Class

1

Multiple Choice Questions
1. Generally, a corporation is owned by the:
I) Managers; II) Board of Directors; III) Shareholders
A. I only
B. II and III
C. III only
D. I, II and III
2. The following are examples of intangible assets except:
A. Buildings
B. Trademarks
C. Patents
D. Technical expertise
3. A firm's investment decision is also called the:
A. Financing decision
B. Liquidity decision
C. Capital budgeting decision
D. None of the above
4. The following are examples of financial assets except:
A. Common stock
B. Bank loan
C. Preferred stock
D. Buildings
5. The following are important functions of financial markets:
I) Source of financing; II) Provide liquidity; III) Reduce risk; IV) Source of information
A. I only
B. I and II only
C. I, II, III, and IV
D. IV only
6. Conflicts of interest between shareholders and managers of a firm result in:
A. Principal-agent problem
B. Increased agency costs
C. Both A and B
D. Managers owning the firm

7. In the principal-agent framework:
A. Shareholders are the principals
B. Managers are the principals
C. Managers are the agents
D. A and C

8. Costs associated with the conflicts of interest between the bondholders and the shareholders of a
corporation are called:
A. Legal costs
B. Bankruptcy costs
C. Administrative costs
D. Agency costs
9. Agency costs are incurred by a corporation because:
A. managers may not attempt to maximize the value of the firm to shareholders
B. shareholders incur monitoring cost
C. separation of ownership and management
D. all of the above
10. The financial goal of a corporation is to:
A. Maximize profits
B. Maximize sales
C. Maximize the value of the firm for the shareholders
D. Maximize managers' benefits
11. The sale of financial assets is also referred to as the:
A. Capital decision
B. CFO decision
C. Financing decision
D. Investment decision
12. The mixture of debt and equity, used to finance a corporation is also known as:
A. Capital budgeting
B. Capital structure
C. Investing
D. Treasury
13. Of the following list, which is a stakeholder?
I) Employee; II) Customer; III) Community; IV) Supplier
A. I, II and IV only
B. III only
C. I and II only
D. All
14. The idea of maximizing shareholder value is widely accepted in:
I) U.S.A.; II) U.K; III) Germany; IV) France; V) Japan
A. I only
B. I and II only
C. III, IV and V only
D. I, II, III, IV and V

15. The idea that firms should be run for stakeholders welfare is accepted in:
I) U.S.A.; II) U.K; III) Germany; IV) France; V) Japan
A. I only
B. I and II only
C. III, IV and V only
D. I, II, III, IV and V
True / False Questions
1. Real assets of a corporation are claims on their financial assets.
FALSE
2. A firm's overall value belongs entirely to the shareholders.
FALSE
3. Managers, Shareholders, and lenders of firm have identical information about the value
of the firm.
FALSE
Short Answer Questions

1. Briefly explain the sequence flow of cash between financial markets and the firm.

Cash is raised by selling financial assets to investors.
Cash is invested in the firm's operation and used to purchase real assets.
Cash is generated by the firm's operations.
Cash is reinvested or returned to investors.

2. Briefly explain the functions of financial markets.

There are five important functions of financial markets. They are:
A source of financing for corporations.
Provide liquidity for the investors.
Reduce risk for the investors.
Source of information.
Monitor of firms' financial performance.

3. Briefly discuss the role of the various types of financial managers.

Chief Financial Officer (CFO): Supervises the treasurer and the controller in a large corporation. CFO is
involved in corporate planning and financial policy.
Treasurer: Is responsible for obtaining funds, managing cash, banking relationships and investor
relationships.
Controller: Is responsible for accounting functions, payroll and taxes.

4. Briefly explain the term Agency costs as related to a corporation.

Agency costs arise in a corporation as a result of principal-agent problems. For example, managers
may not act in the best interests of the shareholders while making decisions, and therefore the
shareholders incur monitoring costs. These monitoring costs are agency costs. Agency costs also arise
as result of informational asymmetry between the managers and other stakeholders of a firm.
Agency costs tend to reduce the value of a firm.
5. Explain why maximization of shareholders' wealth is the appropriate goal of the firm.
Under perfect market conditions, everyone can borrow or lend at the same interest rate. This implies
that differences in consumption patterns can be adjusted in the capital markets. Given this, all
investors will agree that they are better off if the firm maximizes their current wealth, i.e. maximizing
shareholders' wealth.
6. In most large corporations, ownership and management are separated. What are the main
implications of this separation?

Separation of ownership and management typically leads to agency problems, where managers
prefer to consume private perks or make other decisions for their private benefit, rather than
maximize shareholder wealth.

7. Why might one expect managers to act in shareholders interest? Explain.

Managers should act in shareholders interests because they have a legal duty to act in their
interests. Managers may also receive compensation, either bonuses or stock and option payouts
whose value is tied (roughly) to firm performance. Managers may fear personal reputational
damage that would result from not acting in shareholders interests. Managers can be fired by the
board of directors, which, in turn, is elected by shareholders. If managers still fail to act in
shareholders interests, shareholders may sell their shares, lowering the stock price, and potentially
creating the possibility of a takeover, which can again lead to changes in the board of directors and
senior management.

Multiple Choice Questions (Numerical)

1. Mr. Free has $100 dollars income this year and zero income next year. The market interest
rate is 10% per year. If Mr. Free consumes $30 this year, and invests the rest in the market,
what will be his consumption next year?
A. $50
B. $100
C. $77
D. $55

Consumption next year = (100 - 30) * (1.1) = 77

2. Mr. Bird has $100 income this year and zero income next year. The market interest rate is 10%
per year. Mr. Bird also has an investment opportunity in which he can invest $50 today and receive
$80 next year. Suppose Mr. Bird consumes $30 this year and invests in the project. What will be his
consumption next year?
A. $88
B. $102
C. $80
D. $100

Consumption next year = (100 - 30 - 50) * 1.1 + 80 = 102


3. Ms. Venus has $100 income this year and $110 next year. The market interest rate is 10% per
year. Suppose Ms. Venus consumes $60 this year. What will be her consumption next year?
A. $154
B. $170
C. $120
D. None of the above

Consumption next year = (100 - 60) * 1.1 + 110 = 154


4. Mr. Thomas has $100 income this year and zero income next year. The market interest rate is 10%
per year. Mr. Thomas also has an investment opportunity in which he can invest $50 this year and
receive $80 next year. Suppose Mr. Thomas consumes $50 this year and invests in the project. What
will be his consumption next year?
A. $55
B. $80
C. $50
D. None of the above

Mr. Thomas' investment this year = 100 - 50 = 50. His income next year by taking the investment
opportunity is equal to 80.
5. Mr. Dell has $100 income this year and zero income next year. The market interest rate is 10% per
year. Mr. Dell also has an investment opportunity in which he can invest $50 this year and receive
$80 next year. Suppose Mr. Dell consumes $50 this year and invests in the project. What is the NPV
of the investment opportunity?
A. $5
B. $22.73
C. $0 (zero)
D. None of the above.
NPV = (80/1.1) - 50 = + 22.73