(Difficulty: E = Easy, M = Medium, and T = Tough)

True-False
Easy:
(1.2) Goal of firm Answer: b Diff: E
1
. The proper goal of the financial manager should be to maximize the
firm's expected profit, since this will add the most wealth to each of
the individual shareholders (owners) of the firm.
a. True
b. False
(1.2) Goal of firm Answer: b Diff: E

. !f a firm has a single owner, we ma" sa" that the proper goal of a
financial manager would be to maximize the firm's earnings per share.
a. True
b. False
(1.2) Managerial incentives Answer: b Diff: E
#
. Executive stock options are shares of stoc$ awarded to managers on the
basis of corporate performance.
a. True
b. False
(1.2) Social welfare and finance Answer: b Diff: E
%
. The goal of maximizing stoc$ price is a detriment to societ" in that few
of the actions that result in maximization of stoc$ price also benefit
societ".
a. True
b. False
(1.2) Social welfare and finance Answer: a Diff: E
&
. !f a firm's managers want to maximize stoc$ price it is in their best
interests to operate efficient, low'cost plants, develop new and safe
products that consumers want, and maintain good relationships with
customers, suppliers, creditors, and the communities in which the"
operate.
a. True
b. False
Chapter 1: An Overview of Financial Management Page 1
CH!TE" #
$ %&E"&'E( %F F'$$C') M$*EME$T
(1.3) Agenc Answer: b Diff: E
(
. )n agenc" relationship exists when one or more persons hire another
person to perform some service but withhold decision'ma$ing authorit"
from that person.
a. True
b. False
(1.3) Agenc Answer: b Diff: E
*
. !f a firm's stoc$ price falls during the "ear, this indicates that the
firm's managers are not acting in shareholders' best interests.
a. True
b. False
(1.3) Agenc Answer: a Diff: E
+
. )n agenc" problem exists between stoc$holders and managers. ) second
agenc" problem arises between stoc$holders and creditors.
a. True
b. False
Medium:
(1.2) Managerial incentives Answer: a Diff: M
,
. !n a competitive mar$etplace, if managers deviate too far from ma$ing
decisions that are consistent with stoc$holder wealth maximization, the"
ris$ being disciplined b" the mar$et. -art of this discipline involves
the threat of being ta$en over b" groups who are more aligned with
stoc$holder interests.
a. True
b. False
(1.3) !ostile ta"eovers Answer: b Diff: M
1.
. ) hostile ta$eover is a method of seizing control of a compan" and
involves an action ta$en against the opposition of incumbent management.
/owever, this action is t"picall" motivated b" a desire to control the
firm's assets and is rarel" motivated b" a low share price.
a. True
b. False
Page 2 Chapter 1: An Overview of Financial Management
Multi+le Choice: Conce+tual
Easy:
(1.2) Goal of firm Answer: d Diff: E
11
. The primar" goal of a publicl"'owned firm interested in serving its
stoc$holders should be to
a. 0aximize expected total corporate profit.
b. 0aximize expected 1-2.
c. 0inimize the chances of losses.
d. 0aximize the stoc$ price per share.
e. 0aximize expected net income.
(1.3) Agenc Answer: d Diff: E
1
. 3hich of the following statements is most correct4
a. 5ompensating managers with stoc$ can reduce the agenc" problem
between stoc$holders and managers.
b. 6estrictions are included in credit agreements to protect bondholders
from the agenc" problem that exists between bondholders and
stoc$holders.
c. The threat of a ta$eover can reduce the agenc" problem between
bondholders and stoc$holders.
d. 2tatements a and b are correct.
e. )ll of the statements above are correct.
(1.3) Agenc Answer: a Diff: E
1#
. 3hich of the following wor$ to reduce agenc" conflicts between
stoc$holders and bondholders4
a. !ncluding restrictive covenants in the compan"7s bond contract.
b. -roviding managers with a large number of stoc$ options.
c. The passage of laws which ma$e it easier for companies to resist
hostile ta$eovers.
d. 2tatements b and c are correct.
e. )ll of the statements above are correct.
(1.3) Agenc Answer: d Diff: E
1%
. 3hich of the following actions are li$el" to reduce the agenc" problem
between stoc$holders and managers4
a. 5ongress passes a law that severel" restricts hostile ta$eovers.
b. ) manager receives a lower salar" but receives additional shares of
the compan"7s stoc$.
c. The board of directors has become more vigilant in its oversight of
the compan"7s management.
d. 2tatements b and c are correct.
e. )ll of the statements above are correct.
Chapter 1: An Overview of Financial Management Page 3
(1.3) Agenc Answer: b Diff: E
1&
. 3hich of the following actions are li$el" to reduce agenc" conflicts
between stoc$holders and managers4
a. -a"ing managers a large fixed salar".
b. !ncreasing the threat of corporate ta$eover.
c. -lacing restrictive covenants in debt agreements.
d. )ll of the statements above are correct.
e. 2tatements b and c are correct.
(1.3) Managerial incentives Answer: e Diff: E
1(
. 3hich of the following mechanisms is used to motivate managers to act in
the interests of shareholders4
a. 8ond covenants.
b. The threat of a ta$eover.
c. 1xecutive stoc$ options.
d. 2tatements a and b are correct.
e. 2tatements b and c are correct.
(1.#) $nterest rates Answer: a Diff: E
1*
. 3hich of the following statements is 596615T4
a. !f expected inflation increases, interest rates are li$el" to
increase.
b. !f individuals in general increase the percentage of their income
that the" save, interest rates are li$el" to increase.
c. !f companies have fewer good investment opportunities, interest rates
are li$el" to increase.
d. !nterest rates on all debt securities tend to rise during recessions
because recessions increase the possibilit" of ban$ruptc", hence the
ris$iness of all debt securities.
e. !nterest rates on long'term bonds are more volatile than rates on
short'term debt securities li$e T'bills.
Page 4 Chapter 1: An Overview of Financial Management
Medium:
(1.2) %al&ation Answer: e Diff: M
1+
. 3hich of the following statements is most correct4
a. Free cash flows are called :free; because the cost of capital for
these cash flows is zero.
b. 2toc$ is valuable onl" because it generates cash flows for the
investor.
c. 0anagers can affect firm value b" changing the ris$iness of its cash
flows.
d. (a) and (b) are correct.
e. (b) and (c) are correct.
(1.2) '&ndamental val&e Answer: b Diff: M (
1,
. 3hich of the following statements is most correct4
a. ) firm7s fundamental value is its mar$et value.
b. ) firm7s fundamental value is the present value of its future free
cash flows.
c. ) firm7s mar$et price is usuall" greater than its fundamental value.
d. ) firm7s fundamental value is usuall" greater than its mar$et price.
e. ) firm7s fundamental value is its boo$ value.
(1.2) Goal of firm Answer: e Diff: M
.
. 3hich of the following statements is most correct4
a. Firms that tr" to maximize their stoc$ values will tend to la" off
emplo"ees to cut costs.
b. Firms that tr" to maximize their stoc$ values will raise the prices
of their products, gouging customers and driving them awa".
c. )nti'pollution laws are unnecessar" because firms will choose not to
pollute because that is in their best interests.
d. The government should allow monopolies to operate without regulation
so that the" ma" maximize their shareholders7 wealth.
e. <ewl"'privatized firms generall" hire more emplo"ees.
(1.3) Agenc Answer: c Diff: M
1
. 3hich of the following statements is most correct4
a. )genc" conflicts between stoc$holders and managers are not reall" a
problem when outsiders (i.e., non'managers) own shares in a
corporation.
b. 0anagers ma" operate in stoc$holders' best interests, or managers ma"
operate in their own personal best interests. )s long as managers
sta" within the law, there are no effective controls that
stoc$holders can implement to control managerial decision ma$ing.
c. The agenc" conflicts between bondholders and stoc$holders can be
reduced with the use of bond covenants.
d. )n agenc" relationship exists when one or more persons hire another
person to perform some service but withhold decision'ma$ing authorit"
from that person.
e. )ll of the statements above are false.
Chapter 1: An Overview of Financial Management Page 5
(1.3) Agenc Answer: d Diff: M

. 3hich of the following statements is most correct4

a. 9ne of the wa"s in which firms can mitigate or reduce agenc" problems
between bondholders and stoc$holders is b" increasing the amount of
debt in the capital structure.
b. The threat of ta$eover is one wa" in which the agenc" problem between
stoc$holders and managers can be alleviated.
c. 0anagerial compensation can be structured to reduce agenc" problems
between stoc$holders and managers.
d. 2tatements b and c are correct.
e. )ll of the statements above are correct.
(1.3) Agenc Answer: d Diff: M
#
. 3hich of the following is an example of a moral hazard4
a. ) 519 is awarded =1..,... worth of executive stoc$ options, which he
exercises two "ears later for =1,...,....
b. ) compan" borrows =1,...,... for investment in e>uipment, but uses
the mone" instead to repurchase stoc$.
c. ) compan" declares ban$ruptc", but instead of being li>uidated, it is
reorganized and one set of bondholders who are owed =1. million
accept =# million in pa"ment for the debt.
d. ) 519 orders the head>uarters moved ?ust so he can have a nicer
office.
e. ) group of institutional stoc$holders votes to oust management.
(1.3) Agenc Answer: a Diff: M
%
. ) moral hazard problem arises when@
a. )n agent ta$es unobserved actions on his own behalf.
b. ) principal hires another individual to perform some service.
c. Firms borrow mone" from bondholders.
d. 2toc$holders have to incur costs to ma$e managers act to maximize
stoc$ price.
e. 0anagers are granted performance shares.
(1.3) E%A Answer: c Diff: M
&
. 3hich of the following statements is most correct4
a. 1A) is a measure of the value added to customers.
b. 1A) is a measure of the value added to management.
c. 1A) is a measure of the firm7s true profitabilit".
d. 1A) is a measure of management compensation.
e. 1A) is a measure of stoc$ price.
Page 6 Chapter 1: An Overview of Financial Management
(1.)) *rans+arenc Answer: b Diff: M
(
. 3hich of the following statements is most correct4
a. ) mar$et is transparent when trading is inexpensive.
b. ) mar$et is transparent when accurate information is available to all
mar$et participants.
c. ) transparent mar$et has few regulations.
d. ) transparent mar$et has man" opportunities for trading on insider
information.
e. ) mar$et is transparent when ever"one $nows who the person is that
the" are trading with.
(1.)) Sarbanes,-.le Answer: d Diff: M
*
. 3hich of the following statements is most correct4
a. 2arbanes'9xle" re>uires the 2ecurities 1xchange 5ommission to audit
public companies7 financial statements.
b. 2arbanes'9xle" made it illegal for compan" executives to trade on
insider information.
c. 2arbanes'9xle" re>uires the 5hairman of the 8oard of Birectors to
sign and certif" the compan"7s financial statements.
d. 2arbanes'9xle" re>uires the 519 sign and certif" the compan"7s
financial statements.
e. 2arbanes'9xle" re>uires compan" executives to disclose their
fraudulent activities :in a timel" and accurate manner.;
(1.)) Sarbanes,-.le Answer: e Diff: M
+
. 3hich of the following statements is most correct4
a. 2arbanes'9xle" established a new Federal agenc", the -ublic 5ompan"
)uditing 8oard, to audit public companies7 financial statements.
b. 2arbanes'9xle" prohibited investment ban$s from allowing their
anal"sts to ma$e recommendations on stoc$s the investment ban$s do
business with.
c. 2arbanes'9xle" re>uires that either the 519 or 5F9 hand'deliver the
annual and >uarterl" financial statements to the 215.
d. 2arbanes'9xle" re>uires that auditors maintain extensive records to
document that their consulting and auditing services for a given
compan" are not conflicting.
e. 2arbanes'9xle" prohibits auditors from providing consulting services
to the companies the" audit.

(1.#) Sec&rit +rices and interest rates Answer: e Diff: M
,
. 2uppose the C.2. Treasur" announces plans to issue =&. billion of new
bonds. )ssuming the announcement was not expected, what effect, other
things held constant, would that have on bond prices and interest rates4
a. -rices and interest rates would both rise.
b. -rices would rise and interest rates would decline.
c. -rices and interest rates would both decline.
d. There would be no changes in either prices or interest rates.
e. -rices would decline and interest rates would rise.
(1.#) $nterest rates Answer: d Diff: M
Chapter 1: An Overview of Financial Management Page 7
#.
. 3hich of the following would be most li$el" to lead to higher interest
rates on all debt securities in the econom"4
a. /ouseholds start saving a larger percentage of their income.
b. The econom" moves from a boom to a recession.
c. The level of inflation begins to decline.
d. 5orporations step up their expansion plans and thus increase their
demand for capital.
e. The Federal 6eserve uses monetar" polic" in an attempt to stimulate
the econom".
(1.#) $nterest rates Answer: e Diff: M
#1
. 3hich of the following factors would be most li$el" to lead to an
increase in interest rates in the econom"4
a. /ouseholds reduce their consumption and increase their savings.
b. The Federal 6eserve decides to tr" to stimulate the econom".
c. There is a decrease in expected inflation.
d. The econom" falls into a recession.
e. 0ost businesses decide to modernize and expand their manufacturing
capacit", and to install new e>uipment to reduce labor costs.
Page Chapter 1: An Overview of Financial Management
Chapter 1: An Overview of Financial Management Page !
CH!TE" #
$,(E", $D ,%)-T'%$,
1. (1.2) Goal of firm Answer: b Diff: E
. (1.2) Goal of firm Answer: b Diff: E
#. (1.2) Managerial incentives Answer: b Diff: E
%. (1.2) Social welfare and finance Answer: b Diff: E
&. (1.2) Social welfare and finance Answer: a Diff: E
(. (1.3) Agenc Answer: b Diff: E
*. (1.3) Agenc Answer: b Diff: E
+. (1.3) Agenc Answer: a Diff: E
,. (1.2) Managerial incentives Answer: a Diff: M
1.. (1.3) !ostile ta"eovers Answer: b Diff: M
11. (1.2) Goal of firm Answer: d Diff: E
1. (1.3) Agenc Answer: d Diff: E
8oth statements a and b are correctD therefore, statement d is the correct
choice. The threat of a ta$eover alleviates the agenc" problem between
managers and stoc$holders, not between bondholders and stoc$holders.
1#. (1.3) Agenc Answer: a Diff: E
2tatement a is correctD the other statements are false. 6estrictive
covenants resolve differences between bondholders and stoc$holders.
1%. (1.3) Agenc Answer: d Diff: E
2tatement a will serve to increase the agenc" problems b" preventing
ta$eovers. 8oth statements b and c will reduce agenc" problems.
1&. (1.3) Agenc Answer: b Diff: E
2tatement b is true. 5orporate ta$eovers are most li$el" to occur when a
firm is underperforming. 0anagers who fear losing their ?obs will tr" to
maximize shareholder wealth. The other statements are false. 2tatement a will
exacerbate agenc" conflict, while statement c reduces the agenc" conflict
between stoc$holders and bondholders.
1(. (1.3) Managerial incentives Answer: e Diff: E
2tatements b and c are trueD therefore, statement e is the correct choice.
2tatement a is false, bond covenants force managers to act in the interest of
bondholders.
1*. (1.#) $nterest rates Answer: a EAS/
1+. (1.2) %al&ation Answer: e Diff: M
2tatement e is true. 2toc$ is valuable onl" to the extent that it generates
cash flows for the investor, and managers can impact the value of the firm b"
changing the size, ris$iness, or timing of its cash flows.

1,. (1.2) '&ndamental val&e Answer: b Diff: M (
2tatement b is true. )n investor7s intrinsic value for a stoc$ is the value
that he or she would put on the investment. The mar$et price is determined
b" the marginal investor, hence the mar$et price is the marginal investor7s
intrinsic value for the stoc$.

. .(1.2) Goal of firm Answer: e Diff: M
2tatement e is correct. Eenerall" the performance of firms that are
privatized improves, causing them to hire more emplo"ees as the" grow.
1. (1.3) Agenc Answer: c Diff: M
2tatement c is true. 2tatement a is false because agenc" conflicts can and
do occur when outsiders own shares in a corporation. 2tatement b is false.
1ven if managers sta" within the law, the threat of firing andFor the threat
of ta$eover ma" be used to $eep managers7 interests aligned with those of the
shareholders. 2tatement d is false because the conflict exists when the
decision'ma$ing authorit" is delegated to that person.
. (1.3)Agenc Answer: d Diff: M
2tatement d is most correct. 2tatement a is incorrect, because increasing
the amount of debt can increase agenc" problems.
# .(1.3) Agenc Answer: d Diff: M
2tatement d is correct. ) moral hazard is an unobservable action the agent
ta$es on his behalf to the detriment of the principal. !n this case, the
move is not necessar" for the compan". !t is onl" to better the 5197s
personal situation.
% .(1.3) Agenc Answer: a Diff: M
2tatement a is correct. The definition of a moral hazard problem is when an
agent underta$es unobservable actions on his own behalf to the detriment of
the principal.
& .(1.3) E%A Answer: c Diff: M
2tatement c is correct. 1A), or 1conomic Aalue )dded, is after'tax operating
profit less the cost of all capital used b" the firm. !t is a measure of the
firm7s true profitabilit".
( .(1.)) *rans+arenc Answer: b Diff: M
2tatement b is correct. ) mar$et is transparent when reliable and accurate
information is available to all mar$et participants.
* .(1.)) Sarbanes,-.le Answer: d Diff: M
2tatement d is correct. 9ne of the provisions of the 29G law is that the 519
must sign and personall" certif" that the annual and >uarterl" statements are
complete and accurate.
+ .(1.)) Sarbanes,-.le Answer: e Diff: M
2tatement e is correct. )ccounting firms ma" provide auditing or consulting
services to a compan", but not both. This is to eliminate the conflict of
interests that occurred when auditors were complicit in companies7 fraudulent
activities.
,. (1.#) Sec&rit +rices and interest rates Answer: e Diff: M
#.. (1.#) $nterest rates Answer: d Diff: M
#1. (1.#) $nterest rates Answer: e Diff: M
)n increase in the demand for capital b" businesses will increase interest
rates in the econom".