Finance Management Overview

CHAPTER 1 AN OVERVIEW OF FINANCIAL MANAGEMENT Forms of business organizationAnswer: c [i]. Which of the following could explain why a business might choose to organize as a corporation rather than as a sole proprietorship or a partnership? a. Corporations generally face fewer regulations. b. Corporations generally face lower taxes. c. Corporations generally find it easier to raise capital. d. Corporations enjoy unlimited liability. e. Statements c and d are correct. Firm organizationAnswer: a [ii]. Which of the following statements is most correct? a.

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One advantage of forming a corporation is that you have limited liability. b. Corporations face fewer regulations than sole proprietorships. c. One disadvantage of being a sole proprietor is that you have to pay corporate taxes, even though you don’t realize the benefits of being a corporation. d. Statements b and c are correct. e. None of the statements above is correct. Firm organizationAnswer: c [iii]. Which of the following statements is most correct? a. Corporations generally face fewer regulations than sole proprietor-ships do. b. Corporate shareholders have unlimited liability. . It is usually easier to transfer ownership in a corporation than it is to transfer ownership in a sole proprietorship. d. All of the above statements are correct. e. None of the above statements is correct. Goal of firmAnswer: d [iv]. 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. AgencyAnswer: d [v]. Which of the following statements is most correct? a.

Compensating managers with stock can reduce the agency problem between stockholders and managers. b. Restrictions are included in credit agreements to protect bondholders from the agency problem that exists between bondholders and stockholders. c. The threat of a takeover can reduce the agency problem between bondholders and stockholders. d. Statements a and b are correct. e. All of the statements above are correct. AgencyAnswer: a [vi]. Which of the following work to reduce agency conflicts between stockholders and bondholders? a. Including restrictive covenants in the company’s bond contract. . Providing managers with a large number of stock options. c. The passage of laws that make it easier for companies to resist hostile takeovers. d. Statements b and c are correct. e. All of the statements above are correct. AgencyAnswer: b [vii]. Which of the following actions are likely to reduce agency conflicts between stockholders and managers? a. Paying managers a large fixed salary. b. Increasing the threat of corporate takeover. c. Placing restrictive covenants in debt agreements. d. All of the statements above are correct. e. Statements b and c are correct.

Managerial incentivesAnswer: e [viii]. Which of the following mechanisms is used to motivate managers to act in the interest of shareholders? a. Bond covenants. b. The threat of a takeover. c. Pressure from the board of directors. d. Statements a and b are correct. e. Statements b and c are correct. Managerial incentivesAnswer: e d. Statements a and b are correct. e. Statements a and c are correct. Miscellaneous conceptsAnswer: c [ix]. Which of the following statements is most correct? a. A good goal for a corporate manager is maximization of expected EPS. b.

Most business in the U. S. is conducted by corporations; corpo-rations’ popularity results primarily from their favorable tax treatment. c. A good example of an agency relationship is the one between stockholders and managers. d. Corporations and partnerships have an advantage over proprietorships because a sole proprietor is subject to unlimited liability, but investors in the other types of businesses are not. e. Firms in highly competitive industries find it easier to exercise “social responsibility” than do firms in oligopolistic industries. Miscellaneous conceptsAnswer: e x]. Which of the following statements is most correct? a. One advantage of organizing your business as a corporation is that your shareholders are not subject to limited liability. b. Restrictive covenants in debt agreements are an effective way to reduce agency conflicts between stockholders and managers. c. Managers generally welcome hostile takeovers since they often increase the company’s stock price. d. Statements a and b are correct. e. None of the answers above is correct. Partnership formAnswer: d [xi]. Which of the following statements is most correct? a.

In a partnership, liability for other partners’ misdeeds is limited to the amount a particular partner has invested in the business. b. Partnerships must be formed according to specific rules that include the filing of a formal written agreement with state authorities where the partnership does business. c. A fast-growth company would be more likely to set up a partnership for its business organization than would a slow-growth company. d. Partnerships have difficulty attracting capital in part because of the other disadvantages of the partnership form of business, including impermanence of the organization. e.

A major disadvantage of a partnership as a form of business organization is the high cost and practical difficulty of its formation. Solution: ———————– [i]. Forms of business organizationAnswer: c The advantages of incorporation are unlimited life, easy transfer-ability of ownership interest, limited liability, and ease of raising money in the capital markets. Regulations and double taxation are disadvantages of corporations. [ii]. Firm organizationAnswer: a Statement a is correct; the others are false. Corporations have limited liability; however, they face more regulations than the other forms of organization.

Sole proprietorships do not pay corporate taxes. [iii]. Firm organizationAnswer: c The correct answer is statement c. Corporations face more regulations than sole proprietorships do, so statement a is incorrect. Corporate shareholders have limited liability. Shareholders can’t be sued for the mistakes of the company, so statement b is incorrect. [iv]. Goal of firmAnswer: d [v]. AgencyAnswer: d Both statements a and b are correct; therefore, statement d is the correct choice. The threat of a takeover alleviates the agency problem between managers and stockholders, not between bondholders and stockholders. vi]. AgencyAnswer: a Statement a is correct; the other statements are false. Restrictive covenants resolve differences between bondholders and stockholders. [vii]. AgencyAnswer: b Statement b is true. Corporate takeovers are most likely to occur when a firm is underperforming. Managers who fear losing their jobs will try to maximize shareholder wealth. The other statements are false. Statement a will exacerbate the agency conflict, while statement c reduces the agency conflict between stockholders and bondholders. [viii]. Managerial incentivesAnswer: e

Statements b and c are true; therefore, statement e is the correct choice. Statement a is false, bond covenants force managers to act in the interest of bondholders. [ix]. Miscellaneous conceptsAnswer: c [x]. Miscellaneous conceptsAnswer: e Statements a, b, c, and d are all false; therefore, statement e is the correct choice. Shareholders of corporations are subject to limited liability. Restrictive bond covenants reduce agency conflicts between shareholders (through management) and bondholders. Managers’ jobs are threatened by hostile takeovers. [xi]. Partnership formAnswer: d

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