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True/False 1.

The financial manager should examine available risk-return trade-offs and

make his decision based upon the greatest expected return.
2.Only a fe financial decisions involve some sort of risk-return tradeoff.
!.The sole proprietorship can be described as the absence of any legal business structure.
".#n a general partnership$ all partners have unlimited liability for the actions of any one
partner hen that partner is conducting business for the firm.
%.There is no legal distinction made beteen the assets of the business and the personal
assets of the oners in the limited partnership.
&.'eneral partners have unrestricted transferability of onership$ hile limited partners
must have the consent of all partners to transfer their onership.
(.)ltimate control in a corporation is vested in the board of directors.
*.There are a significant number of legal re+uirements to follo hen establishing a sole
,.-imited partners may actively manage the business.
1..The life of a corporation is not dependent upon the status of the investors.
11./ sole proprietorship is the most desirable business form in all circumstances.
12.#n a sole proprietorship$ the oner is personally responsible ithout limitation for the
liabilities incurred.
1!.#n a limited partnership$ at least one general partner must remain in the association0
the privilege of limited liability still applies to this partner.
1".#n a general partnership$ there is a distinction beteen business and personal assets.
1%.#n order to maximi1e shareholder ealth$ a firm must consider historical costs as an
integral part of their decision-making.
1&.Financial management is concerned ith the maintenance and creation of ealth. True
1(.2hareholder ealth is measured by the market value of the firm3s common stock. True
1*.The agency problem arises due to the separation of onership and control in a firm.
1,.There is little$ if any$ difference beteen a business error and an ethical error.
2..For markets to be efficient$ price ad4ustments to ne information must be correct.
21.5thical dilemmas fre+uently exist in finance.
22.5ven though diversification can eliminate risk$ it also makes it more difficult to
measure a pro4ect3s or an asset3s risk.
2!.6onsider the folloing e+ually likely pro4ect outcomes7 8rofit 9: 8essimistic
prediction;.;%.. 5xpected outcome; %..;%.. Optimistic prediction;1... ;%..
a.8ro4ect : has less uncertainty than 8ro4ect 9. b.8ro4ect 9 has more variability than
8ro4ect :. c.a and b. d.2ince 8ro4ects 9 and : have the same expected outcomes of ;%..$
investors ill vie them as identical in value.
2".<aximi1ation of shareholder ealth as a goal is superior to profit maximi1ation
because7 a.it considers the time value of the money. b.folloing the shareholder ealth
maximi1ation goal ill ensure high stock prices. c.it considers uncertainty. d.a and c.
2%.=hy is maximi1ing shareholder ealth a better goal than maximi1ing profits>
a.<aximi1ing shareholder ealth places greater emphasis on the short term.
b.Maximizing profits ignores the uncertainty that is related to expected profits.
c.<aximi1ing shareholder ealth gives superior consideration to the entire portfolio of
shareholder investments. d.<aximi1ing profits gives too much eight to the tax position
of shareholders.
2&.8rofit maximi1ation does not ade+uately describe the goal of the firm because7 a.profit
maximi1ation does not re+uire the consideration of risk. b.profit maximi1ation ignores
the timing of a pro4ect3s return. c.maximi1ation of dividend payout ratio is a better
description of the goal of the firm. d.a and b.
2(.6onsider cash flos for 8ro4ects 9 and : such as7 8ro4ect 98ro4ect : :ear 1;!... ;.
:ear 2;.;!... / rational person ould prefer receiving cash flos sooner because7 a.the
money can be reinvested. b.the money is nice to have around. c.the investor may be
tired of a particular investment. d.the investor is indifferent to either proposal.
2*.=hat is the chief disadvantage of the sole proprietorship as a form of business
organi1ation hen compared to the corporate form> a.2ole proprietorships are sub4ect to
double taxation of profits. b.The cost of formation. c.#nade+uate profit sharing. d.Owners
have unlimited liability.
2,.=hich of the folloing is not true for limited partnerships> a.Limited partners can
only manage the business. b.One general partner must exist ho has unlimited liability.
c.Only the name of general partners can appear in the name of the firm. d.-imited
partners may sell their interest in the company.
!..#n terms of organi1ational costs$ hich of the folloing se+uences is correct$ moving
from loest to highest cost> a.'eneral partnership$ sole proprietorship$ limited
partnership$ corporation b.Sole proprietorship general partnership limited
partnership corporation c.6orporation$ limited partnership$ general partnership$ sole
proprietorship d.2ole proprietorship$ general partnership$ corporation$ limited partnership
!1.6oplon$ #nc.$ an industrial firm$ earned ;1*.$... in dividends in 1,,! on their stock
holding in the Finco 6ompany. ?o much of the dividends are excluded from 6oplon3s
taxable income> a.;2($... b.@one c.!"#$%%% d.;1%!$...
!2.=hich one of the folloing categories of oners en4oys limited liability> a.'eneral
partners in a limited partnership b.Shareholders &common stoc'( of a corporation
c.2ole proprietors d.Aoth a B b
!!.=hich of the folloing is a characteristic of a limited partnership> a.#t allos one or
more partners to have limited liability. b.#t re+uires one or more of the partners to be a
general partner to hom the privilege of limited liability does not apply. c.#t prohibits the
limited partners from participating in the management of the partnership. d.all of the
!".=hich of the folloing categories of oners have limited liability> a.'eneral partners
b.2ole proprietors c.Shareholders of a corporation d.Aoth a and b
!%.=hich of the statements belo is true> a.The sole proprietorship and the general
partnership both feature unlimited liability. b.#t is very complicated ClegallyD to establish a
corporation. c.@o legal criterion exists for a general partnership. d.)ll of the above are
!&.=hich of the folloing types of business forms is the most ideal in terms of attracting
ne capital> a.2ole proprietorship b.-imited partnership c.'eneral partnership d.)
public corporation
!(.=hich forms of organi1ation are free of initial legal re+uirements> a.2ole
proprietorship b.'eneral partnership c.6orporation d.*oth a and b
!*.For these types of organi1ation$ no distinction is made beteen business and personal
assets. a.2ole proprietorship b.'eneral partnership c.-imited partnership d./ll of the
above e.*oth a and b
!,.=hich of the folloing is a significant disadvantage of a general partnership> a.The
cost of forming it is high. b.+ach partner is fully responsible for the liabilities
incurred by the partnership. c.There is a risk associated ith the industry in hich it
operates. d.Forming the business is very complex.
"..=hich of the folloing should be considered hen assessing the financial impact of
business decisions> a.The amount of pro4ected earnings b.The risk-return tradeoff c.The
timing of pro4ected earnings0 i.e.$ hen they are expected to occur d.The amount of the
investment in a given pro4ect e.)ll of the above
"1.=hich of the folloing forms of business organi1ation is the dominant economic force
in the )nited 2tates> a.The sole proprietorship b.The general partnership c.The limited
partnership d.The 4oint venture e.The corporation
"2.=hich of the folloing reasons is most responsible for corporations being the most
important form of business organi1ation in the )nited 2tates> a.6orporations have limited
life. b.2tockholders have unlimited liability. c.6orporations are sub4ect to less
government regulation than the other forms of business organi1ation. d.,orporations
have the ability to raise larger sums of capital than the other forms of business
organization. e.6orporations are sub4ected to less taxation than the other forms of
business organi1ation.
"!.?o could you compensate an investor for taking on a significant amount of risk>
a.-ncrease the expected rate of return. b.Eaise more debt capital. c.Offer stock at a
higher price. d.#ncrease sales.
"".=hich of the folloing ould be most likely to align the interests of managers and
shareholders> a.Fixed but high salaries b.-arge bonuses c.Stoc' options d./ll of the
above e.@one of the above
"%.=hat does the agency problem refer to> a.The conflict that exists beteen the board of
directors and the employees of the firm b.The problem associated ith financial
managers and #nternal Eevenue agents c.The conflict that exists beteen stockbrokers
and investors d.The problem that results from potential conflicts of interest between
the manager of a business and the stoc'holders e.@one of the above
"&./ limited liability company C--6D is7 a.able to retain limited liability for oners.
b.taxed like a corporation. c.a cross beteen a partnership and a corporation. d.a and c.
e.all of the above.
"(.8urchasing a security of a company that is issuing their stock for the first time publicly
ould be considered7 a.a secondary market transaction. b.an initial public offering. c.a
seasoned ne issue. d.both a and b.
"*.#n measuring value$ the focus should be on7 a.cash flow. b.accounting profits. c.time
value of money. d.earnings per share.
",.=hich of the folloing is true regarding accounting profits> a..eceived by the firm
and reinvested b.Eeflects money in hand c.Eepresents actual money received and paid
out d.5+uals cash in the bank
%..=hich of the folloing statements is true regarding competitive markets> a.-arge
profits exist over the long run. b./roduct differentiation produces insulation for
competitors. c.6ost advantages attract ne entrants. d.Aoth b and c.
%1.=hich of the folloing decrease ne competition in competitive markets>
a.5conomies of scale b.8roprietary technology c.8roduct differentiation d.Aoth a and b
e.)ll of the above
%2.6ost advantages in competitive markets7 a.have the potential to create large profits.
b.deter ne entrants from entering. c.can be created by economies of scale. d.all of the
%!.=hich of the folloing is a characteristic of an efficient market> a.2mall number of
individuals. b.Opportunities exist for investors to profit from publicly available
information. c.Security prices reflect fair value of the firm. d.#mmediate response
occurs for ne public information.
%".Fiversification increases hen GGGGGGGG decreases. a.variability b.return c.risk d.a
and c e.all of the above
%%.#A< issuing ne shares of common stock ould be classified as7 a.a new seasoned
issue. b.an initial public offering. c.a secondary market transaction. d.a and b.
%&./ccording to the agency problem$ GGGGGGGGG represent the principals of a
corporation. a.shareholders b.managers c.employees d.suppliers
%(.The opening of ne international markets to the ).2. can be attributed to7
a.acceptance of a free market system by third orld countries. b.regulation of ).2.
industries. c.increase in information technology. d.a and c. e.all of the above. 2hort-
/nser Huestions
%*.Ariefly discuss mechanisms that can be used to align the interests of shareholders and
The interests of shareholders and managers can be aligned by setting up stoc'
options bonuses and per0uisites that are directly tied to how closely management
decisions coincide with the interest of shareholders.
%,.Ariefly discuss hy financial decision makers must focus on incremental cash flos
hen evaluating ne pro4ects.
)s per /rinciple 12 3,ash45ot /rofits4-s 6ing7 and /rinciple 82 3-ncremental
,ash Flows4-t9s only what changes that counts we should focus on free cash
flows4that is the incremental or different after:tax cash flows attributed to the
investment proposal. ;e focus on cash flows rather than accounting profits
because these are the flows that the firm receives and can reinvest. Only by
examining cash flows are we able to analyze the timing of the benefit or cost
correctly. )lso we are only interested in these cash flows on an after:tax basis as
only those flows are available to the shareholder. -n addition it is only the
incremental cash flows that interest us because loo'ing at the pro<ect from the
point of the company as a whole the incremental cash flows are the marginal
benefits from the pro<ect and as such are the increased value to the firm from
accepting the pro<ect.
&..Fiscuss the risk/return tradeoff and ho it relates to finance.
The .is':.eturn Trade:Off states that investors demand a higher return for ta'ing
on additional ris'= This ris':return relationship will be a 'ey concept as we value
stoc's bonds and proposed new pro<ects because in Finance we learn that the
higher the ris' the higher the return investors would re0uire and the lower the
price of stoc's and bonds.
&1.6ompare and contrast primary market and secondary market transactions as it relates
to the flo of funds in the transactions.
The proceeds from the sale in the primary mar'et go to the corporation issuing the security.
The proceeds from the sale in the secondary mar'et go to the previous owner of the stoc'
not the corporation.
&2.Fiscuss ho ne entrants are deterred from entering a competitive market.
There are several things that can deter new entrants from entering a competitive mar'et. -f
the mar'et consists of a high level of product differentiation new entrants are discouraged
from entry. /rice is no longer a factor in this type of mar'et as consumers are focused on
the 3brand e0uity7 of the products being sold. -n addition some competitive mar'ets
insulate their participants from new entrants through service and 0uality differentiation.
,ost advantages through such things as economies of scale proprietary technologies or
control of raw materials can also deter new entry in competitive mar'ets.
&!.=hat is incremental cash flo and ho is it used in pro4ect analysis>
-ncremental cash flow represents the difference between the cash flows if a pro<ect is ta'en
on versus what they will be if the pro<ect is not underta'en. ;hen conducting pro<ect
analysis the focus should be on incremental cash flow. The concern is over 3what is
different7 if the pro<ect is selected and how the pro<ect adds value to the firm.