CH1PTER 1

1N OVERVIEW OF FIN1NCI1L M1N1GEMENT

Ch1pter 1 - P1ge B

Firm org1niz1tion 1nswer: 1 Diff: E

4. Until this ye1r, Cheers Inc. w1s org1nized 1s 1 p1rtnership. This ye1r,

the p1rtners h1ve decided to org1nize the business 1s 1 corpor1tion. 1s

1 result of this ch1nge in org1niz1tion1l form, which of the following

st1tements is most correct?

1. Cheers’ sh1reholders (the ex-p1rtners) will now h1ve limited li1bility.

b. Cheers will now be subject to fewer regul1tions.

c. Cheers will now p1y less in t1xes.

d. Cheers’ investors will now find it more difficult to tr1nsfer

ownership.

e. Cheers will now find it more difficult to r1ise 1ddition1l c1pit1l.

Firm org1niz1tion 1nswer: c Diff: E N

5. Which of the following st1tements is most correct?

1. Corpor1tions gener1lly f1ce fewer regul1tions th1n sole proprietorships do.

b. Corpor1te sh1reholders h1ve unlimited li1bility.

c. It is usu1lly e1sier to tr1nsfer ownership in 1 corpor1tion th1n it is

to tr1nsfer ownership in 1 sole proprietorship.

d. 1ll of the 1bove st1tements 1re correct.

e. None of the 1bove st1tements is correct.

Corpor1te form 1nswer: c Diff: E

6. Which of the following could expl1in why 1 business might choose to

org1nize 1s 1 corpor1tion r1ther th1n 1s 1 sole proprietorship or 1

p1rtnership?

1. Corpor1tions gener1lly f1ce fewer regul1tions.

b. Corpor1tions gener1lly f1ce lower t1xes.

c. Corpor1tions gener1lly find it e1sier to r1ise c1pit1l.

d. Corpor1tions enjoy unlimited li1bility.

e. St1tements c 1nd d 1re correct.

Corpor1te form 1nswer: 1 Diff: E

7. Which of the following st1tements is most correct?

1. One dr1wb1ck of forming 1 corpor1tion is th1t it subjects the firm to

1ddition1l regul1tions.

b. One dr1wb1ck of forming 1 corpor1tion is th1t it subjects the firm to

limited li1bility.

c. One dr1wb1ck of forming 1 corpor1tion is th1t it m1kes it more

difficult for the firm to r1ise c1pit1l.

d. 1ll of the st1tements 1bove 1re correct.

e. St1tements b 1nd c 1re correct.

Ch1pter 1 - P1ge 3

Go1l of firm 1nswer: d Diff: E

8. The prim1ry go1l of 1 publicly-owned firm interested in serving its

stockholders should be to

1. M1ximize expected tot1l corpor1te profit.

b. M1ximize expected EPS.

c. Minimize the ch1nces of losses.

d. M1ximize the stock price per sh1re.

e. M1ximize expected net income.

1gency 1nswer: d Diff: E

9. Which of the following st1tements is most correct?

1. Compens1ting m1n1gers with stock c1n reduce the 1gency problem between

stockholders 1nd m1n1gers.

b. Restrictions 1re included in credit 1greements to protect bondholders

from the 1gency problem th1t exists between bondholders 1nd

stockholders.

c. The thre1t of 1 t1keover c1n reduce the 1gency problem between

bondholders 1nd stockholders.

d. St1tements 1 1nd b 1re correct.

e. 1ll of the st1tements 1bove 1re correct.

1gency 1nswer: 1 Diff: E

10. Which of the following work to reduce 1gency conflicts between

stockholders 1nd bondholders?

1. Including restrictive coven1nts in the comp1ny’s bond contr1ct.

b. Providing m1n1gers with 1 l1rge number of stock options.

c. The p1ss1ge of l1ws th1t m1ke it e1sier for comp1nies to resist

hostile t1keovers.

d. St1tements b 1nd c 1re correct.

e. 1ll of the st1tements 1bove 1re correct.

1gency 1nswer: b Diff: E

11. Which of the following 1ctions 1re likely to reduce 1gency conflicts

between stockholders 1nd m1n1gers?

1. P1ying m1n1gers 1 l1rge fixed s1l1ry.

b. Incre1sing the thre1t of corpor1te t1keover.

c. Pl1cing restrictive coven1nts in debt 1greements.

d. 1ll of the st1tements 1bove 1re correct.

e. St1tements b 1nd c 1re correct.

Ch1pter 1 - P1ge 4

1gency 1nswer: d Diff: E

1B. Which of the following 1ctions 1re likely to reduce the 1gency problem

between stockholders 1nd m1n1gers?

1. Congress p1sses 1 l1w th1t severely restricts hostile t1keovers.

b. 1 m1n1ger receives 1 lower s1l1ry but receives 1ddition1l sh1res of

the comp1ny’s stock.

c. The bo1rd of directors h1s become more vigil1nt in its oversight of

the comp1ny’s m1n1gement.

d. St1tements b 1nd c 1re correct.

e. 1ll of the st1tements 1bove 1re correct.

M1n1geri1l incentives 1nswer: e Diff: E

13. Which of the following mech1nisms is used to motiv1te m1n1gers to 1ct in

the interest of sh1reholders?

1. Bond coven1nts.

b. The thre1t of 1 t1keover.

c. Pressure from the bo1rd of directors.

d. St1tements 1 1nd b 1re correct.

e. St1tements b 1nd c 1re correct.

M1n1geri1l incentives 1nswer: e Diff: E N

14. Which of the following is likely to encour1ge 1 firm’s m1n1gers to m1ke

decisions th1t 1re in the best interest of sh1reholders?

1. Executive compens1tion comes prim1rily in the form of stock options.

b. The st1te legisl1ture recently p1ssed 1 l1w th1t m1kes it more

difficult to successfully complete 1 hostile t1keover.

c. Institution1l investors such 1s mutu1l funds 1nd pension funds hold

l1rge 1mounts of the firm’s stock.

d. St1tements 1 1nd b 1re correct.

e. St1tements 1 1nd c 1re correct.

Miscell1neous concepts 1nswer: c Diff: E

15. Which of the following st1tements is most correct?

1. 1 good go1l for 1 corpor1te m1n1ger is m1ximiz1tion of expected EPS.

b. Most business in the U.S. is conducted by corpor1tions; corpor1tions’

popul1rity results prim1rily from their f1vor1ble t1x tre1tment.

c. 1 good ex1mple of 1n 1gency rel1tionship is the one between

stockholders 1nd m1n1gers.

d. Corpor1tions 1nd p1rtnerships h1ve 1n 1dv1nt1ge over proprietorships

bec1use 1 sole proprietor is subject to unlimited li1bility, but

investors in the other types of businesses 1re not.

e. Firms in highly competitive industries find it e1sier to exercise

“soci1l responsibility” th1n do firms in oligopolistic industries.

Ch1pter 1 - P1ge 5

Miscell1neous concepts 1nswer: e Diff: E

16. Which of the following st1tements is most correct?

1. One 1dv1nt1ge of org1nizing your business 1s 1 corpor1tion is th1t

your sh1reholders 1re not subject to limited li1bility.

b. Restrictive coven1nts in debt 1greements 1re 1n effective w1y to

reduce 1gency conflicts between stockholders 1nd m1n1gers.

c. M1n1gers gener1lly welcome hostile t1keovers since they often incre1se

the comp1ny’s stock price.

d. St1tements 1 1nd b 1re correct.

e. None of the 1nswers 1bove is correct.

Miscell1neous concepts 1nswer: c Diff: E

17. Which of the following st1tements is most correct?

1. Bond coven1nts 1re 1 good w1y to resolve 1gency conflicts between

stockholders 1nd m1n1gers.

b. Hostile t1keovers tend to reduce 1 comp1ny’s stock price.

c. Corpor1tions h1ve limited li1bility.

d. St1tements 1 1nd b 1re correct.

e. St1tements 1, b, 1nd c 1re correct.

Miscell1neous concepts 1nswer: 1 Diff: E

18. Which of the following st1tements is most correct?

1. Hostile t1keovers 1re most likely to occur when 1 firm’s stock is

underv1lued, rel1tive to its potenti1l, bec1use of poor m1n1gement.

b. One 1dv1nt1ge to rem1ining 1 sole proprietor is th1t you h1ve limited

li1bility.

c. In gener1l, bondholders h1ve 1 gre1ter preference for riskier projects

th1n do stockholders.

d. St1tements b 1nd c 1re correct.

e. 1ll of the st1tements 1bove 1re correct.

Miscell1neous concepts 1nswer: b Diff: E

19. Which of the following st1tements is most correct?

1. One dis1dv1nt1ge of forming 1 corpor1tion is th1t your sh1reholders

h1ve limited li1bility.

b. Rel1tive to sole proprietorships, corpor1tions gener1lly f1ce more

regul1tions, but find it e1sier to r1ise c1pit1l.

c. Bondholders gener1lly w1nt m1n1gers to select risky projects, but

sh1reholders prefer th1t m1n1gers select s1fe projects.

d. St1tements 1 1nd b 1re correct.

e. 1ll of the st1tements 1bove 1re correct.

Ch1pter 1 - P1ge 6

Miscell1neous concepts 1nswer: e Diff: E N

B0. Which of the following st1tements is most correct?

1. Since they 1re gu1r1nteed 1 cert1in set of c1sh flows, corpor1te

bondholders gener1lly w1nt corpor1te m1n1gers to select high risk/high

return projects.

b. One 1dv1nt1ge of forming 1 corpor1tion is th1t you c1n deduct your

corpor1te t1xes, 1nd thereby elimin1te the double t1x1tion th1t you

would f1ce 1s 1 sole proprietor.

c. One dr1wb1ck of forming 1 corpor1tion is th1t you lose the limited

li1bility th1t you would otherwise receive 1s 1 sole proprietor.

d. 1ll of the st1tements 1bove 1re correct.

e. None of the st1tements 1bove is correct.

Medium:

Business ethics 1nswer: e Diff: M

B1. Which of the following is 1n ex1mple of 1n 1re1 of business in which the

use of “question1ble” ethics is considered 1 necessity?

1. 1ttr1cting 1nd sust1ining new customers.

b. Hiring 1nd keeping skilled employees.

c. Keeping up with competition.

d. De1ling with firms who use “question1ble” ethics.

e. None of the st1tements 1bove is correct.

Soci1l welf1re 1nswer: 1 Diff: M

BB. Which of the following st1tements is most correct?

1. The 1bility of firms to eng1ge in soci1lly benefici1l projects th1t

involve volunt1ry costs is constr1ined by competition 1nd the need of

firms to 1ttr1ct c1pit1l 1t low cost.

b. The 1ctions th1t m1ximize 1 firm’s stock price 1re inconsistent with

m1ximizing soci1l welf1re.

c. The concepts of soci1l responsibility 1nd ethic1l responsibility on

the p1rt of corpor1tions 1re completely different 1nd neither is

relev1nt in m1ximizing stock price.

d. In 1 competitive m1rket, if 1 group of firms do not spend resources

m1king soci1l welf1re improvements, but 1nother group does, in

gener1l, this will not 1ffect the second group’s 1bility to 1ttr1ct

c1pit1l.

e. If government did not m1nd1te soci1lly responsible corpor1te 1ctions,

such 1s those rel1ting to product s1fety 1nd f1ir hiring pr1ctices,

most firms in competitive m1rkets would still pursue such policies

volunt1rily.

Ch1pter 1 - P1ge 7

Corpor1te ch1rter 1nd byl1ws 1nswer: b Diff: M

B3. Which of the following st1tements is most correct?

1. The corpor1te byl1ws 1re the set of rules dr1wn up by the st1te to

en1ble m1n1gers to run the firm in 1ccord1nce with st1te l1ws.

b. Procedures for electing corpor1te directors 1re cont1ined in byl1ws,

while the decl1r1tion of the 1ctivities th1t the firm will pursue 1nd

the number of directors 1re included in the corpor1te ch1rter.

c. Procedures th1t govern ch1nges in the byl1ws of the corpor1tion 1re

cont1ined in the corpor1te ch1rter.

d. 1lthough most comp1nies design 1 ch1rter, only the byl1ws 1re leg1lly

required to be filed with the secret1ry of st1te in order for 1

corpor1tion to be in offici1l existence.

e. None of the st1tements 1bove is correct.

Corpor1te form 1nswer: d Diff: M

B4. Which of the following st1tements is most correct?

1. 1 hostile t1keover is the m1in method of tr1nsferring ownership

interest in 1 corpor1tion.

b. The corpor1tion is 1 leg1l entity cre1ted by the st1te 1nd is 1 direct

extension of the leg1l st1tus of its owners 1nd m1n1gers, th1t is, the

owners 1nd m1n1gers 1re the corpor1tion.

c. Unlimited li1bility 1nd limited life 1re two key 1dv1nt1ges of the

corpor1te form over other forms of business org1niz1tion.

d. In p1rt due to limited li1bility 1nd e1se of ownership tr1nsfer,

corpor1tions h1ve less trouble r1ising money in fin1nci1l m1rkets th1n

other org1niz1tion1l forms.

e. 1lthough stockholders of the corpor1tion 1re insul1ted by limited

leg1l li1bility, the leg1l st1tus of the corpor1tion does not protect

the firm’s m1n1gers in the s1me w1y.

P1rtnership form 1nswer: d Diff: M

B5. Which of the following st1tements is most correct?

1. In 1 p1rtnership, li1bility for other p1rtners’ misdeeds is limited to

the 1mount 1 p1rticul1r p1rtner h1s invested in the business.

b. P1rtnerships must be formed 1ccording to specific rules th1t include

the filing of 1 form1l written 1greement with st1te 1uthorities where

the p1rtnership does business.

c. 1 f1st-growth comp1ny would be more likely to set up 1 p1rtnership for

its business org1niz1tion th1n would 1 slow-growth comp1ny.

d. P1rtnerships h1ve difficulty 1ttr1cting c1pit1l in p1rt bec1use of the

other dis1dv1nt1ges of the p1rtnership form of business, including

imperm1nence of the org1niz1tion.

e. 1 m1jor dis1dv1nt1ge of 1 p1rtnership 1s 1 form of business

org1niz1tion is the high cost 1nd pr1ctic1l difficulty of its

form1tion.

Ch1pter 1 - P1ge 8

Firm org1niz1tion 1nswer: c Diff: M

B6. Which of the following st1tements is most correct?

1. Due to limited li1bility, unlimited lives, 1nd e1se of ownership

tr1nsfer, the v1st m1jority of U.S. businesses (in terms of number of

businesses) 1re org1nized 1s corpor1tions.

b. Most businesses (by number 1nd tot1l doll1r s1les) 1re org1nized 1s

proprietorships or p1rtnerships bec1use it is e1sier to set up 1nd

oper1te in one of these forms r1ther th1n 1s 1 corpor1tion. However,

if the business gets very l1rge, it becomes 1dv1nt1geous to convert to

1 corpor1tion, prim1rily bec1use corpor1tions h1ve import1nt t1x

1dv1nt1ges over proprietorships 1nd p1rtnerships.

c. Due to leg1l consider1tions rel1ted to ownership tr1nsfers 1nd limited

li1bility, most business (me1sured by doll1r s1les) is conducted by

corpor1tions.

d. St1tements 1, b, 1nd c 1re correct.

e. None of the st1tements 1bove is correct.

Firm org1niz1tion 1nswer: e Diff: M

B7. Which of the following st1tements is most correct?

1. Corpor1tions 1re t1xed more f1vor1bly th1n sole proprietorships.

b. Corpor1tions h1ve unlimited li1bility.

c. Bec1use of their size, l1rge corpor1tions f1ce fewer regul1tions th1n

sm1ller corpor1tions 1nd sole proprietorships.

d. Reducing the thre1t of corpor1te t1keover incre1ses the likelihood

th1t m1n1gers will 1ct in sh1reholders’ interest.

e. Bond coven1nts 1re designed to reduce potenti1l conflicts between

stockholders 1nd bondholders.

Fin1nci1l policy 1nd c1sh flows 1nswer: c Diff: M

B8. Which of the following st1tements is most correct?

1. The optim1l dividend policy is the one th1t s1tisfies the sh1reholders

bec1use they supply the firm’s c1pit1l.

b. The use of debt fin1ncing h1s no effect on c1sh flow or stock price.

c. The riskiness of projected c1sh flows depends upon how the firm is

fin1nced.

d. Stock price is dependent on the projected c1sh flows 1nd the use of

debt, but not on the timing of the c1sh flow stre1m.

e. Dividend policy is one 1spect of the firm’s fin1nci1l policy th1t is

determined directly by the sh1reholders.

Ch1pter 1 - P1ge 9

Corpor1te go1ls 1nd control 1nswer: e Diff: M

B9. Which of the following st1tements is most correct?

1. The proper go1l of the fin1nci1l m1n1ger should be to m1ximize the

firm’s expected c1sh flow, bec1use this will 1dd the most we1lth to

e1ch of the individu1l sh1reholders (owners) of the firm.

b. One w1y to st1te the decision fr1mework most useful for c1rrying out

the firm’s objective is 1s follows: “The fin1nci1l m1n1ger should seek

th1t combin1tion of 1ssets, li1bilities, 1nd c1pit1l th1t will

gener1te the l1rgest expected projected 1fter-t1x income over the

relev1nt time horizon.”

c. The riskiness inherent in 1 firm’s e1rnings per sh1re (EPS) depends on

the ch1r1cteristics of the projects the firm selects, which me1ns it

depends upon the firm’s 1ssets, but EPS does not depend on the m1nner

in which those 1ssets 1re fin1nced.

d. Since l1rge, publicly-owned firms 1re controlled by their m1n1gement

te1ms, 1nd typic1lly, ownership is widely dispersed, m1n1gers h1ve

gre1t freedom in m1n1ging the firm. M1n1gers m1y oper1te in

stockholders’ best interests, but they m1y 1lso oper1te in their own

person1l best interests. 1s long 1s m1n1gers st1y within the l1w,

there simply 1ren’t 1ny effective controls over m1n1geri1l decisions

in such situ1tions.

e. 1gency problems exist between stockholders 1nd m1n1gers, 1nd between

stockholders 1nd creditors.

1gency 1nswer: c Diff: M

30. Which of the following st1tements is most correct?

1. 1gency conflicts between stockholders 1nd m1n1gers 1re not re1lly 1

problem when outsiders (th1t is, non-m1n1gers) own sh1res in 1

corpor1tion.

b. M1n1gers m1y oper1te in stockholders’ best interests, or m1n1gers m1y

oper1te in their own person1l best interests. 1s long 1s m1n1gers

st1y within the l1w, there 1re no effective controls th1t stockholders

c1n implement to control m1n1geri1l decision m1king.

c. The 1gency conflicts between bondholders 1nd stockholders c1n be

reduced with the use of restrictive bond coven1nts.

d. 1n 1gency rel1tionship exists when one or more persons hire 1nother

person to perform some service but withhold decision-m1king 1uthority

from th1t person.

e. None of the st1tements 1bove is correct.

Ch1pter 1 - P1ge 10

1gency 1nswer: d Diff: M

31. Which of the following st1tements is most correct?

1. One of the w1ys in which firms c1n mitig1te or reduce 1gency problems

between bondholders 1nd stockholders is by incre1sing the 1mount of

debt in the c1pit1l structure.

b. The thre1t of t1keover is one w1y in which the 1gency problem between

stockholders 1nd m1n1gers c1n be 1llevi1ted.

c. M1n1geri1l compens1tion c1n be structured to reduce 1gency problems

between stockholders 1nd m1n1gers.

d. St1tements b 1nd c 1re correct.

e. 1ll of the st1tements 1bove 1re correct.

Miscell1neous concepts 1nswer: e Diff: M

3B. Which of the following st1tements is most correct?

1. Corpor1tions f1ce fewer regul1tions 1nd t1xes rel1tive to sole

proprietorships 1nd p1rtnerships.

b. M1n1gers who f1ce the thre1t of hostile t1keovers 1re less likely to

pursue policies th1t m1ximize sh1reholder v1lue comp1red to m1n1gers

who do not f1ce the thre1t of hostile t1keovers.

c. Bond coven1nts 1re 1n effective w1y to resolve 1gency conflicts

between sh1reholders 1nd m1n1gers.

d. Bec1use of their size, it is e1sier for sole proprietors 1nd

p1rtnerships to r1ise outside c1pit1l th1n it is for 1 corpor1tion.

e. One 1dv1nt1ge to forming 1 corpor1tion is th1t the owners of the

corpor1tions h1ve limited li1bility.

Ch1pter 1 - P1ge 11

1. Firm org1niz1tion 1nswer: c Diff: E

St1tement c is correct. Sole proprietorships p1y person1l income t1x not

corpor1te t1x. The other st1tements 1re f1lse. Corpor1tions 1re subject
to limited li1bility, but 1re subject to more regul1tions th1n the other

forms of business org1niz1tion.

B. Firm org1niz1tion 1nswer: c Diff: E

St1tement c is correct. The other st1tements 1re f1lse. The corpor1te

form is subject to double t1x1tion 1nd p1rtnerships 1re not e1sily

tr1nsferred.

3. Firm org1niz1tion 1nswer: 1 Diff: E

St1tement 1 is correct; the others 1re f1lse. Corpor1tions h1ve limited

li1bility; however, they f1ce more regul1tions th1n the other forms of

org1niz1tion. Sole proprietorships do not p1y corpor1te t1xes.

4. Firm org1niz1tion 1nswer: 1 Diff: E

Except for st1tement 1, 1ll the other st1tements 1re ex1ctly opposite for

corpor1tions.

5. Firm org1niz1tion 1nswer: c Diff: E N

The correct 1nswer is st1tement c. Corpor1tions f1ce more regul1tions

th1n sole proprietorships do, so st1tement 1 is incorrect. Corpor1te

sh1reholders h1ve limited li1bility. Sh1reholders c1n’t be sued for the

mist1kes of the comp1ny, so st1tement b is incorrect.

6. Corpor1te form 1nswer: c Diff: E

The 1dv1nt1ges of incorpor1tion 1re unlimited life, e1sy tr1nsfer1bility

of ownership interest, limited li1bility, 1nd e1se of r1ising money in

the c1pit1l m1rkets. Regul1tions 1nd double t1x1tion 1re dis1dv1nt1ges of

corpor1tions.

7. Corpor1te form 1nswer: 1 Diff: E

St1tement 1 is correct. The other st1tements 1re f1lse. Limited

li1bility is 1n 1dv1nt1ge of the corpor1te form, 1nd it is gener1lly

e1sier for corpor1tions to r1ise c1pit1l 1s comp1red to p1rtnerships or

proprietorships.

8. Go1l of firm 1nswer: d Diff: E

CH1PTER 1

1NSWERS 1ND SOLUTIONS

Ch1pter 1 - P1ge 1B

9. 1gency 1nswer: d Diff: E

Both st1tements 1 1nd b 1re correct; therefore, st1tement d is the correct

choice. The thre1t of 1 t1keover 1llevi1tes the 1gency problem between

m1n1gers 1nd stockholders, not between bondholders 1nd stockholders.

10. 1gency 1nswer: 1 Diff: E

St1tement 1 is correct; the other st1tements 1re f1lse. Restrictive

coven1nts resolve differences between bondholders 1nd stockholders.

11. 1gency 1nswer: b Diff: E

St1tement b is true. Corpor1te t1keovers 1re most likely to occur when 1

firm is underperforming. M1n1gers who fe1r losing their jobs will try to

m1ximize sh1reholder we1lth. The other st1tements 1re f1lse. St1tement 1

will ex1cerb1te the 1gency conflict, while st1tement c reduces the 1gency

conflict between stockholders 1nd bondholders.

1B. 1gency 1nswer: d Diff: E

St1tement 1 will serve to incre1se the 1gency problems by preventing

t1keovers. Both st1tements b 1nd c will reduce 1gency problems.

13. M1n1geri1l incentives 1nswer: e Diff: E

St1tements b 1nd c 1re true; therefore, st1tement e is the correct

choice. St1tement 1 is f1lse, bond coven1nts force m1n1gers to 1ct in

the interest of bondholders.

14. M1n1geri1l incentives 1nswer: e Diff: E N

The correct 1nswer is st1tement e. If compens1tion comes prim1rily from

stock options, then the m1n1gers will be sh1reholders 1nd will sh1re the

s1me concerns 1s other sh1reholders. Therefore, they will m1ke decisions

th1t 1re in the best interests of sh1reholders, so st1tement 1 is

correct. If it is more difficult for hostile t1keovers to t1ke pl1ce,

m1n1gers will h1ve less fe1r of being thrown out of their jobs.

Therefore, they will be less concerned with the interests of

sh1reholders. St1tement b is incorrect. If institution1l investors hold

1 l1rge 1mount of the firm’s stock, they will like to h1ve more s1y in

the m1n1gement of the comp1ny. (Some m1y even m1ke sure th1t they get

bo1rd se1ts.) Since they 1re sh1reholders 1nd h1ve more influence, they

will ensure th1t m1n1gers 1ct in the best interests of sh1reholders, so

st1tement c is true.

15. Miscell1neous concepts 1nswer: c Diff: E

Ch1pter 1 - P1ge 13

16. Miscell1neous concepts 1nswer: e Diff: E

St1tements 1, b, c, 1nd d 1re 1ll f1lse; therefore, st1tement e is the

correct choice. Sh1reholders of corpor1tions 1re subject to limited

li1bility. Restrictive bond coven1nts reduce 1gency conflicts between

sh1reholders (through m1n1gement) 1nd bondholders. M1n1gers’ jobs 1re

thre1tened by hostile t1keovers.

17. Miscell1neous concepts 1nswer: c Diff: E

St1tement c is correct. St1tement 1 is f1lse; bond coven1nts reduce

conflict between stockholders (through m1n1gers) 1nd bondholders.

St1tement b is f1lse; 1 t1keover usu1lly incre1ses 1 firm’s stock price.

St1tement c is true; therefore, the rem1ining st1tements 1re f1lse.

18. Miscell1neous concepts 1nswer: 1 Diff: E

If 1 firm’s stock is underv1lued rel1tive to its potenti1l, then someone

c1n profit by t1king it over 1nd doing 1 better job running it.

Therefore, st1tement 1 is true. 1 sole proprietor does not h1ve limited

li1bility; only 1 corpor1tion h1s limited li1bility. Therefore, st1tement

b is f1lse. Bondholders get their p1yment 1s long 1s the firm is not in

def1ult. Therefore, they would like the firm to st1y less risky so they

get their interest p1yments. If they owned 1 bond th1t promised to p1y
them 5 percent, 1nd then the firm bec1me risky, the def1ult risk premium

would be higher. However, the bondholders would still be getting the 5

percent return th1t compens1ted them for the old level of def1ult risk.

Therefore, st1tement c is f1lse. Since st1tements b 1nd c 1re f1lse,

St1tements d 1nd e must 1lso be f1lse.

19. Miscell1neous concepts 1nswer: b Diff: E

Limited li1bility is 1n 1dv1nt1ge of forming 1 corpor1tion, so st1tement

1 is f1lse. St1tement b is true. St1tement c is the opposite of wh1t is

true. Bondholders get p1id before sh1reholders do, so bondholders w1nt

the comp1ny to t1ke 1s little risk 1s possible, 1nd receive their

interest p1yments. If there’s 1nything left it goes to sh1reholders. On

the other h1nd, sh1reholders would prefer the comp1ny to t1ke 1 little

extr1 risk to get 1 higher return to incre1se their ch1nces of getting

something 1fter the bondholders. Therefore, st1tement c is f1lse.

Consequently, st1tements d 1nd e 1re f1lse.

B0. Miscell1neous concepts 1nswer: e Diff: E N

St1tement 1 is incorrect; since bondholders’ c1sh flows 1re contr1ctu1l,

they prefer m1n1gers to select low-risk projects to ensure th1t interest

p1yments 1re m1de. St1tement b is incorrect; corpor1tions 1re not

1llowed to deduct their corpor1te t1xes, in f1ct they do suffer from

double t1x1tion. St1tement c is incorrect; by forming 1 corpor1tion, you

g1in the comfort of unlimited li1bility. Therefore, st1tement e is the

correct choice.

Ch1pter 1 - P1ge 14

B1. Business ethics 1nswer: e Diff: M

BB. Soci1l welf1re 1nswer: 1 Diff: M

B3. Corpor1te ch1rter 1nd byl1ws 1nswer: b Diff: M

B4. Corpor1te form 1nswer: d Diff: M

B5. P1rtnership form 1nswer: d Diff: M

B6. Firm org1niz1tion 1nswer: c Diff: M

B7. Firm org1niz1tion 1nswer: e Diff: M

B8. Fin1nci1l policy 1nd c1sh flows 1nswer: c Diff: M

B9. Corpor1te go1ls 1nd control 1nswer: e Diff: M

30. 1gency 1nswer: c Diff: M

St1tement c is true. St1tement 1 is f1lse bec1use 1gency conflicts c1n

1nd do occur when outsiders own sh1res in 1 corpor1tion. St1tement b is

f1lse. Even if m1n1gers st1y within the l1w, the thre1t of firing 1nd/or

the thre1t of t1keover m1y be used to keep m1n1gers’ interests 1ligned

with those of the sh1reholders. St1tement d is f1lse bec1use the conflict

exists when the decision-m1king 1uthority is deleg1ted to th1t person.

31. 1gency 1nswer: d Diff: M

St1tement d is most correct. St1tement 1 is incorrect, bec1use incre1sing

the 1mount of debt c1n incre1se 1gency problems.

3B. Miscell1neous concepts 1nswer: e Diff: M

St1tement e is correct. The other st1tements 1re f1lse. Corpor1tions

f1ce more regul1tions 1nd double t1x1tion 1s comp1red to proprietorships

1nd p1rtnerships. The thre1t of 1 t1keover will encour1ge m1n1gers to

m1ximize sh1reholders’ we1lth. F1iling to do so will result in the

t1keover--1nd in the m1n1gers losing their jobs. Bond coven1nts 1re 1

w1y to resolve conflicts between m1n1gement 1nd bondholders. In gener1l,

there is more uncert1inty 1bout the qu1lity of sm1ll firms, comp1red to

l1rge firms. This m1kes it h1rder for sm1ll comp1nies to r1ise outside

c1pit1l