally A) neutral to risk. B) averse to risk. C) fond of risk. D) none of the above.
averse to risk
Managers of corporations need to act in an ethical manner
because a business must be trusted by investors, customer and the publ ic if it is to succeed.
The area of finance that deals with long - term investment decisions is known as
capital budgeting.
In measuring value, th e focus should be on
cash flow.
The true owners of the corporation are the
common stockholders.
The major sources of financing for corporations are
debt and equity
Investors choose to invest in higher risk investments because these investments offer higher
expected returns
A sole pr oprietorship is the most desirable business form in all circumstances.
false
General partners have unrestri cted transferability of ownership, while limited partners must have the consent of all partners to transfer their ownership.
false
In a general partnership, each partner is liable for the partnership's obligations only up to a percentage of the obligation equal to that partner's percentage of ownership of the partnership.
false
In a limited partnership, at least one gener al partner must remain in the association; the privilege of limited liability still applies to this partner.
false
In efficient markets, price adjustments to new information are gradual.
false
Limited partners may actively manage the business.
false
Only a few financial decisions involve some sort of risk - return tradeoff.
false
Owners must register and pay year ly fees to their State of residence when establishing a sole proprietorship.
false
Rewarding executives for increasing quarterly earnings will motivate them to act in the long - term best interests of shareholders
false
The S arbane - Oxley Act addresses insider trading by members of Congress.
false
The financial ma nager should examine available risk - return trade - offs and make his decision based upon the greatest expected return.
false
The goal of maximize shareholder wealth inevitably conflicts with socially responsible behavior on the part of corporation.
false
The goal of profit maximization is equivalent to the goal of maximization of share value.
false
The goal of the firm should be the maximization of profit.
false
There is no legal distinction made between the assets of the business and the personal assets of the owners in the limited partnership.
false
Ultimate control in a corporation is vested in the board of directors.
false
If managers are making decisions to maximize shareholder wealth, then they are primarily concerned with making decisions that should
increase the market valu e of the firm's common stock.
The personal decision to obtain a college degree in business is primarily a(n) ________ decision
investment
A limited partner is liabl e
only up to the amount invested by that partner.
Foregoing the earning potential of a dollar today is referred to as the
opportunity cost concept.
The term stockholder is equivalent to
shareholder
In regard to the agency problem, ________ are the principal owners of a corporation .
shareholders
Serious ethical violations by corporations such as Enron led to the passage of
the Sa rbanes - Oxley Act.
Working capital management refers to
the management of cash flows
Consider cash flows for Projects X and Y such as: Project X Project Y Year 1 $300 0 $ 0 Year 2 $ 0 $3000 A rational person would prefer receiving cash flows sooner because A) the money can be reinvested. B) the money is nice to have around. C) the investor may be tired of a particular investment. D) the investor is indif ferent to either proposal
the money can be reinvested.
If managers do not pursue the goal of maximizing shareholder wealth
they are likely to lose their jobs
Investors prefer $1 today versus $1 in the future due to
time value of money.
) In a general partnership, all partners have unlimited liability for the actions of any one partner when that partner is conducting business for the firm.
true
A reputation for unethical behavior can negatively affect the value of a company's stock
true
For the risk - return principle implies that the more risky a given course of action, the higher the expected return must be
true
In a sole proprietorship, the owner is personally responsible without limitation for the liabilities incurred.
true
In an efficient market, prices will quickly adjust to new information.
true
One of the problems associated with profit maximization is that it ignores the timing of a project's return
true
The agency problem ar ises due to the separation of ownership and control in a corporation.
true
The goal of profit m aximization ignores the timing of profit
true
The life of a corporation is not dependent upon the status of the investors.
true
The owners of a corporation are liable for the corporation's obligations up to the amount of their investment.
true
Why do you think many companies compensate executives with options based on long - term increases in the value of the com pany's stock
tying executive compensation to long - term increases in the stock price makes sense because they are supposed to be working to maximize shareholder wealth. Stock - based compensation plans imply that decisions made to benefit sharehold ers will also benefit themselves.