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CHAPTER 1

Introduction to Corporate Finance I. DEFINITIONS

CONTROLLER c 1. The person generally directly responsible for overseeing the tax management, cost accounting, financial accounting, and data processing functions is the: a. treasurer. b. director. c. controller. d. chairman of the board. e. chief executive officer. TREASURER a 2. The person generally directly responsible for overseeing the cash and credit functions, financial planning, and capital expenditures is the: a. treasurer. b. director. c. controller. d. chairman of the board. e. chief operations officer. CAPITAL BUDGETING d 3. The process of planning and managing a firm’s long-term investments is called: a. working capital management. b. financial depreciation. c. agency cost analysis. d. capital budgeting. e. capital structure. CAPITAL STRUCTURE e 4. The mixture of debt and equity used by a firm to finance its operations is called: a. working capital management. b. financial depreciation. c. cost analysis. d. capital budgeting. e. capital structure. WORKING CAPITAL MANAGEMENT a 5. The management of a firm’s short-term assets and liabilities is called: a. working capital management. b. debt management. c. equity management. d. capital budgeting. e. capital structure.

b. indenture contract. statement of purpose. limited partnership. c. e. d. general partnership. corporation. c. d. e. group charter. A business formed by two or more individuals who each have unlimited liability for business debts is called a: a. ARTICLES OF INCORPORATION e 10. corporation. e. b. corporation. PARTNERSHIP AGREEMENT d 8. limited partnership. sole proprietorship. general partnership. c. b. unlimited liability company. indenture contract. c. d. c. d. e. corporate charter. sole proprietorship. b. limited liability company. limited liability company. The division of profits and losses among the members of a partnership is formalized in the: a. limited partnership. articles of incorporation. indemnity clause. .CHAPTER 1 SOLE PROPRIETORSHIP b 6. general partnership. partnership agreement. GENERAL PARTNERSHIP c 7. state tax agreement. A business created as a distinct legal entity composed of one or more individuals or entities is called a: a. A business owned by a single individual is called a: a. The corporate document that sets forth the business purpose of a firm is the: a. corporate bylaws. d. CORPORATION a 9. b. e. sole proprietorship.

d. indenture provisions. The rules by which corporations govern themselves are called: a. limited liability company. indemnity provisions. e. b. e. d. LIMITED LIABILITY COMPANY a 12. Agency costs refer to: a. d. AGENCY PROBLEM c 14. FINANCIAL MANAGEMENT GOAL b 13. the total interest paid to creditors over the lifetime of the firm. b. e. is called a: a. b. e. maximize current dividends per share of the existing stock. stockholders’ liability. c. bylaws. the agency problem. limited proprietorship. the costs that result from default and bankruptcy of a firm. articles of incorporation. . legal liability. charter agreements. maintain steady growth in both sales and net earnings. sole proprietorship. c. corporate activism. avoid financial distress. d. The primary goal of financial management is to: a. but with limited liability for the owners.CHAPTER 1 BYLAWS d 11. d. the total dividends paid to stockholders over the lifetime of a firm. c. b. minimize operational costs and maximize firm efficiency. c. general partnership. corporation. maximize the current value per share of the existing stock. b. A conflict of interest between the stockholders and management of a firm is called: a. AGENCY COSTS d 15. c. the costs of any conflicts of interest between stockholders and management. corporate breakdown. e. corporate income subject to double taxation. A business entity operated and taxed like a partnership.

PRIMARY MARKET a 17. e. b. dealer market. liquidation market. c. d. primary market. NASDAQ market. secondary market. b. any person or entity that has voting rights based on stock ownership of a corporation. e. d. c. DEALER MARKET c 19. A stakeholder is: a. primary market. d. OTC market. dealer market. SECONDARY MARKET c 18. c. .CHAPTER 1 STAKEHOLDERS e 16. b. d. secondary market. a person who initially started a firm and currently has management control over the cash flows of the firm due to his/her current ownership of company stock. any person or entity other than a stockholder or creditor who potentially has a claim on the cash flows of the firm. private placement market. any person or entity that owns shares of stock of a corporation. A market where trading takes place directly between buyers and sellers is called a(n): a. When one shareholder sells stock directly to another the transaction is said to occur in the: a. auction market. liquidation market. liquidation market. c. c. A market where dealers buy and sell securities for themselves. OTC market. dealer market. at their own risk. AUCTION MARKET d 20. b. is called a(n): a. primary market. primary market. a creditor to whom the firm currently owes money and who consequently has a claim on the cash flows of the firm. proprietary market. The original sale of securities by governments and corporations to the general public occurs in the: a. secondary market. d. e. e. auction market. e. b.

Which of the following questions are addressed by financial managers? I. The controller reports to the president. determining how much debt should be borrowed from a particular lender b. . e. The vice president of finance reports to the chairman of the board. and III only d. II and III only c. d. When considering a capital budgeting project the financial manager should consider: a. vice president of finance. I. Should the firm build a new factory? a. I. b. How long will it take to produce a product? II. c. and IV ORGANIZATIONAL STRUCTURE e 22. II. The chief executive officer reports to the board of directors. III. only the risk of the project cash flows. II. III. II. chief executive officer. the size. only the size of the project.CHAPTER 1 II. timing. c. deciding whether or not to open a new store c. president. determining how much money should be kept in the checking account CAPITAL BUDGETING e 25. Which one of the following statements is correct concerning the organizational structure of a corporation? a. Should the firm borrow more money? IV. only the timing of the project cash flows. d. The treasurer and the controller of a corporation generally report to the: a. determining how much inventory to keep on hand e. How long should customers be given to pay for their credit purchases? III. I and IV only b. only the size and timing of the project cash flows. and IV only e. deciding when to repay a long-term debt d. b. d. CAPITAL BUDGETING b 24. c. ORGANIZATIONAL STRUCTURE b 23. board of directors. b. The treasurer reports to the chief executive officer. and risk of the project cash flows. CONCEPTS FINANCIAL MANAGEMENT d 21. chairman of the board. e. Which one of the following is a capital budgeting decision? a. e. The chief operations officer reports to the vice president of production.

II. I and II only b. current assets and liabilities. II and III only c. working capital management. III. I. d. c. Capital structure decisions include consideration of the: I. c. is concerned with having sufficient funds to operate the business on a daily basis. capital budgeting. long-term debt III. net working capital. and IV only WORKING CAPITAL MANAGEMENT e 29. e. e. accounts payable II. ensures that sufficient equipment is available to produce the amount of product desired on a daily basis. and IV only CAPITAL STRUCTURE e 27. ensures that long-term debt is acquired at the lowest possible cost. Working capital management: a. III. b. I. d. I and III only c. I. II and IV only d. ensures that dividends are paid to all stockholders on an annual basis. balances the amount of company debt to the amount of available equity. II. I and II only b. cost of acquiring funds. a. I. . b. accounts receivable IV. II. inventory a. and III only e. III. a controller’s duties. IV. III and IV only d.CHAPTER 1 CAPITAL STRUCTURE a 26. WORKING CAPITAL MANAGEMENT e 28. Working capital management includes decisions concerning which of the following? I. the net working capital decision. The decision of which lender to use and which type of long-term loan is best for a project is part of: a. amount of long-term debt to assume. the capital structure decision. and IV only e.

ability to manage the day-to-day affairs of the business c. A general partner: a. no potential financial loss d.CHAPTER 1 SOLE PROPRIETORSHIP d 30. b. is taxed the same as a corporation. The ownership of the firm is easy to transfer to another individual. Which one of the following statements concerning a sole proprietorship is correct? a. The profits of a sole proprietorship are taxed twice. b. PARTNERSHIP e 32. c. PARTNERSHIP c 34. d. allows for easy transfer of interest from one general partner to another. The legal costs to form a sole proprietorship are quite substantial. d. e. The owner of a sole proprietorship may be forced to sell his/her personal assets to pay company debts. b. The company must pay separate taxes from those paid by the owner. The owner can generally raise large sums of capital quite easily. liability for firm debts limited to the capital invested PARTNERSHIP b 33. The life of the firm is limited to the life span of the owner. faces double taxation whereas a limited partner does not. greater management responsibility e. SOLE PROPRIETORSHIP a 31. c. cannot lose more than the amount of his/her equity investment. e. c. A partnership: a. has less of an ability to raise capital than a proprietorship. The owners of a sole proprietorship share profits as established by the partnership agreement. c. d. Which one of the following best describes the primary advantage of being a limited partner rather than a general partner? a. terminates at the death of any general partner. A sole proprietorship is often structured as a limited liability company. entitlement to a larger portion of the partnership’s income b. b. e. . is the term applied only to corporations which invest in partnerships. A sole proprietorship is the least common form of business ownership. has less legal liability than a limited partner. agreement defines whether the business income will be taxed like a partnership or a corporation. has more management responsibility than a limited partner. e. Which one of the following statements concerning a sole proprietorship is correct? a. d.

I and II only b. can set forth the conditions under which the firm can avoid double taxation. III and IV only c. I. . can be used to remove company management. Both partnerships and corporations have bylaws. personal liability for firm debt III. double taxation III. III. The majority of firms are corporations. limited liability for firm debt II. The largest firms are usually corporations. The articles of incorporation: a. e. Both partnerships and corporations incur double taxation. I. e. Which one of the following statements is correct concerning corporations? a. and IV only e. e. b. d. Which of the following are advantages of the corporate form of business ownership? I. The ability of a corporation to raise capital is quite limited. and IV only e. greater ability to raise capital than a sole proprietorship IV. II. I. Partnerships are the most complicated type of business to form. are amended annually by the company stockholders. II. c. Which one of the following statements is correct? a. d. c. and III only d. II and III only d. and IV only CORPORATION a 37. d. limited life of the firm II. III. c. II. and IV only CORPORATION e 36. unlimited firm life a. b. ability to raise capital IV. III and IV only c. The income of a corporation is taxed as personal income of the stockholders. I. set forth the rules by which the corporation regulates its existence. set forth the number of shares of stock that can be issued. Which of the following are disadvantages of a partnership? I. Both sole proprietorships and partnerships are taxed in a similar fashion.CHAPTER 1 PARTNERSHIP d 35. b. The stockholders are usually the managers of a corporation. I and II only b. ARTICLES OF INCORPORATION c 39. lack of ability to transfer partnership interest a. III. All types of business formations have limited lives. BUSINESS TYPES b 38.

b. b. doing so increases the salaries of all the employees. e. are rules which apply only to limited liability companies. having liability exposure similar to that of a general partner. CORPORATION c 42. corporation d. d. limited partnership CORPORATION d 43. c. The bylaws: a. sole proprietorship b. market value of the existing owners’ equity. doing so guarantees the company will grow in size at the maximum possible rate. d. doing so means the firm is growing in size faster than its competitors. limited liability company c. Which type of business organization has all the respective rights and privileges of a legal person? a. c. b. having liability exposure similar to that of a sole proprietor. GOAL OF FINANCIAL MANAGEMENT d 45. AGENCY PROBLEM . the current stockholders are the owners of the corporation. set forth the purpose of the firm. c. corporation e. general partnership c. d. being taxed like a corporation with liability like a partnership. d. limited liability company GOAL OF FINANC IAL MANAGEMENT c 44. establish the name of the corporation. Financial managers should strive to maximize the current value per share of the existing stock because: a. sole proprietorship b. Which one of the following business types is best suited to raising large amounts of capital? a. e. general partnership e. e. being taxed like a corporation. limited partnership d. e. set forth the procedure by which the stockholders elect the senior managers of the firm. growth rate of the firm.CHAPTER 1 BYLAWS d 40. size of the firm. financial distress of the firm. LIMITED LIABILITY COMPANY c 41. being taxed personally on all business income. b. The owners of a limited liability company prefer: a. marketability of the managers. the managers often receive shares of stock as part of their compensation. c. The decisions made by financial managers should all be ones which increase the: a. mandate the procedure for electing corporate directors.

II and III only b. limited liability company AGENCY COST c 49. III. corporation e. Which one of the following actions by a financial manager creates an agency problem? refusing to borrow money when doing so will create losses for the firm refusing to lower selling prices if doing so will reduce the net profits agreeing to expand the company at the expense of stockholders’ value agreeing to pay bonuses based on the market value of the company stock increasing current costs in order to increase the market value of the stockholders’ equity AGENCY PROBLEM e 47. limited partnership d. I and IV only d. and IV only . II. compensation based on the value of the stock II. forgoing an investment opportunity which would add to the market value of the owner’s equity II. Which of the following help convince managers to work in the best interest of the stockholders? I. general partnership c. Which form of business structure faces the greatest agency problems? a. hiring outside auditors to verify the accuracy of the company financial statements a. III. III and IV only c. II. threat of a company takeover IV. a. and IV only e. I. e. I. stock option plans III. I and III only c. b. and IV AGENCY PROBLEM d 48.CHAPTER 1 c 46. d. and III only d. II and IV only e. c. threat of a proxy fight a. I. Which of the following are agency costs? I. sole proprietorship b. paying a dividend to each of the existing shareholders III. I. I and II only b. II. purchasing new equipment which increases the value of each share of stock IV.

. The NYSE is a dealer market. I. an individual investor selling shares of stock to another individual d. II. a. The exchange with the strictest listing requirements is NASDAQ. II and IV only c. new loan proceeds IV. and IV only e. II and IV only STOCK EXCHANGE d 54. I and IV only d. The NYSE is an auction market. I and III only d. a bank selling shares of a medical firm to an individual e. d. payment of dividends III.CHAPTER 1 STAKEHOLDERS a 50. a dealer selling shares of stock to an individual investor b. I and III only b. Which of the following represent cash outflows from a firm? I. II and III only e. IV. Some large companies are listed on NASDAQ. short-term creditor c. preferred stockholder e. a dealer buying newly issued shares of stock from a corporation c. Which one of the following statements concerning stock exchanges is correct? a. III. II. issuance of securities II. employee b. c. and IV only PRIMARY MARKET b 52. The NYSE has more listed stocks than NASDAQ. e. payment of government taxes a. Which of the following statements concerning auction markets is (are) correct? I. NASDAQ is an auction market. long-term creditor d. All trades involve a dealer in an auction market. a sole proprietor buying shares of stock from an individual investor AUCTION MARKET b 53. II. I only b. Which one of the following is a primary market transaction? a. Most debt securities are traded on the NYSE. II only c. common stockholder CASH FLOWS b 51. III. An auction market is called an over-the-counter market. Which one of the following parties is considered a stakeholder of a firm? a. b.

Which one of the following statements is correct concerning the NYSE? a. are reserved strictly for trading debt securities. IV. and IV only e. b. III. c. NASDAQ is an OTC market. PROBLEMS Not applicable for Chapter 1 . II. I and II only b. d. I. Most smaller firms are listed on NASDAQ rather than on the NYSE. only exist outside of the United States. Dealer markets: a. NASDAQ d 57. A firm is expected to have a market value for its publicly held shares of at least $100 million to be listed on the NYSE. I and III only c. I. III. c. The NYSE is an over-the-counter exchange functioning as both a primary and a secondary market. II. Which of the following statements concerning NASDAQ are correct? I.CHAPTER 1 DEALER MARKETS c 55. Any corporation desiring to be listed on the NYSE can do so. NASDAQ is an auction market. The NYSE is the largest dealer market for listed securities in the United States. and IV III. a. e. NYSE a 56. e. list only the securities of the largest firms. NASDAQ is an electronic market. II. d. II and IV only d. b. include the American Exchange and the Pacific Stock Exchange. The NYSE accounts for only 50 percent of the shares traded in the auction markets. are called over-the-counter markets.

Other goals. it may not be desirable to spend part of that capital forming a corporation. Capital structure: This refers to the specific mixture of long-term debt and equity a firm uses to finance its operations. . focus too narrowly on accounting income and ignore the importance of market values in managerial finance. the heart and sole of the business is the person who founded it. such as maximizing earnings. limited liability for business debts may not be a significant advantage if the proprietor has limited capital. so the life of the business may effectively be limited to the life of the founder during its early years. the ability to raise more capital. Capital budgeting: The financial manager ties to identify investment opportunities that are worth more to the firm than they cost to acquire. 3. Working capital management: This refers to a firm’s short-term assets and short-term liabilities. ESSAYS FINANCIAL MANAGEMENT 58. If the sole proprietor has limited capital to start with. for a typical small business. Managing the firm’s working capital is a day-to-day activity that ensures the firm has sufficient resources to continue its operations and avoid costly interruptions. BUSINESS ORGANIZATIONS 60. most of which is tied up in the business anyway. FINANCIAL MANAGEMENT GOAL 61. BUSINESS ORGANIZATIONS 59. and the opportunity of an unlimited life of the business. the owners’ limited liability for business debts. why is it so common for small businesses to initially be formed as sole proprietorships? A significant advantage of the sole proprietorship is that it is cheap and easy to form. If the corporate form of business organization has so many advantages over the sole proprietorship. Also. What advantages does the corporate form of organization have over sole proprietorships or partnerships? The advantages of the corporate form of organization over sole proprietorships and partnerships are the ease of transferring ownership. Finally. This goal focuses on enhancing the returns to stockholders who are the owners of the firm.CHAPTER 1 IV. List and briefly describe the three basic questions addressed by a financial manager. The three areas are: 1. 2. What should be the goal of the financial manager of a corporation? Why? The correct goal is to maximize the current value of the outstanding stock.

If so. should IBM’s management care about the price you get for your shares? The current market price of IBM stock reflects. FINANCIAL MANAGEMENT GOALS 65.CHAPTER 1 AGENCY THEORY 62. For example. However. Thus. If the shareholder’s sale price is low. When the Small Business Administration (SBA) makes a loan to a sole proprietorship. untested business to acquire enough capital to grow. In a sole proprietorship and a small partnership. among other things. Why. BUSINESS ORGANIZATIONS 63. it typically requires life insurance be carried on the business owner in an amount sufficient to cover the loan. Suppose you own 100 shares of IBM stock which you intend to sell today. you would not invest in companies you expected to be unable to satisfy their financial obligations. then. such separation is not likely to exist to the degree it does in a corporation. as employees are hired to represent the firm. It would be very difficult for a young. what impact would this have on the functioning of primary and secondary markets for common stock? With unlimited liability. LIMITED LIABILITY 64. market opinion about the quality of firm management. if the sale price is high. and therefore doing a good job. there is once again a separation of ownership and management. Both the primary and secondary markets for common stock would be severely hampered if this rule existed. Why might the SBA demand such coverage? The SBA knows that the heart of a small business is the existence of the owner and that a sole proprietorship ends when the owner dies. Do you think agency problems arise in sole proprietorships and/or partnerships? Agency conflicts typically arise when there is a separation of ownership and management of a business. you would be very careful which stocks you invest in. Should the owner die. the SBA requires the life insurance to ensure the loan will be repaid should the owner die. Since you will sell it in the secondary market. Alternatively. there is still potential for agency conflicts. this indirectly reflects on the reputation of the managers. IBM will receive no direct cash flows as a consequence of your sale. it is likely the business will be severely harmed and the sale value of the firm greatly diminished. Assume for a moment that the stockholders in a corporation have unlimited liability for corporate debts. as well as potentially impacting their standing in the employment market. . In particular. this indicates that the market believes current management is increasing firm value.

EXCHANGE LISTINGS 67. Plus. the ownership of the stock certificates can be transferred directly to the lender. One thing lenders sometimes require when loaning money to a small corporation is an assignment of the common stock as collateral on the loan. By taking control of the stock.CHAPTER 1 TRANSFER OF OWNERSHIP IN A CORPORATION 66. However. such as Microsoft. if the business fails to repay its loan. Why might a corporation wish to list its shares on a national exchange such as the NYSE as opposed to a regional exchange or NASDAQ? Being listed on a regional exchange effectively limits the capital access for the business. . Often it is time consuming and difficult to take title of all of the business assets individually. the lure of greater prestige certainly hasn’t prompted some major corporations. There is still a prestige factor in moving from NASDAQ to the NYSE since the NYSE has more restrictive membership requirements. to move to the NYSE. there is a prestige factor in being listed on one of the national exchanges. Why might a lender want such an assignment? What advantage of the corporate form of organization comes into play here? In the event of a loan default. a lender may wish to liquidate the business. This illustrates once again the ease of transfer of ownership of a corporation. Then. the lender is able to sell the business simply by reselling the stock in the business.