Question 1

Which of the following statements is CORRECT?
A) 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.
B) Most businesses (by number and total dollar sales) are organized as proprietorships or partnerships because it is easier to set up and operate one of these forms rather than as a corporation. However, if the business gets large, it becomes advantageous to convert to a corporation, primarily because corporations have important tax advantages over proprietorships and partnerships.
C) Due to legal considerations related to ownership transfers and limited liability, which affect the ability to attract capital, most business (measured by dollar sales) is conducted by corporations in spite of large corporations' less favorable tax treatment.
D) Large corporations are taxed more favorably than sole proprietorships.
E) Corporate stockholders are exposed to unlimited liability.

Accepted Answer

Corporations conduct most business by dollar sales due to advantages like limited liability and ease of raising capital, despite less favorable tax treatment compared to sole proprietorships and partnerships.

Question 2

Which of the following statements is CORRECT?
A) Compensating managers with stock options can do nothing to help eliminate potential conflicts between stockholders and managers.
B) Restrictions can be included in credit agreements, but these restrictions can do nothing to protect bondholders from conflicts of interest between them and the firm's managers and stockholders.
C) The threat of takeovers reduces conflict of interest problems, but only between bondholders and stockholders.
D) Compensating managers with stock options can help reduce conflicts of interest between stockholders and managers, but if the options are all exercisable on a specific date in the near future, this can motivate managers to do something other than try to maximize the stock's intrinsic value.
E) Conflicts would not exist if the Security and Exchange Commission were abolished.

Accepted Answer

Compensating managers with stock options can help reduce conflicts of interest between stockholders and managers. However, if the options are all exercisable on a specific date in the near future, this can motivate managers to do something other than try to maximize the stock's intrinsic value, as they may be more focused on increasing the stock price in the short term rather than the long term. Therefore, it is important to properly structure and time the issuance of stock options to align the interests of managers with those of the company's stockholders. None of the other statements are correct.

Question 3

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

Accepted Answer

Most people in business would agree that it is useful for business schools to cover ethics, as it gives students an understanding of the adverse consequences of unethical behavior to themselves, their firms, and the nation. While some individuals may already have developed their moral character before entering business school, it is still important for them to understand the potential impact of their actions in a business context.

Question 4

The primary operating goal of a publicly-owned firm trying to best serve its stockholders should be to
A) Maximize managers' own interests, which are by definition consistent with maximizing shareholders' wealth.
B) Maximize the firm's expected EPS, which must also maximize the firm's price per share.
C) Minimize the firm's risks because most stockholders dislike risk. In turn, this will maximize the firm's stock price.
D) Use a well-structured managerial compensation package to reduce conflicts that may exist between stockholders and managers.
E) Since it is impossible to measure a stock's intrinsic value, the text states that it is better for managers to attempt to maximize the current stock price than its intrinsic value.

Accepted Answer

The answer of The primary operating goal of a publicly-owned...

Question 5

Which of the following statements is CORRECT?
A) In a typical partnership, liability for other partners' misdeeds is limited to the amount of a particular partner's investment in the business.
B) In a limited partnership, the limited partners have voting control, while the general partner has operating control over the business, and the limited partners are individually responsible, on a pro rata basis, for the firm's debts in the event of bankruptcy.
C) A slow-growth company, with little need for new capital, would be more likely to organize as a corporation than would a faster growing company.
D) Partnerships have more difficulty attracting large amounts of capital than corporations because of such factors as unlimited liability, the need to reorganize when a partner dies, and the illiquidity (difficulty buying and selling) of partnership interests.
E) A major disadvantage of a partnership relative to a corporation is the fact that federal income taxes must be paid by the partners rather than by the firm itself.

Accepted Answer

The answer of Which of the following statements is CORRECT?
A)...

Question 6

Which of the following actions would be most likely to reduce potential conflicts of interest between stockholders and managers?
A) Pay managers large cash salaries and give them no stock options.
B) Change the corporation's formal documents to make it easier for outside investors to acquire a controlling interest in the firm through a hostile takeover.
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 that are received can be sold.

Accepted Answer

The answer of Which of the following actions would be...

Question 7

Which of the following statements is CORRECT?
A) 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.
B) Using restrictive covenants in debt agreements is an effective way to reduce conflicts between stockholders and managers.
C) Managers generally welcome hostile takeovers since the "raider" generally offers a price for the stock that is higher than the price before the takeover action started.
D) The 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.
E) The 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.

Accepted Answer

The statement that "The 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" is correct. Managers of established, stable companies often try to protect themselves from hostile takeovers, which can lead to changes in management and a loss of job security. They may lobby their state legislatures to impose rules that make it more difficult for raiders to succeed with hostile takeovers, such as "poison pills" and other antitakeover measures.

Question 8

Which of the following statements is CORRECT?
A) If a corporation elects to be taxed as an S corporation, then both it and its stockholders can avoid all Federal taxes. This provision was put into the Federal Tax Code in order to encourage the formation of small businesses.
B) The more capital a firm is likely to require, the smaller the probability that it will be organized as a corporation.
C) It is generally easier to transfer one's ownership interest in a partnership than in a corporation.
D) One danger of starting a proprietorship is that you may be exposed to personal liability if the business goes bankrupt. This problem would be avoided if you formed a corporation to operate the business.
E) Corporate shareholders are exposed to unlimited liability, but this factor is offset by the tax advantages of incorporation.

Accepted Answer

The answer of Which of the following statements is CORRECT?
A)...

Question 9

Which of the following statements is CORRECT?
A) One drawback of forming a corporation is that it generally subjects the firm to additional regulations.
B) One drawback of forming a corporation is that it subjects the firm's investors to increased personal liabilities.
C) One drawback of forming a corporation is that it makes it more difficult for the firm to raise capital.
D) One advantage of forming a corporation is that it subjects the firm's investors to fewer taxes.
E) One disadvantage of forming a corporation is that this makes it more difficult for the firm's investors to transfer their ownership interests.

Accepted Answer

Forming a corporation subjects the firm to additional regulations, such as the requirement to file annual reports and hold regular shareholder meetings.

Question 10

Which of the following actions would be likely to encourage a firm's managers to make decisions that are in the best interests of shareholders?
A) 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.
B) The state legislature passes a law that makes it more difficult to successfully complete a hostile takeover.
C) 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 80%.
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 think best without obtaining board approval.

Accepted Answer

Institutional investors are more likely to be focused on maximizing shareholder value and will therefore put pressure on the firm's managers to make decisions that benefit shareholders.

Question 11

Which of the following statements is CORRECT?
A) The ability of firms in competitive industries to voluntarily undertake socially beneficial but costly projects is constrained by competition and the need to attract capital.
B) Any action that would maximize a firm's stock price must be consistent with the maximization of social welfare.
C) Decisions regarding social and ethical behavior have no effect, either positive or negative, on firms' stock prices.
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) Even if the government did not mandate some actions deemed to be socially responsible, such as those relating to fair hiring and environmentally sound practices, most firms in competitive markets would still pursue these policies.

Accepted Answer

The competitive nature of the industry and the need to attract capital make it difficult for firms to undertake costly socially beneficial projects. This is because such actions may reduce their competitiveness and make them less attractive to investors.

Question 12

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

Accepted Answer

Bond covenants are agreements within bond contracts that aim to protect bondholders by restricting certain actions of the issuer, thereby reducing conflicts between stockholders and bondholders.

Question 13

Which of the following statements is CORRECT?
A) One of the ways in which firms can mitigate or reduce potential conflicts between bondholders and stockholders is by increasing the amount of debt in the firm's capital structure.
B) The threat of takeover generally increases potential conflicts between stockholders and managers.
C) Managerial compensation plans cannot be used to reduce potential conflicts between stockholders and managers.
D) The threat of takeovers tends to reduce potential conflicts between stockholders and managers.
E) The creation of the Securities and Exchange Commission (SEC) has eliminated conflicts between managers and stockholders.

Accepted Answer

The answer of Which of the following statements is CORRECT?
A)...

Question 14

Which of the following statements is CORRECT?
A) Well designed bond covenants are useful for reducing agency conflicts between stockholders and managers.
B) The bid price in a hostile takeover is generally above the price before the takeover attempt is announced, because otherwise there would be no incentive for the stockholders to sell to the hostile bidder and the takeover attempt would probably fail.
C) Stockholders in general would be better off if managers never disclosed favorable events and therefore caused the price of the firm's stock to sell at a price below its intrinsic value.
D) Takeovers are most likely to be attempted if the target firm's stock price is above its intrinsic value.
E) The efficiency of the U.S. economy would probably be increased if hostile takeovers were absolutely forbidden.

Accepted Answer

The bid price in a hostile takeover is generally above the pre-announcement price to incentivize stockholders to sell their shares to the bidder, increasing the likelihood of a successful takeover.

Question 15

Which of the following mechanisms would be most likely to help motivate managers to act in the best interests of shareholders?
A) Decrease the use of restrictive covenants in bond agreements.
B) Take actions that reduce the possibility of a hostile takeover.
C) Elect a board of directors that allows managers greater freedom of action.
D) Increase the proportion of executive compensation that comes from stock options and reduce the proportion that is paid as cash salaries.
E) Eliminate a requirement that members of the board of directors have a substantial investment in the firm's stock.

Accepted Answer

By increasing the proportion of executive compensation that comes from stock options and reducing the proportion that is paid as cash salaries, managers are incentivized to focus on increasing the share price since their compensation is tied to it. This aligns their interests with those of shareholders.

Question 16

Which of the following actions would be likely to reduce conflicts of interest between stockholders and managers?
A) Congress passes a law that severely restricts hostile takeovers.
B) A firm's compensation system is changed so that managers receive larger cash salaries but fewer long-term options to buy stock.
C) The company changes the way executive stock options are handled, with all options vesting after 2 years rather than having 20% of the options awarded vest e2 years over a 10-year period.
D) The company's outside auditing firm is given a lucrative year-by-year consulting contract with the company.
E) The composition of the board of directors is changed from all inside directors to all outside directors, and the directors are compensated with stock rather than cash.

Accepted Answer

By changing the composition of the board of directors from all inside directors to all outside directors, the board is less likely to be influenced by the managers and more likely to act in the best interest of the stockholders. Compensating the directors with stock rather than cash further aligns their interests with those of the stockholders. This would reduce conflicts of interest between stockholders and managers.

Question 17

Which of the following statements is CORRECT?
A) A good goal for a firm's management is the maximization of expected EPS.
B) Most business in the U.S. is conducted by corporations, and corporations' popularity results primarily from their favorable tax treatment.
C) Conflicts can exist between stockholders and managers, but potential conflicts are reduced by the possibility of hostile takeovers.
D) 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.
E) Firms in highly competitive industries are more likely to consciously exercise "social responsibility" than are firms in oligopolistic industries.

Accepted Answer

Conflicts can arise between stockholders and managers because they may have different goals or interests. However, the possibility of hostile takeovers can reduce these conflicts by holding managers accountable for their actions and decisions.

Question 18

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) The financial manager should seek that combination of assets, liabilities, and capital that will generate the largest expected after-tax income over the relevant time horizon.
C) 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.
D) 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.
E) Potential conflicts of interest can exist between stockholders and managers, and also between stockholders and bondholders.

Accepted Answer

Potential conflicts of interest can exist between stockholders and managers, who may prioritize their own interests over those of the shareholders. Likewise, conflicts can also arise between stockholders and bondholders, since the actions that benefit one group may potentially harm the other.

Question 19

Which of the following actions would be most likely to reduce conflicts of interest between stockholders and bondholders?
A) If a lower level person in a firm does something illegal, like "cooking the books" to understate costs and thereby artificially increase profits because he or she was ordered to do so by a superior, the lower level person cannot be prosecuted but the superior can be prosecuted.
B) There are many types of unethical business behavior. One example is where executives provide information that they know is incorrect to outsiders. It is illegal to provide such information to federally regulated banks, but it is not illegal to provide it to stockholders because they are the owners of the firm.
C) The bankruptcy of Enron Corporation, and the fraud committed by some of its officers, was much discussed, but it did not lead to any important changes in business practices.
D) If someone deliberately understates costs and thereby causes reported profits to increase, then this can cause the price of the stock to rise above its intrinsic value. The stock will probably fall in the future. Both those who participated in the fraud and the firm itself can be prosecuted.
E) Ethical behavior is not influenced by training and auditing procedures. People are either ethical or they are not, and this is what determines ethical behavior in business.

Accepted Answer

Prosecution of both the individuals and the firm for fraudulent behavior that harms stockholders and bondholders alike would be the most effective way to reduce conflicts of interest between them.

Question 20

Which of the following statements is CORRECT?
A) A hostile takeover is the main method of transferring ownership interest in a corporation.
B) 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.
C) Unlimited liability and limited life are two key advantages of the corporate form over other forms of business organization.
D) 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.
E) 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.

Accepted Answer

A corporation is a legal entity that has a separate legal existence from its owners and managers. It is created by the state and has legal rights and obligations. The other statements are incorrect. A hostile takeover is not the main method of transferring ownership interest in a corporation; it is a hostile act. Unlimited liability and limited life are not advantages of the corporate form; in fact, limited liability and perpetual life are two key advantages. The corporate form is not more complex than other forms of organization and it is actually easier for corporations to raise money in financial markets because of their ability to issue stocks and bonds. Additionally, while it is true that stockholders are insulated by limited legal liability, the legal status of the corporation does protect its managers from lawsuits by bondholders, as long as they have acted in good faith and within the scope of their authority.

Quiz 1: An Overview of Financial Management

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Which of the following statements would most people in business agree with?

The primary operating goal of a publicly-owned firm trying to best serve its stockholders should be to

Which of the following statements is CORRECT?

Which of the following actions would be most likely to reduce potential conflicts of interest between stockholders and managers?

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Which of the following actions would be likely to encourage a firm's managers to make decisions that are in the best interests of shareholders?

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Which of the following mechanisms would be most likely to help motivate managers to act in the best interests of shareholders?

Which of the following actions would be likely to reduce conflicts of interest between stockholders and managers?

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Which of the following actions would be most likely to reduce conflicts of interest between stockholders and bondholders?

Which of the following statements is CORRECT?