Chap 001

Chapter 01 - Introduction to Corporate Finance
Chapter 01
Introduction to Corporate Finance

Multiple Choice Questions

1. Which one of the following terms is defined as the management of a firm's long-term
investments?
A. woring capital management
!. financial allocation
C. agenc" cost anal"sis
#. capital $udgeting
%. capital structure

&. Which one of the following terms is defined as the mi'ture of a firm's de$t and e(uit"
financing?
!. cash management
C. cost anal"sis

). Which one of the following is defined as a firm's short-term assets and its short-term
lia$ilities?
A. woring capital
!. de$t
C. investment capital
#. net capital

*. A $usiness owned $" a solitar" individual who has unlimited lia$ilit" for its de$t is called
a+
A. corporation.
!. sole proprietorship.
C. general partnership.
#. limited partnership.
%. limited lia$ilit" compan".
,. A $usiness formed $" two or more individuals who each have unlimited lia$ilit" for all of
the firm's $usiness de$ts is called a+
A. corporation.

1-1
-. A $usiness partner whose potential financial loss in the partnership will not e'ceed his or
her investment in that partnership is called a+
A. generall" partner.
!. sole proprietor.
C. limited partner.
#. corporate shareholder.
%. .ero partner.

/. A $usiness created as a distinct legal entit" and treated as a legal 0person0 is called a+
A. corporation.
%. unlimited lia$ilit" compan".

1. Which one of the following terms is defined as a conflict of interest $etween the corporate
shareholders and the corporate managers?
A. articles of incorporation
!. corporate $readown
C. agenc" pro$lem
#. $"laws
%. legal lia$ilit"

2. A staeholder is+
A. a person who owns shares of stoc.
!. an" person who has voting rights $ased on stoc ownership of a corporation.
C. a person who initiall" founded a firm and currentl" has management control over that firm.
#. a creditor to whom a firm currentl" owes mone".
%. an" person or entit" other than a stocholder or creditor who potentiall" has a claim on the
cash flows of a firm.

10. Which of the following (uestions are addressed $" financial managers?
I. 3ow should a product $e mareted?
II. 4hould customers $e given )0 or *, da"s to pa" for their credit purchases?
III. 4hould the firm $orrow more mone"?
I5. 4hould the firm ac(uire new e(uipment?
A. I and I5 onl"
!. II and III onl"
C. I6 II6 and III onl"
#. II6 III6 and I5 onl"
%. I6 II6 III6 and I5
1-&
11. Which one of the following functions should $e the responsi$ilit" of the controller rather
than the treasurer?
A. dail" cash deposit
!. income ta' returns
C. e(uipment purchase anal"sis
#. customer credit approval
%. pa"ment to a vendor

1&. 7he controller of a corporation generall" reports directl" to the+
A. $oard of directors.
!. chairman of the $oard.
C. chief e'ecutive officer.
#. president.
%. vice president of finance.

1). Which one of the following correctl" defines the upward chain of command in a t"pical
corporate organi.ational structure?
A. 7he vice president of finance reports to the chairman of the $oard.
!. 7he chief e'ecutive officer reports to president.
C. 7he controller reports to the president.
#. 7he treasurer reports to the vice president of finance.
%. 7he chief operations officer reports to the vice president of production.

1*. Which one of the following is a capital $udgeting decision?
A. determining how man" shares of stoc to issue
!. deciding whether or not to purchase a new machine for the production line
C. deciding how to refinance a de$t issue that is maturing
#. determining how much inventor" to eep on hand
%. determining how much mone" should $e ept in the checing account

1,. Which of the following should a financial manager consider when anal".ing a capital
$udgeting pro8ect?
I. pro8ect start up costs
II. timing of all pro8ected cash flows
III. dependa$ilit" of future cash flows
I5. dollar amount of each pro8ected cash flow
A. I and I5 onl"
!. I6 II6 and I5 onl"
1-. Which one of the following is a capital structure decision?
A. determining which one of two pro8ects to accept
!. determining how to allocate investment funds to multiple pro8ects
C. determining the amount of funds needed to finance customer purchases of a new product
#. determining how much de$t should $e assumed to fund a pro8ect
%. determining how much inventor" will $e needed to support a pro8ect

1-)
1/. 7he decision to issue additional shares of stoc is an e'ample of which one of the
following?
!. net woring capital decision
C. capital $udgeting
#. controller's duties
%. capital structure decision

11. Which of the following accounts are included in woring capital management?
I. accounts pa"a$le
II. accounts receiva$le
III. fi'ed assets
I5. inventor"
A. I and II onl"
!. I and III onl"
C. II and I5 onl"
#. I6 II6 and I5 onl"
%. II6 III6 and I5 onl"

12. Which one of the following is a woring capital management decision?
A. determining the amount of e(uipment needed to complete a 8o$
!. determining whether to pa" cash for a purchase or use the credit offered $" the supplier
C. determining the amount of long-term de$t re(uired to complete a pro8ect
#. determining the num$er of shares of stoc to issue to fund an ac(uisition
%. determining whether or not a pro8ect should $e accepted

&0. Which one of the following statements concerning a sole proprietorship is correct?
A. A sole proprietorship is designed to protect the personal assets of the owner.
!. 7he profits of a sole proprietorship are su$8ect to dou$le ta'ation.
C. 7he owner of a sole proprietorship is personall" responsi$le for all of the compan"'s de$ts.
#. 7here are ver" few sole proprietorships remaining in the 9.4. toda".
%. A sole proprietorship is structured the same as a limited lia$ilit" compan".

A. 7he life of a sole proprietorship is potentiall" unlimited.
!. A sole proprietor can generall" raise large sums of capital (uite easil".
C. 7ransferring ownership of a sole proprietorship is easier than transferring ownership of a
corporation.
#. A sole proprietorship is ta'ed the same as a C corporation.
%. It is eas" to create a sole proprietorship.

1-*
&&. Which of the following individuals have unlimited lia$ilit" $ased on their ownership
interest?
I. general partner
II. sole proprietor
III. stocholder
I5. limited partner
A. II onl"
!. I and II onl"
C. II and I5 onl"
#. I6 II6 and III onl"
%. I6 II6 and I5 onl"

&). Which one of the following $est descri$es the primar" advantage of $eing a limited
partner instead of a general partner?
A. ta'-free income
!. active participation in the firm's activities
C. no potential financial loss
#. greater control over the $usiness affairs of the partnership
%. ma'imum loss limited to the capital invested

&*. A general partner+
A. is solel" responsi$le for all the partnership de$ts.
!. has no sa" over a firm's dail" operations.
C. faces dou$le ta'ation whereas a limited partner does not.
#. has a ma'imum loss e(ual to his or her e(uit" investment.
%. receives a salar" in lieu of a portion of the profits.

&,. A limited partnership+
A. has an unlimited life.
!. can opt to $e ta'ed as a corporation.
C. terminates at the death of an" limited partner.
#. has a greater a$ilit" to raise capital than a sole proprietorship.
%. consists solel" of limited partners.

&-. Which of the following appl" to a partnership that consists solel" of general partners?
I. dou$le ta'ation of partnership profits
II. limited partnership life
III. active involvement in the firm $" all the partners
I5. unlimited personal lia$ilit" for all partnership de$ts
A. II onl"
!. I and II onl"
C. II and III onl"

1-,
&/. Which of the following are advantages of the corporate form of $usiness ownership?
I. limited lia$ilit" for firm de$t
II. dou$le ta'ation
III. a$ilit" to raise capital
I5. unlimited firm life
A. I and II onl"
!. III and I5 onl"
C. I6 III6 and I5 onl"

&1. Which one of the following statements is correct?
A. 7he ma8orit" of firms in the 9.4. are structured as corporations.
!. Corporate profits are ta'a$le income to the shareholders when earned.
C. Corporations can raise large amounts of capital generall" easier than partnerships can.
#. 4tocholders face no potential losses related to their corporate investment.
%. Corporate shareholders elect the corporate president.

A. A general partnership is legall" the same as a corporation.
!. !oth sole proprietorship and partnership income is ta'ed as individual income.
C. :artnerships are the most complicated t"pe of $usiness to form.
#. All $usiness organi.ations have $"laws.
%. ;nl" firms organi.ed as sole proprietorships have limited lives.

)0. 7he articles of incorporation+
I. descri$e the purpose of the firm.
II. are amended periodicall".
III. set forth the num$er of shares of stoc that can $e issued.
I5. detail the method that will $e used to elect corporate directors.
A. I and III onl"
!. I and I5 onl"
C. II and III onl"
#. II and I5 onl"
%. I6 III6 and I5 onl"

)1. Corporate $"laws+
A. must $e amended should a firm decide to increase the num$er of shares authori.ed.
!. cannot $e amended once adopted.
C. define the name $" which the firm will operate.
#. descri$e the intended life and purpose of the organi.ation.
%. determine how a corporation regulates itself.

1--
)&. Which one of the following characteristics applies to a limited lia$ilit" compan"?
A. availa$le onl" to firms having a single owner
!. limited lia$ilit" for limited partners onl"
C. ta'ed similar to a partnership
#. ta'ed similar to a C corporation
%. all income generated is totall" ta'-free

)). Which one of the following $usiness t"pes is $est suited to raising large amounts of
capital?
A. sole proprietorship
!. limited lia$ilit" compan"
C. corporation
#. general partnership
%. limited partnership

)*. Which t"pe of $usiness organi.ation has all the respective rights and privileges of a legal
person?
!. general partnership
C. limited partnership
#. corporation
%. limited lia$ilit" compan"

),. 4am6 Alfredo6 and <uan want to start a small 9.4. $usiness. <uan will fund the venture $ut
wants to limit his lia$ilit" to his initial investment and has no interest in the dail" operations.
4am will contri$ute his full efforts on a dail" $asis $ut has limited funds to invest in the
$usiness. Alfredo will $e involved as an active consultant and manager and will also
contri$ute funds. 4am and Alfredo are willing to accept lia$ilit" for the firm's de$ts as the"
feel the" have nothing to lose $" doing so. All three individuals will share in the firm's profits
and wish to eep the initial organi.ational costs of the $usiness to a minimum. Which form of
$usiness entit" should these individuals adopt?
!. 8oint stoc compan"
%. corporation

1-/
)-. 4all" and Alicia currentl" are general partners in a $usiness located in Atlanta6 =eorgia.
7he" are content with their current ta' situation $ut are $oth ver" uncomforta$le with the
unlimited lia$ilit" to which the" are each su$8ected. Which form of $usiness entit" should
the" consider to replace their general partnership assuming the" wish to remain the onl" two
owners of their $usiness? Whichever organi.ation the" select6 the" wish to $e treated e(uall".
#. limited lia$ilit" compan"
%. corporation

)/. Which one of the following $est states the primar" goal of financial management?
A. ma'imi.e current dividends per share
!. ma'imi.e the current value per share
C. increase cash flow and avoid financial distress
#. minimi.e operational costs while ma'imi.ing firm efficienc"
%. maintain stead" growth while increasing current profits

)1. Which one of the following $est illustrates that the management of a firm is adhering to
the goal of financial management?
A. increase in the amount of the (uarterl" dividend
!. decrease in the per unit production costs
C. increase in the num$er of shares outstanding
#. decrease in the net woring capital
%. increase in the maret value per share

)2. Wh" should financial managers strive to ma'imi.e the current value per share of the
e'isting stoc?
A. doing so guarantees the compan" will grow in si.e at the ma'imum possi$le rate
!. doing so increases emplo"ee salaries
C. $ecause the" have $een hired to represent the interests of the current shareholders
#. $ecause this will increase the current dividends per share
%. $ecause managers often receive shares of stoc as part of their compensation

1-1
*0. #ecisions made $" financial managers should primaril" focus on increasing which one of
the following?
A. si.e of the firm
!. growth rate of the firm
C. gross profit per unit produced
#. maret value per share of outstanding stoc
%. total sales
*1. 7he 4ar$anes-;'le" Act of &00& is a governmental response to+
A. decreasing corporate profits.
!. the terrorists attacs on 2>11>&001.
C. a weaening econom".
#. deregulation of the stoc e'changes.
%. management greed and a$uses.

*&. Which one of the following is an unintended result of the 4ar$anes-;'le" Act?
A. more detailed and accurate financial reporting
!. increased management awareness of internal controls
C. corporations delisting from ma8or e'changes
#. increased responsi$ilit" for corporate officers
%. identification of internal control weanesses

*). A firm which opts to 0go dar0 in response to the 4ar$anes-;'le" Act+
A. must continue to provide audited financial statements to the pu$lic.
!. must continue to provide a detailed list of internal control deficiencies on an annual $asis.
C. can provide less information to its shareholders than it did prior to 0going dar0.
#. can continue pu$licl" trading its stoc $ut onl" on the e'change on which it was previousl"
listed.
%. ceases to e'ist.

**. Which of the following are results related to the enactment of the 4ar$anes-;'le" Act of
&00&?
I. increased foreign stoc e'change listings of 9.4. stocs
II. decreased compliance costs
III. increased privati.ation of pu$lic corporations
I5. increased pu$lic disclosure $" all corporations
A. I and III onl"
!. II and I5 onl"

1-2
*,. Which one of the following actions $" a financial manager is most apt to create an agenc"
pro$lem?
A. refusing to $orrow mone" when doing so will create losses for the firm
!. refusing to lower selling prices if doing so will reduce the net profits
C. refusing to e'pand the compan" if doing so will lower the value of the e(uit"
#. agreeing to pa" $onuses $ased on the maret value of the compan" stoc rather than on the
firm's level of sales
%. increasing current profits when doing so lowers the value of the firm's e(uit"

*-. Which of the following help convince managers to wor in the $est interest of the
stocholders? Assume there are no golden parachutes.
I. compensation $ased on the value of the stoc
II. stoc option plans
III. threat of a compan" taeover
I5. threat of a pro'" fight
A. I and II onl"
!. III and I5 onl"
#. I6 III6 and I5 onl"

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*/. Which form of $usiness structure is most associated with agenc" pro$lems?
#. corporation

*1. Which one of the following is an agenc" cost?
A. accepting an investment opportunit" that will add value to the firm
!. increasing the (uarterl" dividend
C. investing in a new pro8ect that creates firm value
#. hiring outside accountants to audit the compan"'s financial statements
%. closing a division of the firm that is operating at a loss

*2. Which one of the following is least liel" to $e an agenc" pro$lem?
A. increasing the si.e of a firm
!. concentrating on ma'imi.ing current profits
C. closing a division with net losses
#. increasing the maret value of the firm's shares
%. o$taining a patent for a new product

,0. Which one of the following is a means $" which shareholders can replace compan"
management?
A. stoc options
!. promotion
C. 4ar$anes-;'le" Act
#. agenc" pla"
%. pro'" fight

,1. Which one of the following grants an individual the right to vote on $ehalf of a
shareholder?
A. pro'"
!. $"-laws
C. indenture agreement
#. stoc option
%. stoc audit

,&. Which one of the following parties has ultimate control of a corporation?
A. chairman of the !oard
!. $oard of directors
C. chief e'ecutive officer
#. chief operating office
%. shareholders

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,). Which of the following parties are considered staeholders of a firm?
I. emplo"ee
II. long-term creditor
III. government
I5. common stocholder
A. I onl"
!. I5 onl"
C. I and III onl"
#. II and I5 onl"

,*. Which of the following represent cash outflows from a corporation?
I. issuance of securities
II. pa"ment of dividends
III. new loan proceeds
I5. pa"ment of government ta'es
A. I and III onl"
!. II and I5 onl"
C. I and I5 onl"

,,. Which of the following are cash flows from a corporation into the financial marets?
I. repa"ment of long-term de$t
II. pa"ment of government ta'es
III. pa"ment of loan interest
I5. pa"ment of (uarterl" dividend
A. I and II onl"
!. I and III onl"
C. II and I5 onl"
%. I6 II6 and III onl"

,-. Which one of the following is a primar" maret transaction?
A. sale of currentl" outstanding stoc $" a dealer to an individual investor
!. sale of a new share of stoc to an individual investor
C. stoc ownership transfer from one shareholder to another shareholder
#. gift of stoc from one shareholder to another shareholder
%. gift of stoc $" a shareholder to a famil" mem$er

,/. 4hareholder A sold ,00 shares of A!C stoc on the ?ew @or 4toc %'change. 7his
transaction+
A. too place in the primar" maret.
!. occurred in a dealer maret.
C. was facilitated in the secondar" maret.
#. involved a pro'".
%. was a private placement.

1-1&
,1. :u$lic offerings of de$t and e(uit" must $e registered with which one of the following?
A. ?ew @or !oard of =overnors
!. Federal Aeserve
C. ?@4% Aegistration ;ffice
#. 4ecurities and %'change Commission
%. Baret #ealers %'change

,2. Which one of the following statements is generall" correct?
A. :rivate placements must $e registered with the 4%C.
!. All secondar" marets are auction marets.
C. #ealer marets have a ph"sical trading floor.
#. Auction marets match $u" and sell orders.
%. #ealers arrange trades $ut never own the securities traded.

-0. Which one of the following statements concerning stoc e'changes is correct?
A. ?A4#AC is a $roer maret.
!. 7he ?@4% is a dealer maret.
C. 7he e'change with the strictest listing re(uirements is ?A4#AC.
#. 4ome large companies are listed on ?A4#AC.
%. Bost de$t securities are traded on the ?@4%.

-1. 4hareholder A sold shares of Baplewood Ca$inets stoc to 4hareholder !. 7he stoc is
listed on the ?@4%. 7his trade occurred in which one of the following?
A. primar"6 dealer maret
!. secondar"6 dealer maret
C. primar"6 auction maret
#. secondar"6 auction maret
%. secondar"6 ;7C maret

-&. Which one of the following statements is correct concerning the ?@4%?
A. 7he pu$licl" traded shares of a ?@4%-listed firm must $e worth at least D&,0 million.
!. 7he ?@4% is the largest dealer maret for listed securities in the 9nited 4tates.
C. 7he listing re(uirements for the ?@4% are more stringent than those of ?A4#AC.
#. An" corporation desiring to $e listed on the ?@4% can do so for a fee.
%. 7he ?@4% is an ;7C maret functioning as $oth a primar" and a secondar" maret.

-). Which one of the following statements concerning ?A4#AC is FAE4%?
A. It is easier to $e listed on ?A4#AC than on the ?@4%.
!. ?A4#AC is an electronic maret.
C. ?A4#AC is a dealer maret.
#. ?A4#AC is an ;7C maret.
%. ?A4#AC is an auction maret.

1-1)

Essay Questions

-*. Eist and $riefl" descri$e the three general areas of responsi$ilit" for a financial manager.

-,. #escri$e the e" advantages associated with the corporate form of organi.ation.

--. Wh" are so man" $usinesses structured as sole proprietorships when the corporate form of
$usiness offers more advantages?

-/. What concerns might a loan officer have when loaning funds to a sole proprietorship that
he or she might not have when loaning funds to a corporation?

1-1*
-1. From a lia$ilit" point of view6 what is the difference $etween investing in a sole
proprietorship and a general partnership?

-2. =ive some e'amples of wa"s in which manager's goals can differ from those of
shareholders.

/0. 3ow do the actual effects of the 4ar$anes-;'le" Act of &00& compare to the initial intent
of that Act?

/1. 3ow might agenc" pro$lems arise in partnerships?

1-1,
/&. Compare and contrast the ?@4% with ?4A#AC.

1-1-
Chapter 01 Introduction to Corporate Finance Answer Fe"

Multiple Choice Questions

1. Which one of the following terms is defined as the management of a firm's long-term
investments?
!. financial allocation
C. agenc" cost anal"sis
D. capital $udgeting
Aefer to section 1.1

AACSB: N/A
Difficulty: Basic
Learning Objective: 1-1
Section: 1.1
o!ic: Ca!ital bu"geting

&. Which one of the following terms is defined as the mi'ture of a firm's de$t and e(uit"
financing?
!. cash management
C. cost anal"sis
E. capital structure

AACSB: N/A
Difficulty: Basic
Section: 1.1
o!ic: Ca!ital structure

1-1/
). Which one of the following is defined as a firm's short-term assets and its short-term
lia$ilities?
A. woring capital
!. de$t
C. investment capital
#. net capital

AACSB: N/A
Difficulty: Basic
Section: 1.1
o!ic: #or$ing ca!ital

*. A $usiness owned $" a solitar" individual who has unlimited lia$ilit" for its de$t is called
a+
A. corporation.
B. sole proprietorship.
Aefer to section 1.&

AACSB: N/A
Difficulty: Basic
Learning Objective: 1-%
Section: 1.&
o!ic: Sole !ro!rietors'i!

1-11
,. A $usiness formed $" two or more individuals who each have unlimited lia$ilit" for all of
the firm's $usiness de$ts is called a+
A. corporation.

AACSB: N/A
Difficulty: Basic
Section: 1.&
o!ic: (eneral !artners'i!

-. A $usiness partner whose potential financial loss in the partnership will not e'ceed his or
her investment in that partnership is called a+
A. generall" partner.
!. sole proprietor.
C. limited partner.
#. corporate shareholder.
%. .ero partner.

AACSB: N/A
Difficulty: Basic
Section: 1.&
o!ic: Li)ite" !artner

1-12
/. A $usiness created as a distinct legal entit" and treated as a legal 0person0 is called a+
A. corporation.
%. unlimited lia$ilit" compan".

AACSB: N/A
Difficulty: Basic
Section: 1.&
o!ic: Cor!oration

1. Which one of the following terms is defined as a conflict of interest $etween the corporate
shareholders and the corporate managers?
A. articles of incorporation
!. corporate $readown
C. agenc" pro$lem
#. $"laws
%. legal lia$ilit"
Aefer to section 1.*

AACSB: *t'ics
Difficulty: Basic
Learning Objective: 1-+
Section: 1.+
o!ic: Agency !roble)

1-&0
2. A staeholder is+
A. a person who owns shares of stoc.
!. an" person who has voting rights $ased on stoc ownership of a corporation.
C. a person who initiall" founded a firm and currentl" has management control over that firm.
#. a creditor to whom a firm currentl" owes mone".
E. an" person or entit" other than a stocholder or creditor who potentiall" has a claim on the
cash flows of a firm.

AACSB: *t'ics
Difficulty: Basic
Section: 1.+
o!ic: Sta$e'ol"er

10. Which of the following (uestions are addressed $" financial managers?
I. 3ow should a product $e mareted?
II. 4hould customers $e given )0 or *, da"s to pa" for their credit purchases?
III. 4hould the firm $orrow more mone"?
I5. 4hould the firm ac(uire new e(uipment?
A. I and I5 onl"
!. II and III onl"
D. II6 III6 and I5 onl"

AACSB: N/A
Difficulty: Basic
Section: 1.1
o!ic: ,inancial )anage)ent

1-&1
11. Which one of the following functions should $e the responsi$ilit" of the controller rather
than the treasurer?
A. dail" cash deposit
B. income ta' returns
C. e(uipment purchase anal"sis
#. customer credit approval
%. pa"ment to a vendor

AACSB: N/A
Difficulty: Basic
Section: 1.1
o!ic: ,inancial )anage)ent

1&. 7he controller of a corporation generall" reports directl" to the+
A. $oard of directors.
!. chairman of the $oard.
C. chief e'ecutive officer.
#. president.
E. vice president of finance.

AACSB: N/A
Difficulty: Basic
Section: 1.1
o!ic: Cor!orate structure

1-&&
1). Which one of the following correctl" defines the upward chain of command in a t"pical
corporate organi.ational structure?
A. 7he vice president of finance reports to the chairman of the $oard.
!. 7he chief e'ecutive officer reports to president.
C. 7he controller reports to the president.
D. 7he treasurer reports to the vice president of finance.
%. 7he chief operations officer reports to the vice president of production.

AACSB: N/A
Difficulty: Basic
Section: 1.1
o!ic: Cor!orate structure

1*. Which one of the following is a capital $udgeting decision?
A. determining how man" shares of stoc to issue
B. deciding whether or not to purchase a new machine for the production line
C. deciding how to refinance a de$t issue that is maturing
#. determining how much inventor" to eep on hand
%. determining how much mone" should $e ept in the checing account

AACSB: N/A
Difficulty: Basic
Section: 1.1

1-&)
1,. Which of the following should a financial manager consider when anal".ing a capital
$udgeting pro8ect?
I. pro8ect start up costs
II. timing of all pro8ected cash flows
III. dependa$ilit" of future cash flows
I5. dollar amount of each pro8ected cash flow
A. I and I5 onl"
!. I6 II6 and I5 onl"
E. I6 II6 III6 and I5

AACSB: N/A
Difficulty: Basic
Section: 1.1

1-. Which one of the following is a capital structure decision?
A. determining which one of two pro8ects to accept
!. determining how to allocate investment funds to multiple pro8ects
C. determining the amount of funds needed to finance customer purchases of a new product
D. determining how much de$t should $e assumed to fund a pro8ect
%. determining how much inventor" will $e needed to support a pro8ect

AACSB: N/A
Difficulty: Basic
Section: 1.1

1-&*
1/. 7he decision to issue additional shares of stoc is an e'ample of which one of the
following?
!. net woring capital decision
C. capital $udgeting
#. controller's duties
E. capital structure decision

AACSB: N/A
Difficulty: Basic
Section: 1.1

11. Which of the following accounts are included in woring capital management?
I. accounts pa"a$le
II. accounts receiva$le
III. fi'ed assets
I5. inventor"
A. I and II onl"
!. I and III onl"
C. II and I5 onl"
D. I6 II6 and I5 onl"

AACSB: N/A
Difficulty: Basic
Section: 1.1
o!ic: #or$ing ca!ital )anage)ent

1-&,
12. Which one of the following is a woring capital management decision?
A. determining the amount of e(uipment needed to complete a 8o$
B. determining whether to pa" cash for a purchase or use the credit offered $" the supplier
C. determining the amount of long-term de$t re(uired to complete a pro8ect
#. determining the num$er of shares of stoc to issue to fund an ac(uisition
%. determining whether or not a pro8ect should $e accepted

AACSB: N/A
Difficulty: Basic
Section: 1.1
o!ic: #or$ing ca!ital )anage)ent

A. A sole proprietorship is designed to protect the personal assets of the owner.
!. 7he profits of a sole proprietorship are su$8ect to dou$le ta'ation.
C. 7he owner of a sole proprietorship is personall" responsi$le for all of the compan"'s de$ts.
#. 7here are ver" few sole proprietorships remaining in the 9.4. toda".
%. A sole proprietorship is structured the same as a limited lia$ilit" compan".

AACSB: N/A
Difficulty: Basic
Section: 1.&

1-&-
A. 7he life of a sole proprietorship is potentiall" unlimited.
!. A sole proprietor can generall" raise large sums of capital (uite easil".
C. 7ransferring ownership of a sole proprietorship is easier than transferring ownership of a
corporation.
#. A sole proprietorship is ta'ed the same as a C corporation.
E. It is eas" to create a sole proprietorship.

AACSB: N/A
Difficulty: Basic
Section: 1.&

&&. Which of the following individuals have unlimited lia$ilit" $ased on their ownership
interest?
I. general partner
II. sole proprietor
III. stocholder
I5. limited partner
A. II onl"
B. I and II onl"
C. II and I5 onl"
#. I6 II6 and III onl"
%. I6 II6 and I5 onl"

AACSB: N/A
Difficulty: Basic
Section: 1.&
o!ic: -nli)ite" liability

1-&/
&). Which one of the following $est descri$es the primar" advantage of $eing a limited
partner instead of a general partner?
A. ta'-free income
!. active participation in the firm's activities
C. no potential financial loss
#. greater control over the $usiness affairs of the partnership
E. ma'imum loss limited to the capital invested

AACSB: N/A
Difficulty: Basic
Section: 1.&
o!ic: Li)ite" !artner

&*. A general partner+
A. is solel" responsi$le for all the partnership de$ts.
!. has no sa" over a firm's dail" operations.
C. faces dou$le ta'ation whereas a limited partner does not.
#. has a ma'imum loss e(ual to his or her e(uit" investment.
%. receives a salar" in lieu of a portion of the profits.

AACSB: N/A
Difficulty: Basic
Section: 1.&
o!ic: (eneral !artner

1-&1
&,. A limited partnership+
A. has an unlimited life.
!. can opt to $e ta'ed as a corporation.
C. terminates at the death of an" limited partner.
D. has a greater a$ilit" to raise capital than a sole proprietorship.
%. consists solel" of limited partners.

AACSB: N/A
Difficulty: Basic
Section: 1.&
o!ic: .artners'i!

&-. Which of the following appl" to a partnership that consists solel" of general partners?
I. dou$le ta'ation of partnership profits
II. limited partnership life
III. active involvement in the firm $" all the partners
I5. unlimited personal lia$ilit" for all partnership de$ts
A. II onl"
!. I and II onl"
C. II and III onl"
E. II6 III6 and I5 onl"

AACSB: N/A
Difficulty: Basic
Section: 1.&
o!ic: .artners'i!

1-&2
&/. Which of the following are advantages of the corporate form of $usiness ownership?
I. limited lia$ilit" for firm de$t
II. dou$le ta'ation
III. a$ilit" to raise capital
I5. unlimited firm life
A. I and II onl"
!. III and I5 onl"
C. I6 III6 and I5 onl"

AACSB: N/A
Difficulty: Basic
Section: 1.&
o!ic: Cor!oration

A. 7he ma8orit" of firms in the 9.4. are structured as corporations.
!. Corporate profits are ta'a$le income to the shareholders when earned.
C. Corporations can raise large amounts of capital generall" easier than partnerships can.
#. 4tocholders face no potential losses related to their corporate investment.
%. Corporate shareholders elect the corporate president.

AACSB: N/A
Difficulty: /nter)e"iate
Section: 1.&
o!ic: Cor!oration

1-)0
A. A general partnership is legall" the same as a corporation.
B. !oth sole proprietorship and partnership income is ta'ed as individual income.
C. :artnerships are the most complicated t"pe of $usiness to form.
#. All $usiness organi.ations have $"laws.
%. ;nl" firms organi.ed as sole proprietorships have limited lives.

AACSB: N/A
Section: 1.&
o!ic: Business entity

)0. 7he articles of incorporation+
I. descri$e the purpose of the firm.
II. are amended periodicall".
III. set forth the num$er of shares of stoc that can $e issued.
I5. detail the method that will $e used to elect corporate directors.
A. I and III onl"
!. I and I5 onl"
C. II and III onl"
#. II and I5 onl"

AACSB: N/A
Section: 1.&
o!ic: Articles of incor!oration

1-)1
)1. Corporate $"laws+
A. must $e amended should a firm decide to increase the num$er of shares authori.ed.
!. cannot $e amended once adopted.
C. define the name $" which the firm will operate.
#. descri$e the intended life and purpose of the organi.ation.
E. determine how a corporation regulates itself.

AACSB: N/A
Difficulty: Basic
Section: 1.&
o!ic: Cor!orate byla0s

)&. Which one of the following characteristics applies to a limited lia$ilit" compan"?
A. availa$le onl" to firms having a single owner
!. limited lia$ilit" for limited partners onl"
C. ta'ed similar to a partnership
#. ta'ed similar to a C corporation
%. all income generated is totall" ta'-free

AACSB: N/A
Section: 1.&
o!ic: Li)ite" liability co)!any

1-)&
)). Which one of the following $usiness t"pes is $est suited to raising large amounts of
capital?
!. limited lia$ilit" compan"
C. corporation
%. limited partnership

AACSB: N/A
Difficulty: Basic
Section: 1.&
o!ic: Cor!oration

)*. Which t"pe of $usiness organi.ation has all the respective rights and privileges of a legal
person?
D. corporation

AACSB: N/A
Difficulty: Basic
Section: 1.&
o!ic: Cor!oration

1-))
),. 4am6 Alfredo6 and <uan want to start a small 9.4. $usiness. <uan will fund the venture $ut
wants to limit his lia$ilit" to his initial investment and has no interest in the dail" operations.
4am will contri$ute his full efforts on a dail" $asis $ut has limited funds to invest in the
$usiness. Alfredo will $e involved as an active consultant and manager and will also
contri$ute funds. 4am and Alfredo are willing to accept lia$ilit" for the firm's de$ts as the"
feel the" have nothing to lose $" doing so. All three individuals will share in the firm's profits
and wish to eep the initial organi.ational costs of the $usiness to a minimum. Which form of
$usiness entit" should these individuals adopt?
%. corporation

AACSB: 1eflective t'in$ing
Section: 1.&
o!ic: Li)ite" !artners'i!

)-. 4all" and Alicia currentl" are general partners in a $usiness located in Atlanta6 =eorgia.
7he" are content with their current ta' situation $ut are $oth ver" uncomforta$le with the
unlimited lia$ilit" to which the" are each su$8ected. Which form of $usiness entit" should
the" consider to replace their general partnership assuming the" wish to remain the onl" two
owners of their $usiness? Whichever organi.ation the" select6 the" wish to $e treated e(uall".
D. limited lia$ilit" compan"
%. corporation

Section: 1.&
o!ic: Li)ite" liability co)!any

1-)*
)/. Which one of the following $est states the primar" goal of financial management?
A. ma'imi.e current dividends per share
B. ma'imi.e the current value per share
C. increase cash flow and avoid financial distress
#. minimi.e operational costs while ma'imi.ing firm efficienc"
%. maintain stead" growth while increasing current profits
Aefer to section 1.)

AACSB: N/A
Difficulty: Basic
Learning Objective: 1-&
Section: 1.%
o!ic: (oal of financial )anage)ent

)1. Which one of the following $est illustrates that the management of a firm is adhering to
the goal of financial management?
A. increase in the amount of the (uarterl" dividend
!. decrease in the per unit production costs
C. increase in the num$er of shares outstanding
#. decrease in the net woring capital
E. increase in the maret value per share

AACSB: N/A
Section: 1.%

1-),
)2. Wh" should financial managers strive to ma'imi.e the current value per share of the
e'isting stoc?
A. doing so guarantees the compan" will grow in si.e at the ma'imum possi$le rate
!. doing so increases emplo"ee salaries
C. $ecause the" have $een hired to represent the interests of the current shareholders
#. $ecause this will increase the current dividends per share
%. $ecause managers often receive shares of stoc as part of their compensation

AACSB: N/A
Section: 1.%

*0. #ecisions made $" financial managers should primaril" focus on increasing which one of
the following?
A. si.e of the firm
!. growth rate of the firm
C. gross profit per unit produced
D. maret value per share of outstanding stoc
%. total sales

AACSB: N/A
Section: 1.%

1-)-
*1. 7he 4ar$anes-;'le" Act of &00& is a governmental response to+
A. decreasing corporate profits.
!. the terrorists attacs on 2>11>&001.
C. a weaening econom".
#. deregulation of the stoc e'changes.
E. management greed and a$uses.

AACSB: *t'ics
Difficulty: Basic
Section: 1.%
o!ic: Sarbo2

*&. Which one of the following is an unintended result of the 4ar$anes-;'le" Act?
A. more detailed and accurate financial reporting
!. increased management awareness of internal controls
C. corporations delisting from ma8or e'changes
#. increased responsi$ilit" for corporate officers
%. identification of internal control weanesses

AACSB: *t'ics
Difficulty: Basic
Section: 1.%
o!ic: Sarbo2

1-)/
*). A firm which opts to 0go dar0 in response to the 4ar$anes-;'le" Act+
A. must continue to provide audited financial statements to the pu$lic.
!. must continue to provide a detailed list of internal control deficiencies on an annual $asis.
C. can provide less information to its shareholders than it did prior to 0going dar0.
#. can continue pu$licl" trading its stoc $ut onl" on the e'change on which it was previousl"
listed.
%. ceases to e'ist.

AACSB: *t'ics
Section: 1.%
o!ic: Sarbo2

**. Which of the following are results related to the enactment of the 4ar$anes-;'le" Act of
&00&?
I. increased foreign stoc e'change listings of 9.4. stocs
II. decreased compliance costs
III. increased privati.ation of pu$lic corporations
I5. increased pu$lic disclosure $" all corporations
A. I and III onl"
!. II and I5 onl"

AACSB: *t'ics
Section: 1.%
o!ic: Sarbo2

1-)1
*,. Which one of the following actions $" a financial manager is most apt to create an agenc"
pro$lem?
A. refusing to $orrow mone" when doing so will create losses for the firm
!. refusing to lower selling prices if doing so will reduce the net profits
C. refusing to e'pand the compan" if doing so will lower the value of the e(uit"
#. agreeing to pa" $onuses $ased on the maret value of the compan" stoc rather than on the
firm's level of sales
E. increasing current profits when doing so lowers the value of the firm's e(uit"

AACSB: *t'ics
Section: 1.+

*-. Which of the following help convince managers to wor in the $est interest of the
stocholders? Assume there are no golden parachutes.
I. compensation $ased on the value of the stoc
II. stoc option plans
III. threat of a compan" taeover
I5. threat of a pro'" fight
A. I and II onl"
!. III and I5 onl"
E. I6 II6 III6 and I5

AACSB: *t'ics
Difficulty: Basic
Section: 1.+

1-)2
*/. Which form of $usiness structure is most associated with agenc" pro$lems?
D. corporation

AACSB: *t'ics
Difficulty: Basic
Section: 1.+

*1. Which one of the following is an agenc" cost?
A. accepting an investment opportunit" that will add value to the firm
!. increasing the (uarterl" dividend
C. investing in a new pro8ect that creates firm value
D. hiring outside accountants to audit the compan"'s financial statements
%. closing a division of the firm that is operating at a loss

AACSB: *t'ics
Difficulty: Basic
Section: 1.+
o!ic: Agency cost

1-*0
*2. Which one of the following is least liel" to $e an agenc" pro$lem?
A. increasing the si.e of a firm
!. concentrating on ma'imi.ing current profits
C. closing a division with net losses
D. increasing the maret value of the firm's shares
%. o$taining a patent for a new product

AACSB: *t'ics
Section: 1.+
o!ic: Agency cost

,0. Which one of the following is a means $" which shareholders can replace compan"
management?
A. stoc options
!. promotion
C. 4ar$anes-;'le" Act
#. agenc" pla"
E. pro'" fight

AACSB: N/A
Difficulty: Basic
Section: 1.+
o!ic: .ro2y fig't

1-*1
,1. Which one of the following grants an individual the right to vote on $ehalf of a
shareholder?
A. pro'"
!. $"-laws
C. indenture agreement
#. stoc option
%. stoc audit

AACSB: N/A
Difficulty: Basic
Section: 1.+
o!ic: .ro2y

,&. Which one of the following parties has ultimate control of a corporation?
A. chairman of the !oard
!. $oard of directors
C. chief e'ecutive officer
#. chief operating office
E. shareholders

AACSB: N/A
Difficulty: Basic
Section: 1.+
o!ic: Cor!orate res!onsibility

1-*&
,). Which of the following parties are considered staeholders of a firm?
I. emplo"ee
II. long-term creditor
III. government
I5. common stocholder
A. I onl"
!. I5 onl"
C. I and III onl"
#. II and I5 onl"

AACSB: N/A
Difficulty: Basic
Section: 1.+
o!ic: Sta$e'ol"er

,*. Which of the following represent cash outflows from a corporation?
I. issuance of securities
II. pa"ment of dividends
III. new loan proceeds
I5. pa"ment of government ta'es
A. I and III onl"
B. II and I5 onl"
C. I and I5 onl"
Aefer to section 1.,

AACSB: N/A
Difficulty: Basic
Section: 1.3
o!ic: Cas' outflo0s

1-*)
,,. Which of the following are cash flows from a corporation into the financial marets?
I. repa"ment of long-term de$t
II. pa"ment of government ta'es
III. pa"ment of loan interest
I5. pa"ment of (uarterl" dividend
A. I and II onl"
!. I and III onl"
C. II and I5 onl"
D. I6 III6 and I5 onl"
%. I6 II6 and III onl"

AACSB: N/A
Difficulty: Basic
Section: 1.3
o!ic: Cas' flo0s

,-. Which one of the following is a primar" maret transaction?
A. sale of currentl" outstanding stoc $" a dealer to an individual investor
B. sale of a new share of stoc to an individual investor
C. stoc ownership transfer from one shareholder to another shareholder
#. gift of stoc from one shareholder to another shareholder
%. gift of stoc $" a shareholder to a famil" mem$er

AACSB: N/A
Difficulty: Basic
Section: 1.3
o!ic: .ri)ary )ar$et

1-**
,/. 4hareholder A sold ,00 shares of A!C stoc on the ?ew @or 4toc %'change. 7his
transaction+
A. too place in the primar" maret.
!. occurred in a dealer maret.
C. was facilitated in the secondar" maret.
#. involved a pro'".
%. was a private placement.

AACSB: N/A
Difficulty: Basic
Section: 1.3
o!ic: Secon"ary )ar$et

,1. :u$lic offerings of de$t and e(uit" must $e registered with which one of the following?
A. ?ew @or !oard of =overnors
!. Federal Aeserve
C. ?@4% Aegistration ;ffice
D. 4ecurities and %'change Commission
%. Baret #ealers %'change

AACSB: N/A
Difficulty: Basic
Section: 1.3
o!ic: S*C

1-*,
,2. Which one of the following statements is generall" correct?
A. :rivate placements must $e registered with the 4%C.
!. All secondar" marets are auction marets.
C. #ealer marets have a ph"sical trading floor.
D. Auction marets match $u" and sell orders.
%. #ealers arrange trades $ut never own the securities traded.

AACSB: N/A
Section: 1.3
o!ic: Auction an" "ealer )ar$ets

-0. Which one of the following statements concerning stoc e'changes is correct?
A. ?A4#AC is a $roer maret.
!. 7he ?@4% is a dealer maret.
C. 7he e'change with the strictest listing re(uirements is ?A4#AC.
D. 4ome large companies are listed on ?A4#AC.
%. Bost de$t securities are traded on the ?@4%.

AACSB: N/A
Section: 1.3
o!ic: N4S* an" NASDA5

1-*-
-1. 4hareholder A sold shares of Baplewood Ca$inets stoc to 4hareholder !. 7he stoc is
listed on the ?@4%. 7his trade occurred in which one of the following?
A. primar"6 dealer maret
!. secondar"6 dealer maret
C. primar"6 auction maret
D. secondar"6 auction maret
%. secondar"6 ;7C maret

AACSB: N/A
Section: 1.3
o!ic: Secon"ary auction )ar$et

-&. Which one of the following statements is correct concerning the ?@4%?
A. 7he pu$licl" traded shares of a ?@4%-listed firm must $e worth at least D&,0 million.
!. 7he ?@4% is the largest dealer maret for listed securities in the 9nited 4tates.
C. 7he listing re(uirements for the ?@4% are more stringent than those of ?A4#AC.
#. An" corporation desiring to $e listed on the ?@4% can do so for a fee.
%. 7he ?@4% is an ;7C maret functioning as $oth a primar" and a secondar" maret.

AACSB: N/A
Section: 1.3
o!ic: N4S*

1-*/
-). Which one of the following statements concerning ?A4#AC is FAE4%?
A. It is easier to $e listed on ?A4#AC than on the ?@4%.
!. ?A4#AC is an electronic maret.
C. ?A4#AC is a dealer maret.
#. ?A4#AC is an ;7C maret.
E. ?A4#AC is an auction maret.

AACSB: N/A
Difficulty: Basic
Section: 1.3
o!ic: NASDA5

Essay Questions

-*. Eist and $riefl" descri$e the three general areas of responsi$ilit" for a financial manager.
7he three $asic areas are+
1. capital $udgeting+ the identification of investment opportunities that have a positive net
value
&. capital structure+ the mi' of long-term de$t and e(uit" used to finance a firm's operations
). woring capital management+ the dail" control of a firm's short-term assets and short-term
lia$ilities
Feed$ac+ Aefer to section 1.1

Section: 1.1
o!ic: ,inancial )anager

1-*1
-,. #escri$e the e" advantages associated with the corporate form of organi.ation.
7he advantages of the corporate form of organi.ation are the ease of transferring ownership6
the owners' limited lia$ilit" for $usiness de$ts6 the a$ilit" to raise large amounts of capital6
and the potential for an unlimited life for the organi.ation.
Feed$ac+ Aefer to section 1.&

Section: 1.&
o!ic: Cor!oration

--. Wh" are so man" $usinesses structured as sole proprietorships when the corporate form of
$usiness offers more advantages?
A significant advantage of the sole proprietorship is that it is ine'pensive and eas" to form. If
the sole proprietor has limited capital to start with6 it ma" not $e desira$le to spend part of that
capital forming a corporation. Also6 limited lia$ilit" for $usiness de$ts ma" not $e a
significant advantage if the proprietor has most of his or her personal assets tied up in the
$usiness alread". Finall"6 for a t"pical small firm6 having an unlimited life for the $usiness has
no real advantage since the heart and soul of the $usiness is the person who founded it6
there$" effectivel" limiting the life of the $usiness to that of its founder.

Section: 1.&

1-*2
-/. What concerns might a loan officer have when loaning funds to a sole proprietorship that
he or she might not have when loaning funds to a corporation?
7he e'istence and via$ilit" of a sole proprietor is dependent upon one individual. 4hould that
individual die6 the entit" would cease to e'ist. Eiewise6 should the owner lose interest in the
$usiness or $ecome ill6 the $usiness might also cease to e'ist. With a corporation6 the
compan" ownership could $e sold in an" one of those situations such that the $usiness entit"
would continue to e'ist.

Section: 1.&
o!ic: Organi6ational structure

-1. From a lia$ilit" point of view6 what is the difference $etween investing in a sole
proprietorship and a general partnership?
!oth a sole proprietor and a general partner have unlimited lia$ilit" for the firm's de$ts.
3owever6 as a sole proprietor "ou should $e totall" aware of all the $usiness dealings of the
firm. In a general partnership6 "ou ma" or ma" not handle the financial transactions and thus
are accepting the responsi$ilit" for actions taen not onl" $" "ourself6 $ut those of "our
partners.

Section: 1.&
o!ic: .ersonal liability

1-,0
-2. =ive some e'amples of wa"s in which manager's goals can differ from those of
shareholders.
7he primar" goal of a financial manager should $e to ma'imi.e the current value of the
outstanding stoc. 7his goal focuses on enhancing the returns to stocholders who are the
owners of the firm. 3owever6 managers fre(uentl" are more concerned with their personal
$enefits from emplo"ment6 the prestige of their position6 and the pers to which the" feel
entitled. 7here are numerous e'amples6 some of which are e'cessive compensation pacages6
large corporate offices6 e'cessive staffing6 and first-class travel and conference locations6 to
name a few.
Feed$ac+ Aefer to section 1.*

AACSB: *t'ics
Section: 1.+
o!ic: Agency conflict

/0. 3ow do the actual effects of the 4ar$anes-;'le" Act of &00& compare to the initial intent
of that Act?
4ome of the e" re(uirements of 4ar$anes-;'le" are+ the prohi$ition of personal loans from
the compan" to its officers6 an annual report $" management of the internal control and
financial reporting within the firm along with an independent auditor's assessment of that
report6 a review and sign off $" the corporate officers of the annual financial statements6 and
the responsi$ilit" for the accurac" of the financial reports placed directl" on senior
management of the firm. While firms that have opted to remain pu$licl"-owned are
compl"ing with these re(uirements6 the" are pa"ing a cost to do so. 7his cost has caused other
firms to 0go dar0 or to opt for listing on a foreign e'change rather than a 9.4. e'change.
While some of the results do match the intent of the Act6 the costs6 0going dar06 and foreign
listings were most liel" not intended $" the supporters of the Act.
Feed$ac+ Aefer to section 1.)

AACSB: *t'ics
Section: 1.%
o!ic: Sarbo2

1-,1
/1. 3ow might agenc" pro$lems arise in partnerships?
Agenc" conflicts t"picall" arise when there is a separation $etween the ownership and the
management of a $usiness. In a general partnership6 especiall" if the partnership is small6
there is less of a chance of an agenc" conflict if all the partners are involved with the $usiness
on a regular $asis. 3owever6 in a limited partnership6 the opportunit" e'ists for an agenc"
pro$lem to arise $etween the general and the limited partners.
Feed$ac+ Aefer to section 1.*

AACSB: *t'ics
Section: 1.+
o!ic: Agency conflict

/&. Compare and contrast the ?@4% with ?4A#AC.
7he ?@4% is an auction maret where sell orders are matched with $u" orders. 7he ?@4%
has a ph"sical trading floor located on Wall 4treet in ?ew @or Cit". ?A4#AC is a dealer
maret which is solel" electronic and therefore has no ph"sical trading floor. #ealers $u" and
sell for their own inventor". 7he listing re(uirements of the ?@4% are more stringent than
those of ?A4#AC and thus the ?@4% tends to list larger firms with smaller firms $eing
listed on ?A4#AC. ?ote however6 that larger firms can6 and do6 opt to remain on ?A4#AC
even though the" (ualif" for ?@4% listing.
Feed$ac+ Aefer to section 1.,

Section: 1.3
o!ic: *2c'anges

1-,&

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Chap 001

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Chapter 01 - Introduction to Corporate Finance

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