FIN 221 Chapter 1 Intro Exercises

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

a. 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 statements is CORRECT? a. One of the disadvantages of a sole proprietorship is that the proprietor is exposed to unlimited liability. b. Corporations of all types are subject to the corporate income tax. c. One of the advantages of the corporate form of organization is that it avoids double taxation. d. 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." e. It is easier to transfer one's ownership interest in a partnership than in a corporation.

a. 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. The riskiness of projected earnings and cash flows to stockholders depends to some extent on how the firm is financed. b. The optimal dividend policy is the one that satisfies the bondholders because they supply the majority of the firm's capital. c. Dividend policy is one aspect of the firm's financial policy that is determined directly by each individual shareholder. d. The use of debt financing affects the probability of bankruptcy, but it has no effect on the firm's earnings or stock price. e. Stock prices are dependent on projected total cash flows and the use of debt, but not on the timing of the cash flow stream.

a. The riskiness of projected earnings and cash flows to stockholders depends to some extent on how the firm is financed.

Which of the following statements is CORRECT? a. 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. b. The efficiency of the U.S. economy would probably be increased if hostile takeovers were absolutely forbidden. c. Hostile takeovers are most likely to occur when a firm's stock is selling below its intrinsic value because of its poor management. 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.

c. 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. Although the 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, i.e., bondholders can sue its managers if the firm defaults on its debt. b. Unlimited liability and limited life are two key advantages of the corporate form over other forms of business organization. c. Limited liability is an advantage of the corporate form of organization to its owners (stockholders), but corporations have more trouble raising money in financial markets because of the complexity of this form of organization. d. A corporation is a legal entity created by a state, and it has a life and existence that is separate from the lives and existence of its owners and managers. e. A hostile takeover is the main method of transferring ownership interest in a corporation.

d. A corporation is a legal entity created by a state, and it has a life and existence that is separate from the lives and existence of its owners and managers.

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

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

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

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

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. Less of a corporation's income is generally subject to taxes. b. Corporations generally face fewer regulations. c. Corporate investors are exposed to unlimited liability. d. Corporate shareholders are exposed to reduced liability, but this factor is offset by the tax advantages of incorporation. e. Corporations generally find it easier to raise capital.

e. Corporations generally find it easier to raise capital.

Which of the following statements is CORRECT? a. 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. b. Corporate stockholders are exposed to unlimited liability. c. Large corporations are taxed more favorably than sole proprietorships. 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. 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.

e. 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. 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. b. 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. c. 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. d. 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. e. 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.

e. 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.