Chapter 1: Introduction to Financial Management

CHAPTER 1 Introduction to Financial Management

I. DEFINITIONS

Topic: CORPORATE CONTROLLER 1.The corporate officer generally responsible for tasks related to ta !anage!ent" cost acco#nting" financial acco#nting" and data processing is the: A$ Corporate Treas#rer. %$ &irector. C$ Corporate Controller. &$ Chair!an of the %oard. E$ 'ice President of Operations. Ans(er: C

Topic: CORPORATE TREA)*RER +.The corporate officer generally responsible for tasks related to cash and credit !anage!ent" financial planning" and capital e pendit#res is the: A$ Corporate Treas#rer. %$ &irector. C$ Corporate Controller. &$ Chair!an of the %oard. E$ 'ice President of Operations. Ans(er: A

Topic: CAP,TAL %*&-ET,N..The process of planning and !anaging a fir!/s long0ter! in1est!ents is called: A$ 2orking capital !anage!ent. %$ 3inancial depreciation. C$ Agency cost analysis. &$ Capital b#dgeting. E$ Capital str#ct#re. Ans(er: &

Topic: CAP,TAL )TR*CT*RE 4.The !i t#re of debt and e5#ity #sed by the fir! to finance its operations is called: A$ (orking capital !anage!ent.

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%$ financial depreciation. C$ agency cost analysis. &$ capital b#dgeting. E$ capital str#ct#re. Ans(er: E

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Topic: 2OR6,N- CAP,TAL 7ANA-E7ENT 8.The !anage!ent of the fir!/s short0ter! assets and liabilities is called: A$ 2orking capital !anage!ent. %$ 3inancial depreciation. C$ Agency cost analysis. &$ Capital b#dgeting. E$ Capital str#ct#re. Ans(er: A

Topic: )OLE PROPR,ETOR)9,P :.A b#siness o(ned by a single indi1id#al is called a;n$: A$ Corporation. %$ )ole proprietorship. C$ Partnership. &$ Closed recei1ership. E$ Open str#ct#re. Ans(er: %

Topic: PARTNER)9,P <.A b#siness for!ed by t(o or !ore indi1id#als or entities is called a;n$: A$ Corporation. %$ )ole proprietorship. C$ Partnership. &$ Closed recei1ership. E$ Open str#ct#re. Ans(er: C

Topic: CORPORAT,ON =.A b#siness created as a distinct legal entity co!posed of one or !ore indi1id#als or entities is called a;n$: A$ Corporation. %$ )ole proprietorship. C$ Partnership. &$ Closed recei1ership. E$ Open str#ct#re. Ans(er: A

Topic: PARTNER)9,P A-REE7ENT >.The di1ision of profits and losses bet(een the !e!bers of a partnership is for!ali?ed in the: A$ ,nde!nity cla#se. %$ ,ndent#re contract. C$ )tate!ent of p#rpose. &$ Partnership agree!ent.

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E$ -ro#p charter. Ans(er: &

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Topic: ART,CLE) O3 ,NCORPORAT,ON 1@. The doc#!ent that legally establishes do!icile for a corporation is called the: A$ ,ndent#re contract. %$ Partnership agree!ent. C$ A!ended ho!estead filing. &$ %yla(s. E$ Articles of incorporation. Ans(er: E

Topic: %ALA2) 11. The r#les by (hich corporations go1ern the!sel1es are called: A$ ,ndent#re pro1isions. %$ ,nde!nity pro1isions. C$ Partnership agree!ents. &$ %yla(s. E$ Articles of incorporation. Ans(er: &

Topic: L,7,TE& L,A%,L,TA CORPORAT,ON 1+. A b#siness entity operated and ta ed like a partnership" b#t (ith the li!ited liability feat#re for o(ners" is called a: A$ Li!ited liability corporation. %$ -eneral partnership. C$ Cartel. &$ )ole proprietorship. E$ Corporation. Ans(er: A

Topic: 3,NANC,AL 7ANA-E7ENT -OAL 1.. The pri!ary goal of financial !anage!ent is to: A$ 7a i!i?e c#rrent sales. %$ 7a i!i?e the c#rrent 1al#e per share of the e isting stock. C$ A1oid financial distress. &$ 7ini!i?e operational costs. E$ 7aintain steady earnings gro(th. Ans(er: %

Topic: A-ENCA PRO%LE7 14. The possibility of conflict of interest bet(een the stockholders and !anage!ent of the fir! is called: A$ The shareholders/ con#ndr#!. %$ Corporate breakdo(n. C$ The agency proble!.

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&$ Corporate acti1is!. E$ Legal liability. Ans(er: C

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Topic: A-ENCA CO)T) 18. Agency costs A$ The total di1idends paid to shareholders o1er the lifeti!e of the fir!. %$ The costs that res#lt fro! defa#lt and bankr#ptcy of the fir!. C$ Corporate inco!e s#bBect to do#ble ta ation. &$ The costs of the conflict of interest bet(een stockholders and !anage!ent. E$ The total interest paid to creditors o1er the lifeti!e of the fir!. Ans(er: &

Topic: )TA6E9OL&ER) 1:. A stakeholder is: A$ -i1en to each stockholder (hen they first p#rchase their stock. %$ A pro y 1ote !ade at a shareholders !eeting. C$ A fo#nding stockholder of the fir!. &$ An original creditor of the fir!. E$ A person or entity other than a stockholder or creditor (ho potentially has a clai! on the cash flo(s of the fir!. Ans(er: E

Topic: PR,7ARA 7AR6ET 1<. The original sale of sec#rities by go1ern!ents and corporations occ#rs in the: A$ Pri!ary !arket. %$ )econdary !arket. C$ &ealer !arket. &$ A#ction !arket. E$ Li5#idation !arket. Ans(er: A

Topic: )ECON&ARA 7AR6ET 1=. The p#rchase and sale of sec#rities after the original iss#ance occ#rs in the: A$ Pri!ary !arket. %$ )econdary !arket. C$ &ealer !arket. &$ A#ction !arket. E$ Li5#idation !arket. Ans(er: %

Topic: &EALER 7AR6ET 1>. A !arket (here dealers b#y and sell sec#rities for the!sel1es" at their o(n risk" is called a;n$: A$ Pri!ary !arket. %$ )econdary !arket. C$ &ealer !arket.

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Chapter 1: Introduction to Financial Management

&$ A#ction !arket. E$ Li5#idation !arket. Ans(er: C

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Topic: A*CT,ON 7AR6ET +@. A !arket (here trading takes place bet(een b#yers and sellers directly is called a;n$: A$ Pri!ary !arket. %$ )econdary !arket. C$ &ealer !arket. &$ A#ction !arket. E$ Li5#idation !arket. Ans(er: &

II CONCEPTS

Topic: %*),NE)) OR-AN,CAT,ON) +1.2hich of the follo(ing does NOT offer the protection of li!ited liabilityD A$ corporation %$ li!ited liability co!pany C$ sole proprietorship &$ li!ited partnership E$ ) corporation Ans(er: C

Topic: 3,NANC,AL 7ANA-E7ENT -OAL ++.The f#nda!ental goal of financial !anage!ent sho#ld be to: A$ 7a i!i?e sales. %$ 7a i!i?e the c#rrent 1al#e per share of the e isting stock. C$ A1oid financial distress. &$ 7aintain steady earnings gro(th. E$ 7a i!i?e profits. Ans(er: %

Topic: 3,NANC,AL 7ANA-ER +..2hich of the follo(ing does NOT address the 5#estion: E2hat are the d#ties of a financial !anagerDE ,. &eciding ho( !#ch interest to pay the holders of the corporation/s bonds. ,,. &eciding the !i of long0ter! debt and e5#ity. ,,,. &eciding (hich proBects a fir! sho#ld #ndertake. ,'. &eciding ho( !#ch short0ter! debt to #se. A$ , only %$ ,,, only C$ ,, and ,,, only

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&$ ,," ,,," and ,' only E$ ," ,," ,,," and ,' Ans(er: A

1@

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Topic: %*),NE)) OR-AN,CAT,ON) +4.2hich of the follo(ing state!ents is tr#e regarding the corporate for! of organi?ation co!pared to that of the sole proprietorshipD A$ The o(ners of the sole proprietorship ha1e li!ited liability for the fir!/s debts. %$ The sole proprietorship is the si!plest b#siness for! to start0#p. C$ The corporation has a li!ited life. &$ &i1idends recei1ed by the corporation/s shareholders are ta 0e e!pt. E$ ,t is !ore diffic#lt to transfer o(nership in a corporation. Ans(er: %

Topic: A-ENCA CO)T) +8.2hich of the follo(ing is NOT a type of agency costD A$ The cost of an a#dit of the fir!/s financial state!ents. %$ The cost of a corporate Bet pro1ided to the CEO as part of her co!pensation package. C$ Loans pro1ided to the fir!/s !anagers at belo(0!arket interest rates. &$ The costs of financing the fir!. E$ The cost of pro1iding life ins#rance to the fir!/s C3O. Ans(er: &

Topic: A-ENCA T9EORA +:.Co!!tel Partners hires )!ith %rothers in1est!ent bank to negotiate the p#rchase of the fiber optic assets of Light(are.co!. ,dentify the parties to this transaction. A$ )!ith is the principal and Co!!tel is the agent. %$ Co!!tel is the principal and )!ith is the agent. C$ Light(are is the principal and Co!!tel is the agent. &$ )!ith is the agent (hile Light(are and Co!!tel together are principals. E$ Co!!tel is the principal and Light(are is the agent. Ans(er: %

Topic: A-ENCA CO)T) +<.The %oard of &irectors of %eeline" ,nc. ha1e decided to base the salary of its financial !anager entirely #pon the !arket share of the fir!. Accordingly" A$ the fir! !ay inc#r so!e agency costs since the !anager (ill be foc#sed on the !arket share of the fir! rather than acting to !a i!i?e earnings. %$ the financial !anager (ill al(ays act in the best interest of the shareholders since all agency costs ha1e been eli!inated thro#gh salary incenti1es. C$ this arrange!ent !ay be #nnecessary" since the goal of the fir! is to !a i!i?e earnings for shareholders" and that is !ost likely acco!plished thro#gh larger !arket share. &$ the !anager !ay not act to !a i!i?e the c#rrent 1al#e of the fir!/s stock" res#lting in agency costs for the fir!/s stockholders. E$ the fir! (ill inc#r so!e agency costs if the !anager acts to !a i!i?e !arket share. Ans(er: &

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Topic: A-ENCA CO)T) +=.2hich of the follo(ing isFare correct regarding agency costsD ,. ,ndirect costs occ#r (hen !anagers" acting to !ini!i?e the risk of the fir!" forego in1est!ents shareholders (o#ld prefer they take. ,,. &irect costs occ#r (hen shareholders !#st inc#r costs to !onitor the !anager/s actions. ,,,. &irect costs occ#r (hen !anagers b#y assets considered necessary by the fir!/s o(ners. A$ %$ C$ &$ E$ , only , and ,, only ,, only ,, and ,,, only ," ,," and ,,, Ans(er: %

Topic: A-ENCA T9EORA +>.2hich of the follo(ing help ens#re !anagers act in the best interest of o(nersD ,. A co!pensation package for !anagers that is a flat cash salary" (ith no bon#ses or options. ,,. 7anagers are pro!oted only (hen they ha1e (orked for the fir! for at least 8 years. ,,,. The threat that if the fir! does poorly" shareholders (ill #se a pro y fight to replace the e isting !anage!ent. ,'. There is a high degree of likelihood the fir! (ill beco!e a takeo1er candidate if the fir! perfor!s poorly. A$ %$ C$ &$ E$ , and ,, only ,, and ,,, only ,,, and ,' only , and ,,, only ," ,," ,,," and ,' Ans(er: C

Topic: )TOC6 EGC9AN-E) .@.2hich of the follo(ing !arkets is considered an a#ction !arketD A$ The Ne( Aork )tock E change %$ The o1er0the0co#nter ;OTC$ !arket C$ NA)&AH Ans(er: A

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Topic: &O*%LE TAGAT,ON .1.2hy does the do#ble ta ation proble! e ist for corporationsD A$ Corporations earn ta able inco!e" pay ta es on that inco!e" and then pay interest to the bondholders" (ho also ha1e net ta able inco!e. %$ Corporations earn ta able inco!e and pay ta es on that inco!e. C$ 3ir!s (ith depreciation e pense !#st repay the ta ded#ction o1er ti!e" in addition to their nor!al ta liability on ta able corporate inco!e. &$ Corporations earn ta able inco!e" pay ta es on that inco!e" and then pay di1idends to the stockholders" (ho also ha1e net ta able inco!e. E$ )tockholders are paid a di1idend and they ha1e net ta able inco!e. Ans(er: &

Topic: 3,NANC,AL 7ANA-E7ENT .+.,f yo# are hired as the ne( CEO of a corporation after grad#ation" (hich of the follo(ing (o#ld yo# consider to be yo#r !ost i!portant criterion for s#ccess fro! the o(ners perspecti1eD A$ P#rs#e acti1ities that red#ce the o1erall riskiness of the fir!. %$ P#rs#e acti1ities that res#lt in the largest profits for the year. C$ P#rs#e acti1ities that !a i!i?e yo#r personal (ealth. &$ P#rs#e acti1ities that !a i!i?e the c#rrent stock price. E$ P#rs#e acti1ities that lead to the !ost stable stock price for the year. Ans(er: &

Topic: 3,NANC,AL 7ANA-E7ENT ...A financial !anager is responsible for deciding (hether an in1est!ent in ne( !an#fact#ring e5#ip!ent sho#ld be financed (ith debt" preferred stock" or co!!on stock. 2hich of the follo(ing financial !anage!ent areas (o#ld be in1ol1ed in the decision processD ,. Capital b#dgeting ,,. Capital str#ct#re !anage!ent ,,,. 2orking capital !anage!ent A$ %$ C$ &$ E$ , only ,, only ,, and ,,, only , and ,,, only ," ,, and ,,, Ans(er: %

Topic: 7AR6ET) .4.Ao# are interested in p#rchasing 1@@ shares of stock in a s!all technology fir! that trades in the *nited )tates. Ao# (o#ld !ost likely p#rchase the shares in IIIIIIIIIIIIIIII. A$ a pri!ary !arket operated as a !oney !arket %$ a pri!ary !arket operated as an a#ction !arket C$ a secondary !arket operated as a dealer !arket

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&$ a pri!ary !arket operated as a dealer !arket E$ a secondary !arket operated as a !oney !arket Ans(er: C

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Topic: 3,NANC,AL 7ANA-E7ENT .8.According to the balance sheet !odel of the fir!" corporate finance !ay be tho#ght of as the analysis of three pri!ary s#bBect areas. 2hich of the follo(ing correctly lists these areasD A$ Capital str#ct#re" capital b#dgeting" sec#rity analysis %$ Capital b#dgeting" capital str#ct#re" capital spending C$ Capital b#dgeting" capital str#ct#re" net (orking capital &$ Capital str#ct#re" net (orking capital" capital rationing E$ Capital b#dgeting" capital spending" net (orking capital Ans(er: C

Topic: CORPORATE 3,NANCE .:.2hich of the follo(ing is NOT considered one of the basic 5#estions of corporate financeD A$ 2hat long0ter! in1est!ents sho#ld the fir! choose. %$ At (hat rate of interest sho#ld a fir! borro(. C$ 2here (ill the fir! get the long0ter! financing to pay for its in1est!ents. &$ 2hat !i t#re of debt and e5#ity sho#ld the fir! #se to f#nd its operations. E$ 9o( sho#ld the fir! !anage its (orking capital" i.e." its e1eryday financial acti1ities. Ans(er: %

Topic: %*),NE)) OR-AN,CAT,ON) .<.2hich of the follo(ing is a 3AL)E state!ent concerning corporationsD A$ The e5#ity that can be raised by the corporation is li!ited to the c#rrent shareholders/ personal (ealth. %$ The life of the corporation is #nli!ited. C$ The corporation has #nli!ited liability for b#siness debts. &$ 2hen di1idends are paid" net corporate profits are essentially ta ed t(ice. E$ ,t is relati1ely si!ple to transfer o(nership of corporate shares. Ans(er: A

Topic: %*),NE)) OR-AN,CAT,ON) .=.2hich of the follo(ing state!ents isFare tr#e concerning partnershipsD ,. Li!ited partners are responsible for all debts of the partnership. ,,. Li!ited partners generally do not !anage the partnership. ,,,. ,n a li!ited partnership" all partners share e5#ally in the gains or losses. A$ %$ C$ &$ E$ , only ,, only , and ,, only ,, and ,,, only ," ,," and ,,, Ans(er: &

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Topic: 7AR6ET) .>.2hich of the follo(ing correctly finishes this sentence: ,n the *)" IIIIIIIIIIIIIIII. A$ the OTC !arket has a central location %$ o1er0the0co#nter !arkets are operated as a#ction !arkets C$ financial !arkets f#nction as both pri!ary and secondary !arkets for debt and e5#ity sec#rities &$ ne( iss#es of sec#rities occ#r in secondary !arkets E$ a#ction !arkets do not ha1e a physical location Ans(er: C

Topic: )TOC6 EGC9AN-E) 4@.2hich of the follo(ing is a criteria that !#st be !et in order for a fir! to be listed on the Ne( Aork )tock E changeD A$ The fir! !#st ha1e at least . shareholders o(ning at least 1@"@@@ shares. %$ The fir! !#st ha1e a !ini!#! n#!ber of shares o#tstanding. C$ The fir! !#st ha1e a !arket 1al#e in e cess of J1 billion. &$ The fir! !#st ha1e a !ini!#! of 8 directors. E$ The fir! !#st not ha1e e1er s#ffered negati1e net inco!e in a gi1en 5#arter. Ans(er: %

Topic: CA)9 3LO2) 41.,n the e1al#ation of cash flo( in a capital b#dgeting decision" (hich of the follo(ing is NOT rele1antD ,. The si?e of the cash flo(. ,,. The ti!ing of the cash flo(. ,,,. The risk of the cash flo(. ,'. The !anager responsible for the acco#nting of the cash flo(. A$ , only %$ , and ,, only C$ ,, only &$ ,, and ,' only E$ ,' only Ans(er: E

Topic: %*),NE)) OR-AN,CAT,ON) 4+.Ao# (ant to pool yo#r reso#rces (ith yo#r best friend and start yo#r o(n teleco!!#nications fir!. 9o(e1er" yo# are concerned abo#t the risk this b#siness poses to yo#r acc#!#lated personal (ealth. To li!it yo#r e pos#re" yo# and yo#r friend sho#ld organi?e the b#siness: A$ As a general partnership %$ As a li!ited partnership C$ As a sole proprietorship &$ As a corporation E$ As a real estate in1est!ent tr#st Ans(er: &

1:

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Chapter 1: Introduction to Financial Management

Ross/Westerfield/Jordan, Essentials of Corporate Finance, 4/e 1<

Chapter 1: Introduction to Financial Management

Topic: 7AR6ET) 4..2hich of the follo(ing (o#ld NOT be considered a secondary !arket transactionD A$ A b#y order to a broker for shares of stock in a co!pany on NA)E. %$ A b#y order to an in1est!ent banker for a ne( ,PO stock offering. C$ A b#y order to a broker for shares of stock in a co!pany on NA)&AH. &$ A b#y order to a dealer for o#tstanding bonds of a co!pany trading OTC. E$ A b#y order to a broker for a stock listed on a regional e change. Ans(er: %

Topic: %*),NE)) OR-AN,CAT,ON) 44.*nli!ited liability is a characteristic of (hich of the follo(ing for!;s$ of organi?ationD A$ sole proprietorship %$ li!ited partnership C$ corporation &$ ) corporation E$ li!ited liability co!pany Ans(er: A

Topic: %*),NE)) OR-AN,CAT,ON) 48.2hich of the follo(ing is a tr#e state!ent concerning a general partnershipD ,. Partners are responsible for the debts of the partnership. ,,. Partners generally do not !anage the partnership. ,,,. The inco!e of a partnership is ta ed at the partners/ inco!e ta rate. A$ %$ C$ &$ E$ , only ,,, only , and ,, only , and ,,, only ," ,," and ,,, Ans(er: &

Topic: 3,NANC,AL 7ANA-E7ENT 4:.2hich of the follo(ing is 3AL)E concerning the econo!ics of ethical decision0!akingD ,. The higher the probability of detection" the !ore likely that one (ill cheat. ,,. The higher the sanctions i!posed if detected" the less likely one is to cheat. ,,,. The e pected costs of #nethical beha1ior are lo(er if infor!ation abo#t cheating is rapidly and (idely distrib#ted. A$ %$ C$ &$ , only ,, only , and ,, only , and ,,, only

1=

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Chapter 1: Introduction to Financial Management

E$ ," ,," and ,,, Ans(er: &

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Chapter 1: Introduction to Financial Management

Topic: 7AR6ET) 4<.2hich of the follo(ing is considered a secondary !arket transactionD ,. Ao# b#y shares in the p#blic offering of a start0#p co!pany in the co!p#ter ind#stry. ,,. Ao#r !other sells yo# the shares she p#rchased in yo#r #ncle/s latest b#siness 1ent#re. ,,,. Ao# b#y shares in -eneral 7otors fro! yo#r closest friend. A$ , only %$ ,, only C$ , and ,, only &$ ,, and ,,, only E$ ," ,," and ,,, Ans(er: &

Topic: 7AR6ET) 4=.On a typical day in the *nited )tates" the largest n#!ber of shares are traded: A$ O1er the co#nter. %$ On the Ne( Aork )tock E change. C$ On the A!erican )tock E change. &$ On the Philadelphia )tock E change. E$ ,n pri!ary !arkets. Ans(er: A

Topic: %*),NE)) OR-AN,CAT,ON) 4>.The death of the fir!/s o(ner;s$ effecti1ely dissol1es (hich type;s$ of organi?ationD ,. )ole proprietorship ,,. Partnership ,,,. Corporation A$ , only %$ ,, only C$ ,,, only &$ , and ,, only E$ ,, and ,,, only Ans(er: &

Topic: %*),NE)) OR-AN,CAT,ON) 8@.2hich of the follo(ing is considered a disad1antage of the corporate for! of organi?ationD ,. Ease of the transfer of o(nership ,,. Li!ited life ,,,. &o#ble ta ation A$ , only %$ ,, only C$ ,,, only

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Chapter 1: Introduction to Financial Management

&$ , and ,, only E$ ," ,," and ,,, Ans(er: C

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Topic: 7AR6ET TRAN)ACT,ON) 81.A;n$ IIIIIIIIIIIIIIII is a sale of sec#rities (hich typically does not re5#ire registration (ith the )EC and is #s#ally sold to a large financial instit#tion. A$ initial p#blic offering %$ o1er0the0co#nter transaction C$ pri!ary !arket transaction &$ secondary !arket transaction E$ pri1ate place!ent Ans(er: E

Topic: 3,NANC,AL 7ANA-E7ENT 8+.A financial !anager is responsible for deter!ining ho( !#ch long0ter! debt the fir! sho#ld #se relati1e to its #se of short0ter! borro(ings. 2hich f#nction is this !anager in1ol1ed (ithD ,. Capital b#dgeting ,,. Capital str#ct#re !anage!ent ,,,. 2orking capital !anage!ent A$ %$ C$ &$ E$ , only ,, only ,,, only , and ,, only ," ,, and ,,, Ans(er: %

Topic: %*),NE)) OR-AN,CAT,ON) 8..A type of s!all corporation that is ta ed like a partnership and th#s a1oids do#ble ta ation is called a IIIIIIIIIIIIIIII. A$ li!ited partnership %$ sole proprietorship C$ ) corporation &$ li!ited liability co!pany E$ general partnership Ans(er: C

Topic: 3,NANC,AL 7ANA-E7ENT 84.2hich of the follo(ing co!binations of attrib#tes (o#ld !ake a capital e pendit#re proBect desirable to a financial !anagerD ,. The proBect has positi1e book 1al#e on the co!pany/s acco#nting state!ents. ,,. The 1al#e of the cash flo( generated by the proBect e ceeds the proBect/s cost. ,,,. The proBect/s cash flo(s ha1e acceptable le1els of risk and si?e" b#t not ti!ing. A$ , only %$ ,, only

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C$ ,,, only &$ ,, and ,,, only E$ ," ,," and ,,, Ans(er: %

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Topic: %*),NE)) OR-AN,CAT,ON) 88.A IIIIIIIIIIIIIIII can lose" in the e tre!e case" her entire personal net (orth. ,. co!!on stockholder ,,. li!ited partner ,,,. general partner ,'. sole proprietor A$ , only %$ , and ,, only C$ ,,, and ,' only &$ ,," ,,," and ,' only E$ ,, and ,,, only Ans(er: C

Topic: 3,NANC,AL 7ANA-E7ENT 8:.The total !arket 1al#e of the fir!/s e5#ity is deter!ined by IIIIIIIIIIIIIIII. A$ the fir!/s acco#ntants %$ the fir!/s !anage!ent C$ in1estors in the stock !arket &$ in1estors in the bond !arket E$ reg#lators at the )ec#rities and E change Co!!ission ;)EC$ Ans(er: C

Topic: A-ENCA CO)T) 8<.Of the follo(ing" (hich state!ent regarding agency costs is tr#eD A$ An agency proble! e ists (hen there is a conflict of interest bet(een the stockholders and !anage!ent of a fir!. %$ An agency proble! does not e ist (hen there are conflicts of interest bet(een principals and agents. C$ An indirect agency cost occ#rs (hen fir! !anage!ent takes on risky proBects that fa1orably affect the stock price" e1en tho#gh the !anagers are (orried abo#t keeping their Bobs. &$ A corporate e pendit#re that benefits stockholders b#t har!s !anage!ent is an agency cost. E$ Agency costs are directly obser1able in the stock !arket. Ans(er: A

III.

PROBLEMS

Not applicable for Chapter 1

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IV.

ESSAYS

Topic: 3,NANC,AL 7ANA-E7ENT 8=.List and briefly describe the three basic 5#estions a financial !anager !#st be concerned (ith. Ans(er: The three areas are: 1. Capital b#dgeting: The financial !anager tries to identify in1est!ent opport#nities that are (orth !ore to the fir! than they cost to ac5#ire. +. Capital str#ct#re: This refers to the specific !i t#re of long0ter! debt and e5#ity a fir! #ses to finance its operations... 2orking capital !anage!ent: This refers to a fir!/s short0ter! assets and short0ter! liabilities. 7anaging the fir!/s (orking capital is a day0to0day acti1ity that ens#res the fir! has s#fficient reso#rces to contin#e its operations and a1oid costly interr#ptions.

Topic: %*),NE)) OR-AN,CAT,ON) 8>.2hy is the corporate for! of b#siness organi?ation considered to be !ore i!portant than sole proprietorships or partnershipsD Ans(er: The i!portance of the corporate for! of organi?ation lies in its ad1antages: ease of transferring o(nership" the o(ners/ li!ited liability for b#siness debts" and #nli!ited life of the b#siness.

Topic: %*),NE)) OR-AN,CAT,ON) :@.,f the corporate for! of b#siness organi?ation has so !any ad1antages o1er the corporate for!" (hy is it so co!!on for s!all b#sinesses to initially be for!ed as sole proprietorshipsD Ans(er: A significant ad1antage of the sole proprietorship is that it is cheap and easy to for!. ,f the sole proprietor has li!ited capital to start (ith" it !ay not be desirable to spend part of that capital for!ing a corporation. Also" li!ited liability for b#siness debts !ay not be a significant ad1antage if the proprietor has li!ited capital" !ost of (hich is tied #p in the b#siness any(ay. 3inally" for a typical s!all b#siness" the heart and sole of the b#siness is the person (ho fo#nded it" so the life of the b#siness !ay effecti1ely be li!ited to the life of the fo#nder d#ring its early years.

Topic: 3,NANC,AL 7ANA-E7ENT -OAL :1.2hat sho#ld be the goal of the financial !anager of a corporationD 2hyD Ans(er: The correct goal is to !a i!i?e the c#rrent 1al#e of the o#tstanding stock. This foc#ses correctly on enhancing the ret#rns to shareholders" the o(ners of the fir!. Other goals" s#ch as !a i!i?ing earnings" foc#s too narro(ly on acco#nting inco!e and ignore the i!portance of !arket 1al#es in !anagerial finance.

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Chapter 1: Introduction to Financial Management

Topic: A-ENCA T9EORA :+.&o yo# think agency proble!s arise in sole proprietorships andFor partnershipsD Ans(er: Agency conflicts typically arise (hen there is a separation of o(nership and !anage!ent of a b#siness. ,n a sole proprietorship and a s!all partnership" s#ch separation is not likely to e ist to the degree it does in a corporation. 9o(e1er" there is still potential for agency conflicts. 3or e a!ple" as e!ployees are hired to represent the fir!" there is once again a separation of o(nership and !anage!ent.

Topic: %*),NE)) OR-AN,CAT,ON) :..2hen the )!all %#siness Ad!inistration ;)%A$ !akes a loan to a sole proprietorship" it typically re5#ires life ins#rance be carried on the b#siness o(ner in an a!o#nt s#fficient to co1er the loan. 2hy !ight the )%A de!and s#ch co1erageD Ans(er: The )%A kno(s that the heart of a s!all b#siness is the e istence of the o(ner. ,f the o(ner dies" it is likely the b#siness (ill be se1erely har!ed. Th#s" the )%A (ants to get o#t in the case of s#ch a tragedy. This also #nderscores the li!ited life of the sole proprietorship.

Topic: L,7,TE& L,A%,L,TA :4.Ass#!e for a !o!ent that the stockholders in a corporation ha1e #nli!ited liability for corporate debts. ,f so" (hat i!pact (o#ld this ha1e on the f#nctioning of pri!ary and secondary !arkets for co!!on stockD Ans(er: 2ith #nli!ited liability" yo# (o#ld be 1ery caref#l (hich stocks yo# in1est in. ,n partic#lar" yo# (o#ld not in1est in co!panies yo# e pected to be #nable to satisfy their financial obligations. %oth the pri!ary and secondary !arkets for co!!on stock (o#ld be se1erely ha!pered if this r#le e isted. ,t (o#ld be 1ery diffic#lt for a yo#ng" #ntested b#siness to get eno#gh capital to gro(.

Topic: 3,NANC,AL 7ANA-E7ENT -OAL) :8.)#ppose yo# o(n 1@@ shares of ,%7 stock (hich yo# intend to sell today. )ince yo# (ill sell it in the secondary !arket" ,%7 (ill recei1e no direct cash flo(s as a conse5#ence of yo#r sale. 2hy" then" sho#ld ,%7/s !anage!ent care abo#t the price yo# get for yo#r sharesD Ans(er: The c#rrent !arket price of ,%7 stock reflects" a!ong other things" !arket opinion abo#t the 5#ality of fir! !anage!ent. ,f the shareholder/s sale price is lo(" this indirectly reflects on the rep#tation of the !anagers" as (ell as potentially i!pacting their standing in the e!ploy!ent !arket. Alternati1ely" if the sale price is high" this indicates that the !arket belie1es c#rrent !anage!ent is increasing fir! 1al#e" and therefore doing a good Bob.

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Ross/Westerfield/Jordan, Essentials of Corporate Finance, 4/e

Chapter 1: Introduction to Financial Management

Topic: TRAN)3ER O3 O2NER)9,P ,N A CORPORAT,ON ::.One thing lenders so!eti!es re5#ire (hen loaning !oney to a s!all corporation is an assign!ent of the co!!on stock as collateral on the loan. Then" if the b#siness fails to repay its loan" the o(nership of the stock certificates can be transferred directly to the lender. 2hy !ight a lender (ant s#ch an assign!entD 2hat ad1antage of the corporate for! of organi?ation co!es into play hereD Ans(er: ,n the e1ent of a loan defa#lt" a lender !ay (ish to li5#idate the b#siness. Often it is ti!e cons#!ing and diffic#lt to take title of all of the b#siness assets indi1id#ally. %y taking control of the stock" the lender is able to sell the b#siness si!ply by reselling the stock in the b#siness. This ill#strates once again the ease of transfer of o(nership of a corporation.

Topic: EGC9AN-E L,)T,N-) :<.2hy !ight a corporation (ish to list its shares on a national e change s#ch as the NA)E as opposed to a regional e changeD 9o( abo#t being traded OTCD Ans(er: %eing listed on a regional e change effecti1ely li!its the capital access for the b#siness. Pl#s" there is a prestige factor in being listed on one of the national e changes. There is still a prestige factor in !o1ing fro! OTC to NA)E since the NA)E has !ore restricti1e !e!bership re5#ire!ents. 9o(e1er" the l#re of greater prestige certainly hasn/t pro!pted so!e !aBor corporations" s#ch as 7icrosoft and Apple Co!p#ter" to !o1e to the NA)E.

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