Chapter1

TheRoleandEnvironment
ofManagerialFinance

Learning Goals
1. Definefinance,itsmajorareasandopportunitiesavailableinthisfield,andthelegalformsof
businessorganization.

2. Describethemanagerialfinancefunctionanditsrelationshiptoeconomicsandaccounting.

3. Identifytheprimaryactivitiesofthefinancialmanager.

4. Explainthegoalofthefirm,corporategovernance,theroleofethics,andtheagencyissue.

5. Understandfinancialinstitutionsandmarkets,andtheroletheyplayinmanagerialfinance.

6. Discussbusinesstaxesandtheirimportanceinfinancialdecisions.

True/False
1. Afinancialanalystisresponsibleformaintainingandcontrollingthefirmsdailycashbalances.
Frequentlymanagesthefirmsshortterminvestmentsandcoordinatesshorttermborrowingand
bankingrelationships.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:1
Topic:CareerOpportunities

2. Financeisconcernedwiththeprocessinstitutions,markets,andinstrumentsinvolvedinthetransfer
ofmoneyamongandbetweenindividuals,businessesandgovernment.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:1
Topic:FinanceDefined

3. Financialservicesareconcernedwiththedutiesofthefinancialmanager.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:1
Topic:RoleofFinancialManager
2GitmanPrinciplesofFinance,EleventhEdition
4. Financialmanagersactivelymanagethefinancialaffairsofmanytypesofbusinessfinancialand
nonfinancial,privateandpublic,forprofitandnotforprofit.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:1
Topic:RoleofFinancialManager

5. Inpartnerships,ownershaveunlimitedliabilityandmayhavetocoverdebtsofotherlessfinancially
soundpartners.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:1
Topic:LegalFormofOrganization

6. Inpartnerships,apartnercanreadilytransferhis/herwealthtootherpartners.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:1
Topic:LegalFormofOrganization

7. Theboardofdirectorsisresponsibleformanagingdaytodayoperationsandcarryingoutthe
policiesestablishedbythechiefexecutiveofficer.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:1
Topic:CorporateGovernance

8. Thesoleproprietorhasunlimitedliability;hisorhertotalinvestmentinthebusinesscanbetakento
satisfycreditors.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:1
Topic:LegalFormofOrganization

9. Inlimitedpartnerships,onlyonepartnermayassumelimitedliability.Allotherpartnershaveto
haveunlimitedliability.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:1
Topic:LegalFormofOrganization

10. Thepresidentorchiefexecutiveofficeriselectedbythefirmsstockholdersandhasultimate
authoritytoguidecorporateaffairsandmakegeneralpolicy.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:1
Topic:CorporateGovernance
 Chapter1TheRoleandEnvironmentofManagerialFinance3
11. Inlimitedpartnerships,partnersliabilitiesarelimitedtotheirinvestmentinthepartnership.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:1
Topic:LegalFormofOrganization

12. Inlimitedliabilitypartnerships,theliabilityprotectiondoesnotprotectpartnersfromtheir
individualactsofmalpractice.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:1
Topic:LegalFormofOrganization

13. Thecapitalexpendituresanalyst/managerisresponsiblefortheevaluationandrecommendationof
proposedassetinvestmentsandmaybeinvolvedinthefinancialaspectsofimplementationof
approvedinvestments.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:1
Topic:ManagerialFinanceFunctions

14. Thefinancialanalystadministersthefirmscreditpolicybyanalyzingormanagingtheevaluationof
creditapplications,extendingcredit,andmonitoringandcollectingaccountsreceivable.
Answer: FALSE
LevelofDifficulty:3
LearningGoal:1
Topic:ManagerialFinanceFunctions

15. Inlargecompanies,theprojectfinancemanagerisresponsibleforcoordinatingtheassetsand
liabilitiesoftheemployeespensionfund.
Answer: FALSE
LevelofDifficulty:4
LearningGoal:1
Topic:ManagerialFinanceFunctions

16. InScorporations,stockholdersreceivealloftheorganizationalbenefitsofacorporationandthetax
advantagesofapartnership,butlosecertaintaxadvantagesrelatedtopensionplansthatare
availabletotraditionalcorporations.
Answer: TRUE
LevelofDifficulty:4
LearningGoal:1
Topic:LegalFormofOrganization

17. UnlikeanScorporation,thelimitedliabilitycorporation(LLC)canownmorethan80percentof
anothercorporation,andcorporations,partnerships,ornonU.S.residentscanownlimitedliability
corporationshares.
Answer: TRUE
LevelofDifficulty:4
LearningGoal:1
Topic:LegalFormofOrganization
4GitmanPrinciplesofFinance,EleventhEdition
18. Inlimitedliabilitypartnership,allpartnershavelimitedliabilitywithregardtothebusinessthey
arenotpersonallyliableforotherpartnersmalpracticeandthelimitedliabilitypartnershipis
taxedaspartnership.
Answer: TRUE
LevelofDifficulty:4
LearningGoal:1
Topic:LegalFormofOrganization

19. Marginalanalysisstatesthatfinancialdecisionsshouldbemadeandactionstakenonlywhenadded
benefitsexceedsaddedcosts.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:2
Topic:FundamentalConcepts

20. Thecorporatecontrollertypicallyhandlestheaccountingactivities,suchastaxmanagement,data
processing,andcostandfinancialaccounting.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:2
Topic:ManagerialFinanceFunctions

21. Thefinancialmanagerplacesprimaryemphasisoncashflows,theinflowandoutflowofcash.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:2
Topic:FundamentalConcepts

22. Managerialfinanceisconcernedwithdesignanddeliveryofadviceandfinancialproductsto
individuals,business,andgovernment.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:2
Topic:ManagerialFinanceFunctions

23. Thecorporatetreasurertypicallyhandlesthebothcostaccountingandfinancialaccounting.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:2
Topic:ManagerialFinanceFunctions

24. Theaccrualmethodrecognizesrevenueatthepointofsaleandrecognizesexpenseswhenincurred.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:2
Topic:AccountingConcepts
 Chapter1TheRoleandEnvironmentofManagerialFinance5
25. Theaccountantevaluatesfinancialstatements,developsadditionaldata,andmakesdecisionsbased
onhisorherassessmentoftheassociatedreturnsandrisks.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:2
Topic:AccountingConcepts

26. Thecorporatetreasureristheofficerresponsibleforthefirmsaccountingactivities,suchas
corporateaccounting,taxmanagement,financialaccounting,andcostaccounting.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:2
Topic:ManagerialFinanceFunctions

27. Thecorporatecontrolleristheofficerresponsibleforthefirmsfinancialactivitiessuchasfinancial
planningandfundraising,makingcapitalexpendituredecisions,andmanagingcash,credit,the
pensionfund,andforeignexchange.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:2
Topic:ManagerialFinanceFunctions

28. Highcashflowisgenerallyassociatedwithahighersharepricewhereashigherrisktendstoresult
inalowershareprice.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:2
Topic:FundamentalConcepts

29. Thecorporatetreasurersfocustendstobemoreexternal,whilethecontrollersfocusismore
internal.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:2
Topic:ManagerialFinanceFunctions

30. Thefinancialmanagerpreparesfinancialstatementsthatrecognizerevenueatthepointofsaleand
expenseswhenincurred.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:2
Topic:RoleofFinancialManager

31. Usingcertainstandardizedandgenerallyacceptedprinciples,theaccountantpreparesfinancial
statementsthatrecognizerevenueatthepointofsaleandexpenseswhenincurred.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:2
Topic:AccountingConcepts
6GitmanPrinciplesofFinance,EleventhEdition
32. Thefinancialmanagermustlookbeyondfinancialstatementstoobtaininsightintodevelopingor
existingproblemssincetheaccrualaccountingdatadonotfullydescribethecircumstancesofa
firm.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:2
Topic:RoleofFinancialManager

33. Whenconsideringeachfinancialdecisionalternativeorpossibleactionintermsofitsimpactonthe
sharepriceofthefirmsstock,financialmanagersshouldacceptonlythoseactionsthatareexpected
toincreasethefirmsprofitability.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:3
Topic:GoaloftheFirm

34. Financialanalysisandplanningisconcernedwithanalyzingthemixofassetsandliabilities.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:3
Topic:ManagerialFinanceFunctions

35. Financingdecisionsdealwiththelefthandsideofthefirmsbalancesheetandinvolvethemost
appropriatemixofcurrentandfixedassets.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:3
Topic:ManagerialFinanceFunctions

36. Thegoalofethicsistomotivatebusinessandmarketparticipantstoadheretoboththeletterandthe
spiritoflawsandregulationsinallaspectsofbusinessandprofessionalpractice.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:4
Topic:TheRoleofEthics

37. Toachievethegoalofprofitmaximization,foreachalternativebeingconsidered,thefinancial
managerwouldselecttheonethatisexpectedtoresultinthehighestmonetaryreturn.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:4
Topic:FundamentalConcepts

38. Dividendpaymentschangedirectlywithchangesinearningspershare.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:4
Topic:FundamentalConcepts
 Chapter1TheRoleandEnvironmentofManagerialFinance7
39. Thewealthofcorporateownersismeasuredbythesharepriceofthestock.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:4
Topic:GoaloftheFirm

40. Economicvalueadded(EVA)isthedifferencebetweenthecostoffundsusedtofinancean
investmentanditsaftertaxoperatingprofits.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:4
Topic:FundamentalConcepts

41. Economicvalueadded(EVA)iscalculatedbysubtractingthecostoffundsusedtofinancean
investmentfromitsaftertaxoperatingprofits.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:4
Topic:FundamentalConcepts

42. Returnandriskarethekeydeterminantsofshareprice,whichrepresentsthewealthoftheownersin
thefirm.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:4
Topic:FundamentalConcepts

43. Ahighearningspershare(EPS)doesnotnecessarilytranslateintoahighstockprice.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:4
Topic:FundamentalConcepts

44. Theprofitmaximizationgoalignoresthetimingofreturns,doesnotdirectlyconsidercashflows,
andignoresrisk.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:4
Topic:GoaloftheFirm

45. Whenconsideringeachfinancialdecisionalternativeorpossibleactionintermsofitsimpactonthe
sharepriceofthefirmsstock,financialmanagersshouldacceptonlythoseactionsthatareexpected
toincreaseshareprice.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:4
Topic:GoaloftheFirm
8GitmanPrinciplesofFinance,EleventhEdition
46. Higherrisktendstoresultinahighersharepricesincethestockholdermustbecompensatedforthe
greaterrisk.
Answer: FALSE
LevelofDifficulty:3
LearningGoal:4
Topic:GoaloftheFirm

47. Whereriskisinvolved,stockholdersexpecttoearnhigherratesofreturnoninvestmentsoflower
riskandviceversa.
Answer: FALSE
LevelofDifficulty:3
LearningGoal:4
Topic:GoaloftheFirm

48. Thelikelihoodthatmanagersmayplacepersonalgoalsaheadofcorporategoalsiscalledtheagency
problem.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:4
Topic:AgencyIssue

49. Agentsofcorporateownersarethemselvesownersofthefirmandhavebeenelectedbyallthe
corporateownerstorepresentthemindecisionmakingandmanagementofthefirm.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:4
Topic:AgencyIssue

50. Theagencyproblemistheacquisitionofafirmbyanotherfirmthatisnotsupportedby
management.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:4
Topic:AgencyIssue

51. Marketforcesandagencycostshelptopreventorminimizeagencyproblems.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:4
Topic:FinancialInstitutions

52. Creditunionsarethelargesttypeoffinancialintermediarythathandleindividualsavings.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:5
Topic:FinancialInstitutions
 Chapter1TheRoleandEnvironmentofManagerialFinance9
53. Amutualfundisatypeoffinancialintermediarythatobtainsfundsthroughthesaleofsharesand
usestheproceedstoacquirebondsandstocksissuedbyvariousbusinessandgovernmentalunits.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:5
Topic:FinancialInstitutions

54. Primaryandsecondarymarketsaremarketsforshorttermandlongtermsecurities,respectively.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:5
Topic:FinancialMarkets

55. Financialmarketsareintermediariesthatchannelthesavingsofindividuals,businessesand
governmentintoloansorinvestments.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:5
Topic:FinancialMarkets

56. Moneymarketsinvolvethetradingofsecuritieswithmaturitiesofoneyearorlesswhilecapital
marketinvolvethebuyingandsellingofsecuritieswithmaturitiesofmorethanoneyear.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:5
Topic:FinancialMarkets

57. Afinancialinstitutionisanintermediarythatchannelsthesavingsofindividuals,businesses,and
governmentsintoloansorinvestments.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:5
Topic:FinancialInstitutions

58. Apublicofferingisthesaleofanewsecurityissuetypicallydebtorpreferredstockdirectlyto
aninvestororgroupofinvestors.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialMarkets

59. Eurocurrencydepositsarisewhenacorporationorindividualmakesadepositinabankina
currencyotherthanthelocalcurrencyofthecountrywherethebankislocated.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialInstitutions
10GitmanPrinciplesofFinance,EleventhEdition
60. TheDepositoryInstitutionsDeregulationandMonetaryControlActof1980(DIDMCA)instituted
interestrateceilingsonallaccountsafinancialinstitutionoffers.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialInstitutions

61. Afinancialsupermarketisaninstitutionatwhichacustomercanobtainafullarrayoffinancial
services,suchaschecking,savings,brokerage,insurance,retirementandestateplanning.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialInstitutions

62. Aprimarymarketisafinancialmarketinwhichpreownedsecuritiesaretraded.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialMarkets

63. Loantransactionsbetweencommercialbanksinwhichthefederalgovernmentbecomesinvolved
arereferredtoasfederalfunds.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialInstitutions

64. TheeurocurrencymarketisamarketforshorttermbankdepositsdenominatedinU.S.dollarsor
othereasilyconvertiblecurrencies.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialMarkets

65. TheOvertheCounter(OTC)exchangeisnotanorganizationbutanintangiblemarketfortrading
securitieswhicharenotlistedbytheorganizedexchanges.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialMarkets

66. Themoneymarketisafinancialrelationshipcreatedbyanumberofinstitutionsandarrangements
thatallowssuppliersanddemandersoflongtermfundstomaketransactions.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialMarkets
 Chapter1TheRoleandEnvironmentofManagerialFinance11
67. Unliketheorganizedexchanges,theOTCmakesamarketinbothoutstandingsecuritiesandnew
publicissues,makingitbothasecondaryandaprimarymarket.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialMarkets

68. IntheOTCmarket,theaskpriceisthehighestpriceofferedbyadealertopurchaseagivensecurity.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialMarkets

69. IntheOTCmarket,thepricesatwhichsecuritiesaretradedresultfrombothcompetitivebidsand
negotiation.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialMarkets

70. Thepricetoearnings(PE)ratiomeasurestheamountcommonstockinvestorsarewillingtopayfor
eachdollarofthefirmsearnings.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:5
Topic:FundamentalConcepts

71. Anefficientmarketisamarketthatallocatesfundstotheirmostproductiveuseasaresultof
competitionamongwealthmaximizinginvestors.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialMarkets

72. InvestorsfindEurobondsattractivebecausetheyprovidecurrencydiversificationandbecausethey
provideanonymitytotheinvestorwishingtoavoidpaymentoftaxes.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:5
Topic:FinancialMarkets

73. Theordinaryincomeofacorporationisincomeearnedthroughthesaleofafirmsgoodsand
servicesandiscurrentlytaxedsubjecttotheindividualincometaxrates.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:6
Topic:BusinessTaxes
12GitmanPrinciplesofFinance,EleventhEdition
74. Themarginaltaxraterepresentstherateatwhichadditionalincomeistaxed.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:6
Topic:BusinessTaxes

75. Dividendsreceivedoncommonandpreferredstocksheldinothercorporationsareallsubjectto
exclusionfortaxpurposesinordertoavoidtripletaxation.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:6
Topic:BusinessTaxes

76. Becauseofthedividendexclusiononly70percentoftheintercorporatedividendsareincludedas
ordinaryincome.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:6
Topic:BusinessTaxes

77. Taxlawsareusedtoaccomplisheconomicgoalssuchasprovidingincentivesforcorporate
investmentincertaintypesofassets.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:6
Topic:BusinessTaxes

78. Withprogressivetaxrates,theaveragetaxrateisalwayslessthanorequaltothemarginaltaxrate.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:6
Topic:BusinessTaxes

79. Dividendsreceivedbycorporationsoncommonandpreferredstockheldinothercorporationsand
representinglessthan20percentownershipinthemissubjectto70percentexclusionfortax
purposes.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:6
Topic:BusinessTaxes

80. Theboardofdirectorsofmostlargecorporationstodayincludebothinsidedirectorsandoutside
directors.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:4
Topic:CorporateGovernance
 Chapter1TheRoleandEnvironmentofManagerialFinance13
81. ThemajorpurposeoftheSarbanesOxleyActof2002wastoplacecapsonthecompensationthat
couldbepaidtocorporateexecutives.
Answer: FALSE
LevelofDifficulty:3
LearningGoal:4
Topic:CorporateGovernance

82. Institutionalinvestorsareprofessionalinvestorswhoworkonbehalfofthefederalgovernmentto
ensurefairnessinthefinancialmarkets.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:4
Topic:CorporateGovernance

83. RecentstudiesonexecutivecompensationhavefailedtofindastrongrelationshipbetweenCEO
compensationandshareprice.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:4
Topic:AgencyIssue

Multiple Choice Questions

1. Thepartoffinanceconcernedwithdesignanddeliveryofadviceandfinancialproductsto
individuals,business,andgovernmentiscalled
(a) ManagerialFinance.
(b) FinancialManager.
(c) FinancialServices.
(d) Noneoftheabove.
Answer: C
LevelofDifficulty:1
LearningGoal:1
Topic:ManagerialFinanceFunctions

2. Managerialfinance
(a) involvestaskssuchasbudgeting,financialforecasting,cashmanagement,andfunds
procurement.
(b) involvesthedesignanddeliveryofadviceandfinancialproducts.
(c) recognizesfundsonanaccrualbasis.
(d) devotesthemajorityofitsattentiontothecollectionandpresentationoffinancialdata.
Answer: A
LevelofDifficulty:1
LearningGoal:1
Topic:ManagerialFinanceFunctions
14GitmanPrinciplesofFinance,EleventhEdition
3. Financecanbedefinedas
(a) thesystemofdebitsandcredits.
(b) thescienceoftheproduction,distribution,andconsumptionofwealth.
(c) theartandscienceofmanagingmoney.
(d) theartofmerchandisingproductsandservices.
Answer: C
LevelofDifficulty:1
LearningGoal:1
Topic:FinanceDefined
4. Financialservice
(a) isconcernedwiththedutiesofthefinancialmanager.
(b) involvesthedesignanddeliveryofadviceandfinancialproducts.
(c) providesguidelinesfortheefficientoperationofthebusiness.
(d) handlesaccountingactivitiesrelatedtodataprocessing.
Answer: B
LevelofDifficulty:1
LearningGoal:1
Topic:CareerOpportunities
5. CareeropportunitiesinfinancialservicesincludeallofthefollowingEXCEPT
(a) investments.
(b) realestateandinsurance.
(c) capitalexpendituresmanagement.
(d) personalfinancialplanning.
Answer: C
LevelofDifficulty:1
LearningGoal:1
Topic:CareerOpportunities
6. Whichofthefollowingisacareeropportunityinmanagerialfinance?
(a) Investment.
(b) RealEstateandInsurance.
(c) CapitalexpendituresManagement.
(d) PersonalFinancialPlanning.
Answer: C
LevelofDifficulty:1
LearningGoal:1
Topic:CareerOpportunities
7. Whichofthefollowinglegalformsoforganizationismostexpensivetoorganize?
(a) Soleproprietorships.
(b) Partnerships.
(c) Corporations.
(d) Limitedpartnership.
Answer: C
LevelofDifficulty:1
LearningGoal:1
 Chapter1TheRoleandEnvironmentofManagerialFinance15
Topic:LegalFormofOrganization
16GitmanPrinciplesofFinance,EleventhEdition
8. WhichofthefollowinglegalformsoforganizationsincomeisNOTtaxedunderindividualincome
taxrate?
(a) Soleproprietorships.
(b) Partnerships.
(c) Limitedpartnership.
(d) Corporation.
Answer: D
LevelofDifficulty:1
LearningGoal:1
Topic:LegalFormofOrganization

9. Underwhichofthefollowinglegalformsoforganization,isownershipreadilytransferable?
(a) Soleproprietorships.
(b) Partnerships.
(c) Limitedpartnership.
(d) Corporation.
Answer: D
LevelofDifficulty:1
LearningGoal:1
Topic:LegalFormofOrganization

10. Thetrueowner(s)ofthecorporationis(are)the_________.
(a) boardofdirectors
(b) chiefexecutiveofficer
(c) stockholders
(d) creditors
Answer: C
LevelofDifficulty:1
LearningGoal:1
Topic:CorporateGovernance

11. The_________has/havetheultimateresponsibilityinguidingcorporateaffairsandcarryingout
policies.
(a) boardofdirectors
(b) chiefexecutiveofficer
(c) stockholders
(d) creditors
Answer: A
LevelofDifficulty:1
LearningGoal:1
Topic:CorporateGovernance
 Chapter1TheRoleandEnvironmentofManagerialFinance17
12. Theresponsibilityformanagingdaytodayoperationsandcarryingoutcorporatepoliciesbelongs
tothe_________.
(a) boardofdirectors
(b) chiefexecutiveofficer
(c) stockholders
(d) creditors
Answer: B
LevelofDifficulty:1
LearningGoal:1
Topic:CorporateGovernance

13. Inacorporation,themembersoftheboardofdirectorsareelectedbythe
(a) chiefexecutiveofficer.
(b) creditors.
(c) stockholders.
(d) employees.
Answer: C
LevelofDifficulty:1
LearningGoal:1
Topic:CorporateGovernance

14. _________isconcernedwiththedutiesofthefinancialmanagerinthebusinessfirm.
(a) FinancialServices
(b) FinancialManager
(c) ManagerialFinance
(d) Noneoftheabove
Answer: C
LevelofDifficulty:2
LearningGoal:1
Topic:RoleoftheFinancialManager

15. About75percentofallbusinessfirmsare
(a) soleproprietorships.
(b) partnerships.
(c) corporations.
(d) Scorporations.
Answer: A
LevelofDifficulty:2
LearningGoal:1
Topic:LegalFormofOrganization
18GitmanPrinciplesofFinance,EleventhEdition
16. Amajorweaknessofapartnershipis
(a) limitedliability.
(b) difficultyliquidatingortransferringownership.
(c) accesstocapitalmarkets.
(d) loworganizationalcosts.
Answer: B
LevelofDifficulty:2
LearningGoal:1
Topic:LegalFormofOrganization

17. AllofthefollowingarekeystrengthsofacorporationEXCEPT
(a) accesstocapitalmarkets.
(b) limitedliability.
(c) loworganizationcosts.
(d) readilytransferableownership.
Answer: C
LevelofDifficulty:2
LearningGoal:1
Topic:LegalFormofOrganization

18. Whichofthefollowinglegalformsoforganizationischaracterizedbylimitedliability?
(a) Soleproprietorship.
(b) Partnership.
(c) Corporation.
(d) Professionalpartnership.
Answer: C
LevelofDifficulty:2
LearningGoal:1
Topic:LegalFormofOrganization

19. Thedominantformoforganizationwithrespecttoreceiptsandnetprofitsisthe
(a) soleproprietorship.
(b) partnership.
(c) corporation.
(d) Scorporation.
Answer: C
LevelofDifficulty:2
LearningGoal:1
Topic:LegalFormofOrganization
 Chapter1TheRoleandEnvironmentofManagerialFinance19
20. Alegalentitywhichcansueandbesued,makeandbepartytocontracts,andacquirepropertyin
itsownnameis
(a) asoleproprietorship.
(b) apartnership.
(c) acorporation.
(d) aprofessionalpartnership.
Answer: C
LevelofDifficulty:2
LearningGoal:1
Topic:LegalFormofOrganization

21. The_________isresponsibleforevaluatingandrecommendingproposedassetinvestments.
(a) FinancialAnalyst
(b) CreditAnalyst
(c) PensionFundManager
(d) CapitalexpendituresAnalyst
Answer: D
LevelofDifficulty:3
LearningGoal:1
Topic:ManagerialFinanceFunctions

22. Ina(n)_________,ownershavelimitedliabilitywithregardtothebusinesstheyarenot
personallyliableforthemalpracticeofotherowners.
(a) limitedpartnership
(b) Scorporation
(c) partnership
(d) limitedliabilitypartnership
Answer: D
LevelofDifficulty:3
LearningGoal:1
Topic:LegalFormofOrganization

23. Managerialfinance
(a) involvestaskssuchasbudgeting,financialforecasting,cashmanagement,andfunds
procurement.
(b) involvesthedesignanddeliveryofadviceandfinancialproducts.
(c) recognizesfundsonanaccrualbasis.
(d) devotesthemajorityofitsattentiontothecollectionandpresentationoffinancialdata.
Answer: A
LevelofDifficulty:1
LearningGoal:2
Topic:ManagerialFinanceFunctions
20GitmanPrinciplesofFinance,EleventhEdition
24. Thetreasureriscommonlyresponsiblefor
(a) taxes.
(b) dataprocessing.
(c) makingcapitalexpenditures.
(d) costaccounting.
Answer: C
LevelofDifficulty:1
LearningGoal:2
Topic:ManagerialFinanceFunctions
25. Thecontrolleriscommonlyresponsiblefor
(a) managingcash.
(b) financialaccounting.
(c) managingcreditactivities.
(d) financialplanning.
Answer: B
LevelofDifficulty:1
LearningGoal:2
Topic:ManagerialFinanceFunctions
26. Theaccountantsprimaryfunctionis
(a) evaluatingthefinancialstatements.
(b) makingdecisionsbasedonfinancialdata.
(c) thecollectionandpresentationoffinancialdata.
(d) planningcashflows.
Answer: C
LevelofDifficulty:1
LearningGoal:2
Topic:AccountingConcepts
27. Theaccountantrecognizesrevenuesandexpenseson
(a) acashbasis.
(b) arevenuebasis.
(c) anaccrualbasis.
(d) anexpensebasis.
Answer: C
LevelofDifficulty:1
LearningGoal:2
Topic:AccountingConcepts
28. Thefinancialmanagerrecognizesrevenuesandexpensesutilizing
(a) theaccrualmethod.
(b) theactualinflowsandoutflowsofcash.
(c) thestandardized,generallyaccepted,accountingprinciples.
(d) therevenuemethod.
Answer: B
LevelofDifficulty:1
LearningGoal:2
 Chapter1TheRoleandEnvironmentofManagerialFinance21
Topic:RoleofFinancialManager
22GitmanPrinciplesofFinance,EleventhEdition
29. Thefinancialmanagerisinterestedinthecashinflowsandoutflowsofthefirm,ratherthanthe
accountingdata,inordertoensure
(a) profitability.
(b) theabilitytopaydividends.
(c) theabilitytoacquirenewassets.
(d) solvency.
Answer: D
LevelofDifficulty:1
LearningGoal:2
Topic:RoleofFinancialManager

30. TheaccountantmayberesponsibleforanyofthefollowingEXCEPT
(a) processingpurchaseordersandinvoices.
(b) ensuringaccountspayablearepaidontime.
(c) preparingthemonthlyincomestatement.
(d) analyzingthemixofcurrenttofixedassets.
Answer: D
LevelofDifficulty:1
LearningGoal:2
Topic:AccountingConcepts

31. Economictheoriesthatthefinancialmanagermustbeabletoutilizeforefficientbusiness
operations,include
(a) supplyanddemandanalysis.
(b) marginalanalysis.
(c) profitmaximizingstrategies.
(d) pricetheory.
(e) alloftheabove.
Answer: E
LevelofDifficulty:1
LearningGoal:2
Topic:FundamentalConcepts

32. Theprimaryeconomicprincipleusedinmanagerialfinanceis
(a) supplyanddemand.
(b) theliquiditytrap.
(c) thecrowdingouteffect.
(d) marginalanalysis.
Answer: D
LevelofDifficulty:2
LearningGoal:2
Topic:FundamentalConcepts
 Chapter1TheRoleandEnvironmentofManagerialFinance23
33. Johnson,Inc.hasjustendedthecalendaryearmakingasaleintheamountof$10,000of
merchandisepurchasedduringtheyearatatotalcostof$7,000.Althoughthefirmpaidinfullfor
themerchandiseduringtheyear,ithasyettocollectatyearendfromthecustomer.Thenetprofit
andcashflowfromthissalefortheyearare
(a) $3,000and$10,000,respectively.
(b) $3,000and$7,000,respectively.
(c) $7,000and$3,000,respectively.
(d) $3,000and$7,000,respectively.
Answer: B
LevelofDifficulty:2
LearningGoal:2
Topic:FundamentalConcepts

34. Afirmhasjustendeditscalendaryearmakingasaleintheamountof$150,000ofmerchandise
purchasedduringtheyearatatotalcostof$112,500.Althoughthefirmpaidinfullforthe
merchandiseduringtheyear,ithasyettocollectatyearendfromthecustomer.Thenetprofitand
cashflowfromthissalefortheyearare
(a) $0and$150,000,respectively.
(b) $37,500and$150,000,respectively.
(c) $37,500and$112,500,respectively.
(d) $150,000and$112,500,respectively.
Answer: C
LevelofDifficulty:2
LearningGoal:2
Topic:FundamentalConcepts

35. Theprimaryemphasisofthefinancialmanageristheuseof
(a) accruedearnings.
(b) cashflow.
(c) organizationcharts.
(d) profitincentives.
Answer: B
LevelofDifficulty:2
LearningGoal:2
Topic:RoleoftheFinancialManager

36. Byconcentratingoncashflowswithinthefirmthefinancialmanagershouldbeableto
(a) preparetaxreturns.
(b) speakauthoritativelytostockholders.
(c) avoidinsolvency.
(d) controlexpenses.
Answer: C
LevelofDifficulty:2
LearningGoal:2
Topic:RoleoftheFinancialManager
24GitmanPrinciplesofFinance,EleventhEdition
37. Theofficerresponsibleforthefirmsfinancialactivitiessuchasfinancialplanningandfundraising,
makingcapitalexpendituredecisions,andmanagingcash,credit,thepensionfund,andforeign
exchangeis
(a) treasurer.
(b) controller.
(c) foreignexchangemanager.
(d) Noneoftheabove.
Answer: A
LevelofDifficulty:3
LearningGoal:2
Topic:ManagerialFinanceFunctions

38. Marginalanalysisstatesthatfinancialdecisionsshouldbemadeandactionstakenonlywhen
(a) demandequalssupply.
(b) benefitsequalcosts.
(c) addedbenefitsexceedaddedcosts.
(d) addedbenefitsaregreaterthanzero.
Answer: C
LevelofDifficulty:3
LearningGoal:2
Topic:FundamentalConcepts

39. Theofficerresponsibleforthefirmsaccountingactivities,suchascorporateaccounting,tax
management,financialaccounting,andcostaccountingisthe
(a) treasurer.
(b) controller.
(c) foreignexchangemanager.
(d) Noneoftheabove.
Answer: B
LevelofDifficulty:3
LearningGoal:2
Topic:ManagerialFinanceFunctions

40. Afirmhasjustendeditscalendaryearmakingasaleintheamountof$200,000ofmerchandise
purchasedduringtheyearatatotalcostof$150,500.Althoughthefirmpaidinfullforthe
merchandiseduringtheyear,ithasyettocollectatyearendfromthecustomer.Thepossible
problemthisfirmmayfaceis
(a) lowprofitability.
(b) lackofcashflow.
(c) inabilitytoreceivecredit.
(d) highleverage.
Answer: B
LevelofDifficulty:3
LearningGoal:2
Topic:FundamentalConcepts
 Chapter1TheRoleandEnvironmentofManagerialFinance25
41. Thekeyroleofthefinancialmanageris
(a) decisionmaking.
(b) thepresentationoffinancialstatements.
(c) thepreparationofdataforfutureevaluation.
(d) thecollectionoffinancialdata.
Answer: A
LevelofDifficulty:1
LearningGoal:3
Topic:RoleoftheFinancialManager

42. ThekeyactivitiesofthefinancialmanagerincludeallofthefollowingEXCEPT
(a) makingfinancingdecisions.
(b) financialanalysisandplanning.
(c) managingfinancialaccounting.
(d) makinginvestmentdecisions.
Answer: C
LevelofDifficulty:1
LearningGoal:3
Topic:RoleoftheFinancialManager

43. Includedintheprimaryactivitiesofthefinancialmanagerare
(a) financialanalysisandplanning.
(b) makinginvestmentdecisions.
(c) makingfinancingdecisions.
(d) analyzingandplanningcashflows.
(e) alloftheabove.
Answer: E
LevelofDifficulty:1
LearningGoal:3
Topic:RoleoftheFinancialManager

44. ThefinancialmanagermayberesponsibleforanyofthefollowingEXCEPT
(a) monitoringofquarterlytaxpayments.
(b) analyzingbudgetandperformancereports.
(c) determiningwhethertoacceptorrejectacapitalassetacquisition.
(d) analyzingtheeffectsofmoredebtonthefirmscapitalstructure.
Answer: A
LevelofDifficulty:1
LearningGoal:3
Topic:RoleoftheFinancialManager
26GitmanPrinciplesofFinance,EleventhEdition
45. MakinginvestmentdecisionsincludesallofthefollowingEXCEPT
(a) inventory.
(b) fixedassets.
(c) accountsreceivable.
(d) notespayable.
Answer: D
LevelofDifficulty:1
LearningGoal:3
Topic:ManagerialFinanceFunctions
46. MakingfinancingdecisionsincludesallofthefollowingEXCEPT
(a) determiningtheappropriatemixofshorttermandlongtermfinancing.
(b) decidingwhichindividualshorttermsourcesarebestatagivenpointintime.
(c) analyzingquarterlybudgetandperformancereports.
(d) decidingwhichindividuallongtermsourcesarebestatagivenpointintime.
Answer: C
LevelofDifficulty:1
LearningGoal:3
Topic:ManagerialFinanceFunctions
47. ManagingthefirmsassetsincludesallofthefollowingEXCEPT
(a) inventory.
(b) fixedassets.
(c) accountsreceivable.
(d) notespayable.
Answer: D
LevelofDifficulty:1
LearningGoal:3
Topic:ManagerialFinanceFunctions
48. ManagingthefirmsliabilitiesincludesallofthefollowingEXCEPT
(a) accruals.
(b) notespayable.
(c) cash.
(d) accountspayable.
Answer: C
LevelofDifficulty:1
LearningGoal:3
Topic:ManagerialFinanceFunctions
49. ThefinancialmanagermayberesponsibleforanyofthefollowingEXCEPT
(a) keepingtrackofquarterlytaxpayments.
(b) analyzingquarterlybudgetandperformancereports.
(c) determiningwhethertoacceptorrejectacapitalassetacquisition.
(d) analyzingtheeffectsofmoredebtonthefirmscapitalstructure.
Answer: A
LevelofDifficulty:1
LearningGoal:3
 Chapter1TheRoleandEnvironmentofManagerialFinance27
Topic:RoleoftheFinancialManager
28GitmanPrinciplesofFinance,EleventhEdition
50. FinancialanalysisandplanninginvolveallofthefollowingEXCEPT
(a) transformingdataintoaformthatcanbeusedtomonitorthefirmsfinancialposition.
(b) evaluatingtheneedforincreasedorreducedproductivecapacity.
(c) controllingthedataprocessingactivities.
(d) determiningtheadditionalfinancingneeds.
Answer: C
LevelofDifficulty:2
LearningGoal:3
Topic:ManagerialFinanceFunctions

51. Thefinancialmanagersinvestmentdecisionsdetermine
(a) boththemixandthetypeofassetsfoundonthefirmsbalancesheet.
(b) boththemixandthetypeofliabilitiesfoundonthefirmsbalancesheet.
(c) boththemixandthetypeofassetsandliabilitiesfoundonthefirmsbalancesheet.
(d) boththemixandthetypeofshorttermandlongtermfinancing.
Answer: A
LevelofDifficulty:2
LearningGoal:3
Topic:ManagerialFinanceFunctions

52. Inplanningandmanagingtherequirementsofthefirm,thefinancialmanagerisconcernedwith
(a) themixandtypeofassets,butnotthetypeoffinancingutilized.
(b) thetypeoffinancingutilized,butnotthemixandtypeofassets.
(c) theacquisitionoffixedassets,allowingsomeoneelsetoplanthelevelofcurrentassetsrequired.
(d) themixandtypeofassets,thetypeoffinancingutilized,andanalysisinordertomonitorthe
financialcondition.
Answer: D
LevelofDifficulty:2
LearningGoal:3
Topic:ManagerialFinanceFunctions

53. Thefinancialmanagersfinancingdecisionsdetermine
(a) boththemixandthetypeofassetsfoundonthefirmsbalancesheet.
(b) themostappropriatemixofshorttermandlongtermfinancing.
(c) boththemixandthetypeofassetsandliabilitiesfoundonthefirmsbalancesheet.
(d) theproportionofthefirmsearningstobepaidasdividend.
Answer: B
LevelofDifficulty:3
LearningGoal:3
Topic:ManagerialFinanceFunctions
 Chapter1TheRoleandEnvironmentofManagerialFinance29
54. Theprimarygoalofthefinancialmanageris
(a) minimizingrisk.
(b) maximizingprofit.
(c) maximizingwealth.
(d) minimizingreturn.
Answer: C
LevelofDifficulty:1
LearningGoal:4
Topic:GoaloftheFirm
55. Corporateownersreceiverealizablereturnthrough
(a) earningspershareandcashdividends.
(b) increaseinsharepriceandcashdividends.
(c) increaseinsharepriceandearningspershare.
(d) profitandearningspershare.
Answer: B
LevelofDifficulty:1
LearningGoal:4
Topic:GoaloftheFirm
56. Thewealthoftheownersofacorporationisrepresentedby
(a) profits.
(b) earningspershare.
(c) shareprice.
(d) cashflow.
Answer: C
LevelofDifficulty:1
LearningGoal:4
Topic:GoaloftheFirm
57. Wealthmaximizationasthegoalofthefirmimpliesenhancingthewealthof
(a) theBoardofDirectors.
(b) thefirmsemployees.
(c) thefederalgovernment.
(d) thefirmsstockholders.
Answer: D
LevelofDifficulty:1
LearningGoal:4
Topic:GoaloftheFirm
58. IfacompanysmanagersareNOTownersofthecompany,theyare
(a) dealers.
(b) agents.
(c) outsiders.
(d) brokers.
Answer: B
LevelofDifficulty:1
LearningGoal:4
30GitmanPrinciplesofFinance,EleventhEdition
Topic:AgencyIssue
 Chapter1TheRoleandEnvironmentofManagerialFinance31
59. Theconflictbetweenthegoalsofafirmsownersandthegoalsofitsnonownermanagersis
(a) theagencyproblem.
(b) incompatibility.
(c) seriousonlywhenprofitsdecline.
(d) oflittleimportanceinmostlargeU.S.firms.
Answer: A
LevelofDifficulty:1
LearningGoal:4
Topic:AgencyIssue

60. TheagencyproblemmayresultfromamanagersconcernsaboutanyofthefollowingEXCEPT
(a) jobsecurity.
(b) personalwealth.
(c) corporategoals.
(d) companyprovidedperquisites.
Answer: C
LevelofDifficulty:1
LearningGoal:4
Topic:AgencyIssue

61. AgencycostsincludeallofthefollowingEXCEPT
(a) bondingandstructuringexpenses.
(b) costofgoodssold.
(c) monitoringexpenditures.
(d) opportunitycosts.
Answer: B
LevelofDifficulty:1
LearningGoal:4
Topic:AgencyIssue

62. AgencycostsincludeallofthefollowingEXCEPT
(a) managementreportstostockholders.
(b) performanceincentivespaidtomanagers.
(c) thecostofmonitoringmanagementbehavior.
(d) purchasinginsuranceagainstmanagementmisconduct.
Answer: A
LevelofDifficulty:2
LearningGoal:4
Topic:AgencyIssue
32GitmanPrinciplesofFinance,EleventhEdition
63. Onewayoftenusedtoinsurethatmanagementdecisionsareinthebestinterestofthestockholders
isto
(a) threatentofiremanagerswhoareseenasnotperformingadequately.
(b) removemanagementsperquisites.
(c) tiemanagementcompensationtotheperformanceofthecompanyscommonstockprice.
(d) tiemanagementcompensationtothelevelofearningspershare.
Answer: C
LevelofDifficulty:2
LearningGoal:4
Topic:AgencyIssue

64. Theamountearnedduringtheaccountingperiodoneachoutstandingshareofcommonstockis
called
(a) commonstockdividend.
(b) earningspershare.
(c) netprofitsaftertaxes.
(d) netincome.
Answer: B
LevelofDifficulty:2
LearningGoal:4
Topic:AccountingConcepts

65. Thegoalofprofitmaximizationwouldresultinpriorityfor
(a) cashflowsavailabletostockholders.
(b) riskoftheinvestment.
(c) earningspershare.
(d) timingofthereturns.
Answer: C
LevelofDifficulty:2
LearningGoal:4
Topic:GoaloftheFirm

66. ProfitmaximizationdoesNOTtakeintoconsideration
(a) riskandcashflow.
(b) cashflowandstockprice.
(c) riskandEPS.
(d) EPSandstockprice.
Answer: A
LevelofDifficulty:2
LearningGoal:4
Topic:AgencyIssue
 Chapter1TheRoleandEnvironmentofManagerialFinance33
67. ProfitmaximizationasthegoalofthefirmisNOTidealbecause
(a) profitsareonlyaccountingmeasures.
(b) cashflowsaremorerepresentativeoffinancialstrength.
(c) profitmaximizationdoesnotconsiderrisk.
(d) profitstodayarelessdesirablethanprofitsearnedinfutureyears.
Answer: C
LevelofDifficulty:2
LearningGoal:4
Topic:AgencyIssue

68. ProfitmaximizationfailsbecauseitignoresallEXCEPT
(a) thetimingofreturns.
(b) earningspershare.
(c) cashflowsavailabletostockholders.
(d) risk.
Answer: B
LevelofDifficulty:2
LearningGoal:4
Topic:GoaloftheFirm

69. Thekeyvariablesintheownerwealthmaximizationprocessare
(a) earningspershareandrisk.
(b) cashflowsandrisk.
(c) earningspershareandshareprice.
(d) profitsandrisk.
Answer: B
LevelofDifficulty:2
LearningGoal:4
Topic:GoaloftheFirm

70. Returnandriskarethekeydeterminantsinshareprice.Increasedreturnresultsin_________,other
thingsremainingthesame.
(a) alowershareprice.
(b) ahighershareprice.
(c) anunchangedshareprice.
(d) anundeterminedshareprice.
Answer: B
LevelofDifficulty:2
LearningGoal:4
Topic:GoaloftheFirm
34GitmanPrinciplesofFinance,EleventhEdition
71. Returnandriskarethekeydeterminantsinshareprice.Increasedrisk,otherthingsremainingthe
same,resultsin
(a) alowershareprice.
(b) ahighershareprice.
(c) anunchangedshareprice.
(d) anundeterminedshareprice.
Answer: A
LevelofDifficulty:2
LearningGoal:4
Topic:GoaloftheFirm

72. Financialmanagersevaluatingdecisionalternativesorpotentialactionsmustconsider
(a) onlyrisk.
(b) onlyreturn.
(c) bothriskandreturn.
(d) risk,return,andtheimpactonshareprice.
Answer: D
LevelofDifficulty:2
LearningGoal:4
Topic:GoaloftheFirm

73. Anethicsprogramisexpectedtohavea_________impactonthefirmsshareprice.
(a) positive
(b) negative
(c) noimpact
(d) undetermined
Answer: A
LevelofDifficulty:2
LearningGoal:4
Topic:RoleofEthics

74. Thedifferencebetweenthecostoffundsusedtofinanceaninvestmentanditsaftertaxoperating
profitsiscalled
(a) earningspershare.
(b) dividend.
(c) economicvalueadded.
(d) retainedearnings.
Answer: C
LevelofDifficulty:3
LearningGoal:4
Topic:FundamentalConcepts
 Chapter1TheRoleandEnvironmentofManagerialFinance35
75. Returnandrisk
(a) havenoeffectonshareprice.
(b) haveaninverseeffectonshareprice.
(c) adverselyaffectshareprice.
(d) havethesameeffectonshareprice.
Answer: B
LevelofDifficulty:3
LearningGoal:4
Topic:GoaloftheFirm

76. Astheriskofastockinvestmentincreases
(a) returnwillincrease.
(b) returnwilldecrease.
(c) requiredrateofreturnwilldecrease.
(d) requiredrateofreturnwillincrease.
Answer: D
LevelofDifficulty:3
LearningGoal:4
Topic:GoaloftheFirm

77. Amorerecentissuethatiscausingmajorproblemsinthebusinesscommunityis
(a) theprivatizationofownership.
(b) shorttermversuslongtermfinancialgoalsofmanagement.
(c) ethicalproblems.
(d) environmentalconcerns.
Answer: C
LevelofDifficulty:3
LearningGoal:4
Topic:RoleofEthics

78. Allofthefollowingaremeasuresthatcanbeusedasaguideforestablishingacorporateethics
policy,EXCEPT
(a) aneffectiveinternalcontrolsystem.
(b) aneffectiveinternalauditsystem.
(c) makingreferencechecksbeforehiringnewemployees.
(d) makingsureviolationsarepenalized,whileatthesametimenotsubjectingtheemployeeto
publicity.
Answer: D
LevelofDifficulty:3
LearningGoal:4
Topic:RoleofEthics
36GitmanPrinciplesofFinance,EleventhEdition
79. Corporateethicspoliciestypicallyapplyto_________indealingwith_________.
(a) employeeactions;customersandcreditors
(b) employeeactions;customers,vendors,andregulators
(c) managementactions;allcorporateconstituents
(d) employeeactions;allcorporateconstituents
Answer: D
LevelofDifficulty:3
LearningGoal:4
Topic:RoleofEthics

80. Afinancialmanagermustchoosebetweenfouralternativeinvestments,1,2,3,and4.Eachasset
costs$35,000andisexpectedtoprovideearningsoverathreeyearperiodasdescribedbelow.

Asset Year1 Year2 Year3

1 $21,000 $15,000 $6,000
2 9,000 15,000 21,000
3 3,000 20,000 19,000
4 6,000 12,000 12,000

Basedontheprofitmaximizationgoal,thefinancialmanagerwouldchoose
(a) Asset1.
(b) Asset2.
(c) Asset3.
(d) Asset4.
Answer: B
LevelofDifficulty:4
LearningGoal:4
Topic:GoaloftheFirm

81. Afinancialmanagermustchoosebetweenfouralternativeinvestments,1,2,3,and4.Eachassetis
expectedtoprovideearningsoverathreeyearperiodasdescribedbelow.

Asset Year1 Year2 Year3

1 $21,000 $15,000 $9,000
2 9,000 15,000 21,000
3 3,000 18,000 19,000
4 6,000 12,000 12,000

Basedontheprofitmaximizationgoal,thefinancialmanagerwouldchoose
(a) Asset1.
(b) Asset2.
(c) Asset3.
(d) Asset4.
Answer: A
LevelofDifficulty:4
LearningGoal:4
Topic:GoaloftheFirm
 Chapter1TheRoleandEnvironmentofManagerialFinance37
82. Afinancialmanagermustchoosebetweenthreealternativeinvestments.Eachassetisexpectedto
provideearningsoverathreeyearperiodasdescribedbelow.Basedonthewealthmaximization
goal,thefinancialmanagerwould

Year Asset1 Asset2 Asset3

1 $21,000 $9,000 $8,000
2 15,000 15,000 21,000
3 9,000 18,000 19,000
$46,000 $41,000 $48,000

(a) chooseAsset1.
(b) chooseAsset2.
(c) chooseAsset3.
(d) beindifferentbetweenAsset1andAsset2.
Answer: A
LevelofDifficulty:4
LearningGoal:4
Topic:GoaloftheFirm

83. Arecentethicssurveyindicatedtheopinionthatmaintaininghighethicalstandards
(a) weakenedafirmscompetitiveposition,particularlyinforeignmarkets.
(b) hadnoeffectonafirmscompetitiveposition.
(c) strengthenedafirmscompetitiveposition.
(d) wasdifficulttoenforce.
Answer: C
LevelofDifficulty:4
LearningGoal:4
Topic:RoleofEthics

84. Theimplementationofaproactiveethicsprogramisexpectedtoresultin
(a) apositivecorporateimageandincreasedrespect,butisnotexpectedtoaffectcashflows.
(b) anincreasedsharepriceresultingfromadecreaseinrisk,butisnotexpectedtoaffectcash
flows.
(c) apositivecorporateimageandincreasedrespect,butisnotexpectedtoaffectshareprice.
(d) apositivecorporateimageandincreasedrespect,areductioninrisk,andenhancedcashflow
resultinginanincreaseinshareprice.
Answer: D
LevelofDifficulty:4
LearningGoal:4
Topic:RoleofEthics
38GitmanPrinciplesofFinance,EleventhEdition
85. Amongsolutionstotheagencyprobleminpubliclyheldcorporationsareallofthefollowing
EXCEPT
(a) stockoptions.
(b) performanceshares.
(c) cashbonusestiedtogoalachievement.
(d) bonusesbasedonshorttermresults.
Answer: D
LevelofDifficulty:4
LearningGoal:4
Topic:AgencyIssue

86. EmergingtrendsresultingfromtheagencyproblemareallofthefollowingEXCEPT
(a) largeprivatecorporations.
(b) restructuringthroughleveragedbuyouts.
(c) managementbyactiveinvestors.
(d) prohibitingmanagersfrommaintaininganownershipinterest.
Answer: D
LevelofDifficulty:4
LearningGoal:4
Topic:AgencyIssue

87. WhichofthefollowingisNOTafinancialinstitution?
(a) Acommercialbank.
(b) Aninsurancecompany.
(c) Apensionfund.
(d) Anewspaperpublisher.
Answer: D
LevelofDifficulty:1
LearningGoal:5
Topic:FinancialInstitutions

88. Thekeyparticipantsinfinancialtransactionsareindividuals,businesses,andgovernments.
Individualsarenet_________offunds,andbusinessesarenet_________offunds.
(a) demanders;suppliers
(b) users;providers
(c) suppliers;demanders
(d) purchasers;sellers
Answer: C
LevelofDifficulty:1
LearningGoal:5
Topic:FinancialMarkets
 Chapter1TheRoleandEnvironmentofManagerialFinance39
89. A_________issimilartoacommercialbankexceptthatitmaynotholddemanddeposits.
(a) savingsbank
(b) creditunion
(c) mutualfund
(d) insurancecompany
Answer: A
LevelofDifficulty:1
LearningGoal:5
Topic:FinancialInstitutions

90. A_________isafinancialintermediarythatdealsprimarilyinthetransferoffundsbetween
consumers.Membershipisgenerallybasedonsomecommonbond.
(a) savingsbank
(b) creditunion
(c) lifeinsurancecompany
(d) commercialbank
Answer: B
LevelofDifficulty:1
LearningGoal:5
Topic:FinancialInstitutions

91. A_________isthelargestfinancialintermediaryhandlingindividualsavings.Itreceivespremium
paymentsthatareplacedinloansorinvestmentstoaccumulatefundstocoverfuturebenefits.
(a) savingsbank
(b) creditunion
(c) lifeinsurancecompany
(d) commercialbank
Answer: C
LevelofDifficulty:1
LearningGoal:5
Topic:FinancialInstitutions

92. A_________issetupsothatemployeesofcorporationsorgovernmentscanreceiveincomeafter
retirement.
(a) savingsbank
(b) creditunion
(c) lifeinsurancecompany
(d) pensionfund
Answer: D
LevelofDifficulty:1
LearningGoal:5
Topic:FinancialInstitutions
40GitmanPrinciplesofFinance,EleventhEdition
93. A_________isatypeoffinancialintermediarythatpoolssavingsofindividualsandmakesthem
availabletobusinessandgovernmentdemanders.Fundsareobtainedthroughthesaleofshares.
(a) savingsbank
(b) creditunion
(c) mutualfund
(d) savingsandloans
Answer: C
LevelofDifficulty:1
LearningGoal:5
Topic:FinancialInstitutions

94. PassageoftheDepositoryInstitutionsDeregulationandMonetaryControlAct(DIDMCA)of1980
signaledthebeginningof
(a) lowerinterestratesontimedeposits.
(b) thefinancialservicesrevolution.
(c) automatedtellermachines.
(d) prohibitiononinterstatebanking.
Answer: B
LevelofDifficulty:1
LearningGoal:5
Topic:FinancialInstitutions

95. Mostbusinessesraisemoneybysellingtheirsecuritiesina
(a) publicoffering.
(b) privateplacement.
(c) directplacement.
(d) stockexchange.
Answer: A
LevelofDifficulty:1
LearningGoal:5
Topic:FinancialMarkets

96. AllofthefollowingareservicesprovidedbyfinancialinstitutionsEXCEPT
(a) paysaversinterestondepositedfunds.
(b) lendmoneytocustomers.
(c) buythebusinessesofcustomers.
(d) investcustomerssavingsinstocksandbonds.
Answer: C
LevelofDifficulty:1
LearningGoal:5
Topic:FinancialInstitutions
 Chapter1TheRoleandEnvironmentofManagerialFinance41
97. The_________iscreatedbyafinancialrelationshipbetweensuppliersanddemandersofshortterm
funds.
(a) stockmarket
(b) capitalmarket
(c) financialmarket
(d) moneymarket
Answer: D
LevelofDifficulty:1
LearningGoal:5
Topic:FinancialMarkets

98. Governmentusually
(a) isanetsupplieroffunds.
(b) isanetdemanderoffunds.
(c) borrowsfundsdirectlyfromfinancialinstitutions.
(d) maintainspermanentdepositswithfinancialinstitutions.
Answer: B
LevelofDifficulty:1
LearningGoal:5
Topic:FinancialMarkets

99. Bydefinition,themoneymarketinvolvesthebuyingandsellingof
(a) stocksandbonds.
(b) shorttermfunds.
(c) fundsthatmatureinmorethanoneyear.
(d) flowsoffunds.
Answer: B
LevelofDifficulty:1
LearningGoal:5
Topic:FinancialMarkets

100. Acompetitivemarketthatallocatesfundstotheirmostproductiveuseiscalleda(n)
(a) liquidmarket.
(b) middlemansmarket.
(c) efficientmarket.
(d) investorsmarket.
Answer: C
LevelofDifficulty:1
LearningGoal:5
Topic:FinancialMarkets
42GitmanPrinciplesofFinance,EleventhEdition
101. Theoverthecounter(OTC)marketis
(a) theNewYorkStockExchange.
(b) anorganizedstockexchange.
(c) aplacewheresecuritiesareboughtandsold.
(d) anintangiblemarketforunlistedsecurities.
Answer: D
LevelofDifficulty:1
LearningGoal:5
Topic:FinancialMarkets

102. Mostmoneymarkettransactionsaremadein
(a) commonstock.
(b) marketablesecurities.
(c) stocksandbonds.
(d) preferredstock.
Answer: B
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialMarkets

103. Firmsthatrequirefundsfromexternalsourcescanobtaintheminoneofthefollowingways
EXCEPT
(a) financialinstitution.
(b) financialmarkets.
(c) government.
(d) privateplacement.
Answer: C
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialInstitutionsandMarkets

104. A_________acceptsbothdemandandtimedepositsandprimarilymakesloansdirectlytoboth
individualandbusinessborrowersorthroughthefinancialmarkets.
(a) savingsbank
(b) creditunion
(c) mutualfund
(d) commercialbank
Answer: D
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialInstitutions
 Chapter1TheRoleandEnvironmentofManagerialFinance43
105. The_________iscreatedbyanumberofinstitutionsandarrangementsthatallowthesuppliersand
demandersoflongtermfundstomaketransactions.
(a) financialmarket
(b) capitalmarket
(c) moneymarket
(d) creditmarket
Answer: B
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialMarkets

106. Firmsthatrequirefundsfromexternalsourcescanobtainthemfrom
(a) privateplacement.
(b) financialinstitutions.
(c) financialmarkets.
(d) Alloftheabove.
Answer: D
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialInstitutionsandMarkets

107. Thenonexclusivesaleofeitherbondsorstockstothegeneralpubliciscalled
(a) privateplacement.
(b) publicoffering.
(c) organizedselling.
(d) Noneoftheabove.
Answer: B
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialMarkets

108. TradingiscarriedoutontheflooroftheNewYorkStockExchangeby
(a) thenegotiationprocess.
(b) theauctionprocess.
(c) atelecommunicationsnetwork.
(d) investmentbankers.
Answer: B
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialMarkets
44GitmanPrinciplesofFinance,EleventhEdition
109. AllofthefollowingarefunctionsofsecurityexchangesEXCEPT
(a) allocatingscarcecapital.
(b) aidinginnewfinancing.
(c) creatingcontinuousmarkets.
(d) holdingdemanddeposits.
Answer: D
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialMarkets
110. TradingiscarriedoutontheflooroftheNewYorkStockExchangeby
(a) thenegotiationprocess.
(b) theauctionprocess.
(c) atelecommunicationsnetwork.
(d) investmentbankers.
Answer: B
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialMarkets
111. AllofthefollowingareexamplesoforganizedstockexchangesEXCEPT
(a) theNewYorkStockExchange.
(b) theAmericanStockExchange.
(c) thePacificStockExchange.
(d) theoverthecounterexchange.
Answer: D
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialMarkets
112. Themajorsecuritiestradedinthecapitalmarketsare
(a) commercialpaperandTreasurybills.
(b) Treasurybillsandcertificatesofdeposit.
(c) stocksandbonds.
(d) bondsandcommercialpaper.
Answer: C
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialMarkets
113. Longtermdebtinstrumentsusedbybothgovernmentandbusinessareknownas
(a) stocks.
(b) bills.
(c) bonds.
(d) equities.
Answer: C
LevelofDifficulty:2
LearningGoal:5
 Chapter1TheRoleandEnvironmentofManagerialFinance45
Topic:FinancialMarkets
46GitmanPrinciplesofFinance,EleventhEdition
114. Thetwokeyfinancialmarketsare
(a) primarymarketandsecondarymarket.
(b) primarymarketandmoneymarket.
(c) moneymarketandcapitalmarket.
(d) capitalmarketandsecondarymarket.
Answer: C
LevelofDifficulty:3
LearningGoal:5
Topic:FinancialMarkets
115. The_________stockexchangeisaprimarymarketwherenewpublicissuesaresold.
(a) regional
(b) American
(c) NewYork
(d) overthecounter
Answer: D
LevelofDifficulty:3
LearningGoal:5
Topic:FinancialMarkets
116. TradingiscarriedoutintheOvertheCounter(OTC)Exchangeby
(a) thecompetitivebidprocess.
(b) thecompetitivebidprocessandthenegotiationprocess.
(c) theauctionprocess.
(d) aninvestmentbanker.
Answer: B
LevelofDifficulty:3
LearningGoal:5
Topic:FinancialMarkets
117. SecuritiesexchangescreateefficientmarketsthatdoallofthefollowingEXCEPT
(a) ensureamarketinwhichthepricereflectsthetruevalueofthesecurity.
(b) allocatefundstothemostproductiveuses.
(c) controlthesupplyanddemandforsecuritiesthroughprice.
(d) allowthepricetobedeterminedbysupplyanddemandofsecurities.
Answer: C
LevelofDifficulty:3
LearningGoal:5
Topic:FinancialMarkets
118. Thetaxdeductibilityofexpenses_________theiraftertaxcost.
(a) increases
(b) reduces
(c) hasnoeffecton
(d) hasanundeterminedeffecton
Answer: B
LevelofDifficulty:1
LearningGoal:6
 Chapter1TheRoleandEnvironmentofManagerialFinance47
Topic:BusinessTaxes
48GitmanPrinciplesofFinance,EleventhEdition
119. Acapitalgainoccurswhenanassethasbeenheldfor
(a) morethansixmonths.
(b) lessthansixmonths.
(c) morethanoneyear.
(d) anylengthoftime.
Answer: D
LevelofDifficulty:1
LearningGoal:6
Topic:BusinessTaxes

120. Thetaxliabilityofacorporationwithordinaryincomeof$105,000is_________.
(a) $42,000
(b) $35,700
(c) $23,950
(d) $24,200
Answer: D
LevelofDifficulty:2
LearningGoal:6
Topic:BusinessTaxes

121. Thetaxliabilityofacorporationwithordinaryincomeof$1,500,000is_________.
(a) $498,250
(b) $510,000
(c) $585,000
(d) $690,000
Answer: B
LevelofDifficulty:2
LearningGoal:6
Topic:BusinessTaxes

122. Thetaxliabilityofacorporationwithordinaryincomeof$1,100,000is_________.
(a) $362,250
(b) $340,000
(c) $374,000
(d) $390,000
Answer: C
LevelofDifficulty:2
LearningGoal:6
Topic:BusinessTaxes
 Chapter1TheRoleandEnvironmentofManagerialFinance49
123. Jennings,Inc.hasataxliabilityof$170,000onpretaxincomeof$500,000.Whatistheaveragetax
rateforJennings,Inc.?
(a) 34percent
(b) 46percent
(c) 25percent
(d) 40percent
Answer: A
LevelofDifficulty:2
LearningGoal:6
Topic:BusinessTaxes

124. Theaveragetaxrateofacorporationwithordinaryincomeof$105,000andataxliabilityof
$24,200is
(a) 46percent.
(b) 23percent.
(c) 34percent.
(d) 15percent.
Answer: B
LevelofDifficulty:2
LearningGoal:6
Topic:BusinessTaxes

125. Ifacorporationsellscertainassetsformorethantheirinitialpurchaseprice,thedifferencebetween
thesalepriceandthepurchasepriceiscalleda(n)
(a) ordinarygain.
(b) capitalloss.
(c) capitalgain.
(d) ordinaryloss.
Answer: C
LevelofDifficulty:2
LearningGoal:6
Topic:BusinessTaxes

126. Ingeneral,mostcorporatecapitalgainsaretaxedat_________taxrate.
(a) a46percent
(b) theordinary
(c) a28percent
(d) a30percent
Answer: B
LevelofDifficulty:2
LearningGoal:6
Topic:BusinessTaxes
50GitmanPrinciplesofFinance,EleventhEdition
127. Congressallowscorporationstoexcludefromtaxes70to100percentofdividendsreceivedfrom
othercorporations.Congressdidthisto
(a) encouragecorporationstoinvestineachother.
(b) avoiddoubletaxationondividends.
(c) avoidtripletaxationondividends.
(d) lowerthecostofequityfinancingforcorporations.
Answer: C
LevelofDifficulty:2
LearningGoal:6
Topic:BusinessTaxes

128. CorporationXneeds$1,000,000andcanraisethisthroughdebtatanannualrateof10percent,or
preferredstockatanannualcostof7percent.Ifthecorporationhasa40percenttaxrate,the
aftertaxcostofeachis
(a) debt:$100,000;preferredstock:$70,000.
(b) debt:$60,000;preferredstock:$42,000.
(c) debt:$60,000;preferredstock:$70,000.
(d) debt:$100,000;preferredstock:$42,000.
Answer: C
LevelofDifficulty:3
LearningGoal:6
Topic:BusinessTaxes

129. CorporationAowns15percentofthestockofcorporationB.CorporationBpayscorporationA
$100,000individendsin2002.CorporationAmustpaytaxon
(a) $100,000ofordinaryincome.
(b) $30,000ofordinaryincome.
(c) $70,000ofordinaryincome.
(d) $70,000ofcapitalgain.
Answer: B
LevelofDifficulty:3
LearningGoal:6
Topic:BusinessTaxes

130. Thedividendexclusionforcorporationsreceivingdividendsfromanothercorporationhasresulted
in
(a) alowercostofequityforthecorporationpayingthedividend.
(b) ahigherrelativecostofbondfinancingforthecorporationpayingthedividend.
(c) stockinvestmentsbeingrelativelylessattractive,relativetobondinvestmentsmadebyone
corporationinanothercorporation.
(d) stockinvestmentsbeingrelativelymoreattractiverelativetobondinvestmentsmadebyone
corporationinanothercorporation.
Answer: D
LevelofDifficulty:3
LearningGoal:6
Topic:BusinessTaxes
 Chapter1TheRoleandEnvironmentofManagerialFinance51
131. AllofthefollowingaretrueEXCEPT
(a) Interestincomereceivedbyacorporationistaxedasordinaryincome.
(b) Corporationspaytaxesonalldividendsreceivedfromothercorporations,nomattertheirshare
ofownership.
(c) Corporationsmaypaytaxesononly30percentofthedividendsreceivedfromother
corporations,dependingontheirpercentageofownership.
(d) Capitalgainsistaxedasordinaryincome.
Answer: B
LevelofDifficulty:4
LearningGoal:6
Topic:BusinessTaxes

132. Theboardofdirectorsistypicallyresponsiblefor
(a) developingstrategicgoalsandplans
(b) hiringandfiring
(c) both(a)and(b)
(d) neither(a)nor(b)
Answer: C
LevelofDifficulty:2
LearningGoal:4
Topic:CorporateGovernance

133. TheSarbanesOxleyActof2002waspassedinresponseto
(a) insidertradingactivities
(b) falsedisclosuresinfinancialreporting
(c) thedeclineintechnologystocks
(d) alloftheabove
Answer: B
LevelofDifficulty:4
LearningGoal:4
Topic:CorporateGovernance

134. TheSarbanesOxleyActof2002didallofthefollowingEXCEPT
(a) tightenauditregulationsandcontrols.
(b) toughenpenaltiesagainstovercompensatedexecutives.
(c) toughenpenaltiesagainstexecutiveswhocommitcorporatefraud.
(d) alloftheabovearetrue.
Answer: B
LevelofDifficulty:4
LearningGoal:4
Topic:CorporateGovernance
52GitmanPrinciplesofFinance,EleventhEdition

Essay Questions
1. MeesePaperDistributors,Inc.hasbeforetaxearningsof$1,900,000.Calculatetheamountofthe
totaltaxliability.
Answer:

MeesePaperDistributors
TaxLiability
0.15$50,000 $7,500
0.25$25,000 6,250
0.34$25,000 8,500
0.39($335,000$100,000) 91,650
0.34(1,900,000$335,000) $532,100
Totaltaxliability $646,000

LevelofDifficulty:3
LearningGoal:6
Topic:BusinessTaxes

2. During2002,afirmhassold5assetsdescribedbelow.Calculatethetaxliabilityontheassets.The
firmpaysa40percenttaxrateonordinaryincome.

Purchase Sale
Asset Price Price
1 $10,000 $12,000
2 $50,000 $40,000
3 $37,500 $50,000
4 $3,000 $3,500
5 $15,000 $12,000

Answer:

Asset TaxLiability
1 $2,000(0.40) $800
2
3 $12,500(0.40) $5,000
4 $500(0.40) $200
5

LevelofDifficulty:3
LearningGoal:6
Topic:BusinessTaxes
 Chapter1TheRoleandEnvironmentofManagerialFinance53
3. Considertwofirms,GoDebtcorporationandNoDebtcorporation.Bothfirmsareexpectedtohave
earningsbeforeinterestandtaxesof$100,000duringthecomingyear.Inaddition,GoDebtis
expectedtoincur$40,000ininterestexpensesasaresultofitsborrowingswhereasNoDebtwill
incurnointerestexpensebecauseitdoesnotusedebtfinancing.However,NoDebtwillhavetopay
stockholders$40,000individendincome.Bothfirmsareinthe40percenttaxbracket.Calculatethe
Earningsaftertaxforbothfirms.Whichfirmhasthehigheraftertaxearnings?Whichfirmappears
tohavethehighercashflow?Howdoyouaccountforthedifference?

Answer:

Go No
Debt Debt
Earningsbeforeinterest $100,000 $100,000
andtaxes
Less:Interestexpense 40,000 0
Earningsbeforetaxes $60,000 $100,000
Less:Taxes(40%) 24,000 40,000
Earningsaftertaxes $36,000 $60,000
Less:Dividendspaid 0 40,000

GoDebthaslowerearningsaftertaxescomparedtoNoDebt.However,fromacash
outflowperspective,GoDebtpaidoutatotalofonly$64,000($40,000ininterest
expensesplus$24,000intaxes)whileNodebtpaidoutatotalof$80.000($40,000in
taxesand$40,000individends).Thedifferencebetweenthetwois$16,000whichis
exactlythedifferenceintaxespaidbetweenthetwofirms($24,000comparedto$40,000).
Thisdifferenceresultsfromthefactthatinterestexpenseisataxdeductibleexpense.
LevelofDifficulty:4
LearningGoal:6
Topic:BusinessTaxes