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 firms long-term investments is called: a. or!ing capital management. b. financial depreciation. c. agency cost analysis. d. capital budgeting. e. capital structure. CAPITAL STRUCTURE e ". The mixture of debt and e#uity used by a firm to finance its operations is called: a. or!ing capital management. b. financial depreciation. c. cost analysis. d. capital budgeting. e. capital structure. WORKING CAPITAL MANAGEMENT a $. The management of a firms short-term assets and liabilities is called: a. or!ing capital management. b. debt management. c. e#uity management. d. capital budgeting. e. capital structure.

CHAPTER 1 SOLE PROPRIETORSHIP b %. & business o ned by a single individual is called a: a. corporation. b. sole proprietorship. c. general partnership. d. limited partnership. e. limited liability company. GENERAL PARTNERSHIP c '. & business formed by t o or more individuals ho each have unlimited liability for business debts is called a: a. corporation. b. sole proprietorship. c. general partnership. d. limited partnership. e. limited liability company. PARTNERSHIP AGREEMENT d (. The division of profits and losses among the members of a partnership is formali)ed in the: a. indemnity clause. b. indenture contract. c. statement of purpose. d. partnership agreement. e. group charter. CORPORATION a *. & business created as a distinct legal entity composed of one or more individuals or entities is called a: a. corporation. b. sole proprietorship. c. general partnership. d. limited partnership. e. unlimited liability company. ARTICLES OF INCORPORATION e 1+. The corporate document that sets forth the business purpose of a firm is the: a. indenture contract. b. state tax agreement. c. corporate byla s. d. corporate charter. e. articles of incorporation.

CHAPTER 1 BYLAWS d 11. The rules by hich corporations govern themselves are called: a. indenture provisions. b. indemnity provisions. c. charter agreements. d. byla s. e. articles of incorporation. LIMITED LIABILITY COMPANY a 12. & business entity operated and taxed li!e a partnership, but ith limited liability for the o ners, is called a: a. limited liability company. b. general partnership. c. limited proprietorship. d. sole proprietorship. e. corporation. FINANCIAL MANAGEMENT GOAL b 13. The primary goal of financial management is to: a. maximi)e current dividends per share of the existing stoc!. b. maximi)e the current value per share of the existing stoc!. c. avoid financial distress. d. minimi)e operational costs and maximi)e firm efficiency. e. maintain steady gro th in both sales and net earnings. AGENCY PROBLEM c 1". & conflict of interest bet een the stoc!holders and management of a firm is called: a. stoc!holders liability. b. corporate brea!do n. c. the agency problem. d. corporate activism. e. legal liability. AGENCY COSTS d 1$. &gency costs refer to: a. the total dividends paid to stoc!holders over the lifetime of a firm. b. the costs that result from default and ban!ruptcy of a firm. c. corporate income sub,ect to double taxation. d. the costs of any conflicts of interest bet een stoc!holders and management. e. the total interest paid to creditors over the lifetime of the firm.

CHAPTER 1 STAKEHOLDERS e 1%. & sta!eholder is: a. any person or entity that o ns shares of stoc! of a corporation. b. any person or entity that has voting rights based on stoc! o nership of a corporation. c. a person ho initially started a firm and currently has management control over the cash flo s of the firm due to his-her current o nership of company stoc!. d. a creditor to hom the firm currently o es money and ho conse#uently has a claim on the cash flo s of the firm. e. any person or entity other than a stoc!holder or creditor ho potentially has a claim on the cash flo s of the firm. PRIMARY MARKET a 1'. The original sale of securities by governments and corporations to the general public occurs in the: a. primary mar!et. b. secondary mar!et. c. private placement mar!et. d. proprietary mar!et. e. li#uidation mar!et. SECONDARY MARKET c 1(. .hen one shareholder sells stoc! directly to another the transaction is said to occur in the: a. dealer mar!et. b. primary mar!et. c. secondary mar!et. d. /T0 mar!et. e. 1&23&4 mar!et. DEALER MARKET c 1*. & mar!et here dealers buy and sell securities for themselves, at their o n ris!, is called a5n6: a. primary mar!et. b. secondary mar!et. c. dealer mar!et. d. auction mar!et. e. li#uidation mar!et. AUCTION MARKET d 2+. & mar!et here trading ta!es place directly bet een buyers and sellers is called a5n6: a. primary mar!et. b. /T0 mar!et. c. dealer mar!et. d. auction mar!et. e. li#uidation mar!et.

CHAPTER 1 II. CONCEPTS FINANCIAL MANAGEMENT d 21. .hich of the follo ing #uestions are addressed by financial managers7 8. 9o long ill it ta!e to produce a product7 88. 9o long should customers be given to pay for their credit purchases7 888. 2hould the firm borro more money7 8:. 2hould the firm build a ne factory7 a. 8 and 8: only b. 88 and 888 only c. 8, 88, and 888 only d. 88, 888, and 8: only e. 8, 88, 888, and 8: ORGANIZATIONAL STRUCTURE e 22. The treasurer and the controller of a corporation generally report to the: a. board of directors. b. chairman of the board. c. chief executive officer. d. president. e. vice president of finance. ORGANIZATIONAL STRUCTURE b 23. .hich one of the follo ing statements is correct concerning the organi)ational structure of a corporation7 a. The vice president of finance reports to the chairman of the board. b. The chief executive officer reports to the board of directors. c. The controller reports to the president. d. The treasurer reports to the chief executive officer. e. The chief operations officer reports to the vice president of production. CAPITAL BUDGETING b 2". .hich one of the follo ing is a capital budgeting decision7 a. determining ho much debt should be borro ed from a particular lender b. deciding hether or not to open a ne store c. deciding hen to repay a long-term debt d. determining ho much inventory to !eep on hand e. determining ho much money should be !ept in the chec!ing account CAPITAL BUDGETING e 2$. .hen considering a capital budgeting pro,ect the financial manager should consider: a. only the si)e of the pro,ect. b. only the timing of the pro,ect cash flo s. c. only the ris! of the pro,ect cash flo s. d. only the si)e and timing of the pro,ect cash flo s. e. the si)e, timing, and ris! of the pro,ect cash flo s.

CHAPTER 1 CAPITAL STRUCTURE a 2%. 0apital structure decisions include consideration of the: 8. amount of long-term debt to assume. 88. cost of ac#uiring funds. 888. current assets and liabilities. 8:. net or!ing capital. a. 8 and 88 only b. 88 and 888 only c. 888 and 8: only d. 8, 88, and 8: only e. 8, 888, and 8: only CAPITAL STRUCTURE e 2'. The decision of hich lender to use and hich type of long-term loan is best for a pro,ect is part of: a. or!ing capital management. b. the net or!ing capital decision. c. capital budgeting. d. a controllers duties. e. the capital structure decision. WORKING CAPITAL MANAGEMENT e 2(. .or!ing capital management includes decisions concerning hich of the follo ing7 8. accounts payable 88. long-term debt 888. accounts receivable 8:. inventory a. 8 and 88 only b. 8 and 888 only c. 88 and 8: only d. 8, 88, and 888 only e. 8, 888, and 8: only WORKING CAPITAL MANAGEMENT e 2*. .or!ing capital management: a. ensures that sufficient e#uipment is available to produce the amount of product desired on a daily basis. b. ensures that long-term debt is ac#uired at the lo est possible cost. c. ensures that dividends are paid to all stoc!holders on an annual basis. d. balances the amount of company debt to the amount of available e#uity. e. is concerned ith having sufficient funds to operate the business on a daily basis.

CHAPTER 1 SOLE PROPRIETORSHIP d 3+. .hich one of the follo ing statements concerning a sole proprietorship is correct7 a. & sole proprietorship is the least common form of business o nership. b. The profits of a sole proprietorship are taxed t ice. c. The o ners of a sole proprietorship share profits as established by the partnership agreement. d. The o ner of a sole proprietorship may be forced to sell his-her personal assets to pay company debts. e. & sole proprietorship is often structured as a limited liability company. SOLE PROPRIETORSHIP a 31. .hich one of the follo ing statements concerning a sole proprietorship is correct7 a. The life of the firm is limited to the life span of the o ner. b. The o ner can generally raise large sums of capital #uite easily. c. The o nership of the firm is easy to transfer to another individual. d. The company must pay separate taxes from those paid by the o ner. e. The legal costs to form a sole proprietorship are #uite substantial. PARTNERSHIP e 32. .hich one of the follo ing best describes the primary advantage of being a limited partner rather than a general partner7 a. entitlement to a larger portion of the partnerships income b. ability to manage the day-to-day affairs of the business c. no potential financial loss d. greater management responsibility e. liability for firm debts limited to the capital invested PARTNERSHIP b 33. & general partner: a. has less legal liability than a limited partner. b. has more management responsibility than a limited partner. c. faces double taxation hereas a limited partner does not. d. cannot lose more than the amount of his-her e#uity investment. e. is the term applied only to corporations hich invest in partnerships. PARTNERSHIP c 3". & partnership: a. is taxed the same as a corporation. b. agreement defines hether the business income ill be taxed li!e a partnership or a corporation. c. terminates at the death of any general partner. d. has less of an ability to raise capital than a proprietorship. e. allo s for easy transfer of interest from one general partner to another.

CHAPTER 1 PARTNERSHIP d 3$. .hich of the follo ing are disadvantages of a partnership7 8. limited life of the firm 88. personal liability for firm debt 888. greater ability to raise capital than a sole proprietorship 8:. lac! of ability to transfer partnership interest a. 8 and 88 only b. 888 and 8: only c. 88 and 888 only d. 8, 88, and 8: only e. 8, 888, and 8: only CORPORATION e 3%. .hich of the follo ing are advantages of the corporate form of business o nership7 8. limited liability for firm debt 88. double taxation 888. ability to raise capital 8:. unlimited firm life a. 8 and 88 only b. 888 and 8: only c. 8, 88, and 888 only d. 88, 888, and 8: only e. 8, 888, and 8: only CORPORATION a 3'. .hich one of the follo ing statements is correct concerning corporations7 a. The largest firms are usually corporations. b. The ma,ority of firms are corporations. c. The stoc!holders are usually the managers of a corporation. d. The ability of a corporation to raise capital is #uite limited. e. The income of a corporation is taxed as personal income of the stoc!holders. BUSINESS TYPES b 3(. .hich one of the follo ing statements is correct7 a. ;oth partnerships and corporations incur double taxation. b. ;oth sole proprietorships and partnerships are taxed in a similar fashion. c. <artnerships are the most complicated type of business to form. d. ;oth partnerships and corporations have byla s. e. &ll types of business formations have limited lives. ARTICLES OF INCORPORATION c 3*. The articles of incorporation: a. can be used to remove company management. b. are amended annually by the company stoc!holders. c. set forth the number of shares of stoc! that can be issued. d. set forth the rules by hich the corporation regulates its existence. e. can set forth the conditions under hich the firm can avoid double taxation.

CHAPTER 1 BYLAWS d "+. The byla s: a. establish the name of the corporation. b. are rules hich apply only to limited liability companies. c. set forth the purpose of the firm. d. mandate the procedure for electing corporate directors. e. set forth the procedure by hich the stoc!holders elect the senior managers of the firm. LIMITED LIABILITY COMPANY c "1. The o ners of a limited liability company prefer: a. being taxed li!e a corporation. b. having liability exposure similar to that of a sole proprietor. c. being taxed personally on all business income. d. having liability exposure similar to that of a general partner. e. being taxed li!e a corporation ith liability li!e a partnership. CORPORATION c "2. .hich one of the follo ing business types is best suited to raising large amounts of capital7 a. sole proprietorship b. limited liability company c. corporation d. general partnership e. limited partnership CORPORATION d "3. .hich type of business organi)ation has all the respective rights and privileges of a legal person7 a. sole proprietorship b. general partnership c. limited partnership d. corporation e. limited liability company GOAL OF FINANC IAL MANAGEMENT c "". =inancial managers should strive to maximi)e the current value per share of the existing stoc! because: a. doing so guarantees the company ill gro in si)e at the maximum possible rate. b. doing so increases the salaries of all the employees. c. the current stoc!holders are the o ners of the corporation. d. doing so means the firm is gro ing in si)e faster than its competitors. e. the managers often receive shares of stoc! as part of their compensation. GOAL OF FINANCIAL MANAGEMENT d "$. The decisions made by financial managers should all be ones hich increase the: a. si)e of the firm. b. gro th rate of the firm. c. mar!etability of the managers. d. mar!et value of the existing o ners e#uity. e. financial distress of the firm. AGENCY PROBLEM

CHAPTER 1 c "%. a. b. c. d. e. .hich one of the follo ing actions by a financial manager creates an agency problem7 refusing to borro money hen doing so ill create losses for the firm refusing to lo er selling prices if doing so ill reduce the net profits agreeing to expand the company at the expense of stoc!holders value agreeing to pay bonuses based on the mar!et value of the company stoc! increasing current costs in order to increase the mar!et value of the stoc!holders e#uity

AGENCY PROBLEM e "'. .hich of the follo ing help convince managers to or! in the best interest of the stoc!holders7 8. compensation based on the value of the stoc! 88. stoc! option plans 888. threat of a company ta!eover 8:. threat of a proxy fight a. 8 and 88 only b. 888 and 8: only c. 8, 88, and 888 only d. 8, 888, and 8: only e. 8, 88, 888, and 8: AGENCY PROBLEM d "(. .hich form of business structure faces the greatest agency problems7 a. sole proprietorship b. general partnership c. limited partnership d. corporation e. limited liability company AGENCY COST c "*. .hich of the follo ing are agency costs7 8. forgoing an investment opportunity hich ould add to the mar!et value of the o ners e#uity 88. paying a dividend to each of the existing shareholders 888. purchasing ne e#uipment hich increases the value of each share of stoc! 8:. hiring outside auditors to verify the accuracy of the company financial statements a. 88 and 888 only b. 8 and 888 only c. 8 and 8: only d. 88 and 8: only e. 8, 88, and 8: only

CHAPTER 1 STAKEHOLDERS a $+. .hich one of the follo ing parties is considered a sta!eholder of a firm7 a. employee b. short-term creditor c. long-term creditor d. preferred stoc!holder e. common stoc!holder CASH FLOWS b $1. .hich of the follo ing represent cash outflo s from a firm7 8. issuance of securities 88. payment of dividends 888. ne loan proceeds 8:. payment of government taxes a. 8 and 888 only b. 88 and 8: only c. 8 and 8: only d. 8, 88, and 8: only e. 88, 888, and 8: only PRIMARY MARKET b $2. .hich one of the follo ing is a primary mar!et transaction7 a. a dealer selling shares of stoc! to an individual investor b. a dealer buying ne ly issued shares of stoc! from a corporation c. an individual investor selling shares of stoc! to another individual d. a ban! selling shares of a medical firm to an individual e. a sole proprietor buying shares of stoc! from an individual investor AUCTION MARKET b $3. .hich of the follo ing statements concerning auction mar!ets is 5are6 correct7 8. 1&23&4 is an auction mar!et. 88. The 1>2? is an auction mar!et. 888. &ll trades involve a dealer in an auction mar!et. 8:. &n auction mar!et is called an over-the-counter mar!et. a. 8 only b. 88 only c. 8 and 888 only d. 88 and 888 only e. 88 and 8: only STOCK EXCHANGE d $". .hich one of the follo ing statements concerning stoc! exchanges is correct7 a. The 1>2? has more listed stoc!s than 1&23&4. b. The 1>2? is a dealer mar!et. c. The exchange ith the strictest listing re#uirements is 1&23&4. d. 2ome large companies are listed on 1&23&4. e. @ost debt securities are traded on the 1>2?.

CHAPTER 1 DEALER MARKETS c $$. 3ealer mar!ets: a. are reserved strictly for trading debt securities. b. only exist outside of the Anited 2tates. c. are called over-the-counter mar!ets. d. include the &merican ?xchange and the <acific 2toc! ?xchange. e. list only the securities of the largest firms. NYSE a $%. .hich one of the follo ing statements is correct concerning the 1>2?7 a. & firm is expected to have a mar!et value for its publicly held shares of at least B1++ million to be listed on the 1>2?. b. The 1>2? is the largest dealer mar!et for listed securities in the Anited 2tates. c. The 1>2? accounts for only $+ percent of the shares traded in the auction mar!ets. d. &ny corporation desiring to be listed on the 1>2? can do so. e. The 1>2? is an over-the-counter exchange functioning as both a primary and a secondary mar!et. NASDAQ d $'. .hich of the follo ing statements concerning 1&23&4 are correct7 8. @ost smaller firms are listed on 1&23&4 rather than on the 1>2?. 88. 1&23&4 is an electronic mar!et. 888. 1&23&4 is an auction mar!et. 8:. 1&23&4 is an /T0 mar!et. a. 8 and 88 only b. 8 and 888 only c. 88 and 8: only d. 8, 88, and 8: only e. 8, 88, 888, and 8: III. PROBLEMS 1ot applicable for 0hapter 1

CHAPTER 1 IV. ESSAYS FINANCIAL MANAGEMENT $(. Cist and briefly describe the three basic #uestions addressed by a financial manager. The three areas are: 1. 0apital budgeting: The financial manager ties to identify investment opportunities that are orth more to the firm than they cost to ac#uire. 2. 0apital structure: This refers to the specific mixture of long-term debt and e#uity a firm uses to finance its operations. 3. .or!ing capital management: This refers to a firms short-term assets and short-term liabilities. @anaging the firms or!ing capital is a day-to-day activity that ensures the firm has sufficient resources to continue its operations and avoid costly interruptions. BUSINESS ORGANIZATIONS $*. .hat advantages does the corporate form of organi)ation have over sole proprietorships or partnerships7 The advantages of the corporate form of organi)ation over sole proprietorships and partnerships are the ease of transferring o nership, the o ners limited liability for business debts, the ability to raise more capital, and the opportunity of an unlimited life of the business. BUSINESS ORGANIZATIONS %+. 8f the corporate form of business organi)ation has so many advantages over the sole proprietorship, hy is it so common for small businesses to initially be formed as sole proprietorships7 & significant advantage of the sole proprietorship is that it is cheap and easy to form. 8f the sole proprietor has limited capital to start ith, it may not be desirable to spend part of that capital forming a corporation. &lso, limited liability for business debts may not be a significant advantage if the proprietor has limited capital, most of hich is tied up in the business any ay. =inally, for a typical small business, the heart and sole of the business is the person ho founded it, so the life of the business may effectively be limited to the life of the founder during its early years. FINANCIAL MANAGEMENT GOAL %1. .hat should be the goal of the financial manager of a corporation7 .hy7 The correct goal is to maximi)e the current value of the outstanding stoc!. This goal focuses on enhancing the returns to stoc!holders ho are the o ners of the firm. /ther goals, such as maximi)ing earnings, focus too narro ly on accounting income and ignore the importance of mar!et values in managerial finance.

CHAPTER 1 AGENCY THEORY %2. 3o you thin! agency problems arise in sole proprietorships and-or partnerships7 &gency conflicts typically arise hen there is a separation of o nership and management of a business. 8n a sole proprietorship and a small partnership, such separation is not li!ely to exist to the degree it does in a corporation. 9o ever, there is still potential for agency conflicts. =or example, as employees are hired to represent the firm, there is once again a separation of o nership and management. BUSINESS ORGANIZATIONS %3. .hen the 2mall ;usiness &dministration 52;&6 ma!es a loan to a sole proprietorship, it typically re#uires life insurance be carried on the business o ner in an amount sufficient to cover the loan. .hy might the 2;& demand such coverage7 The 2;& !no s that the heart of a small business is the existence of the o ner and that a sole proprietorship ends hen the o ner dies. 2hould the o ner die, it is li!ely the business ill be severely harmed and the sale value of the firm greatly diminished. Thus, the 2;& re#uires the life insurance to ensure the loan ill be repaid should the o ner die. LIMITED LIABILITY %". &ssume for a moment that the stoc!holders in a corporation have unlimited liability for corporate debts. 8f so, hat impact ould this have on the functioning of primary and secondary mar!ets for common stoc!7 .ith unlimited liability, you ould be very careful hich stoc!s you invest in. 8n particular, you ould not invest in companies you expected to be unable to satisfy their financial obligations. ;oth the primary and secondary mar!ets for common stoc! ould be severely hampered if this rule existed. 8t ould be very difficult for a young, untested business to ac#uire enough capital to gro . FINANCIAL MANAGEMENT GOALS %$. 2uppose you o n 1++ shares of 8;@ stoc! hich you intend to sell today. 2ince you ill sell it in the secondary mar!et, 8;@ ill receive no direct cash flo s as a conse#uence of your sale. .hy, then, should 8;@s management care about the price you get for your shares7 The current mar!et price of 8;@ stoc! reflects, among other things, mar!et opinion about the #uality of firm management. 8f the shareholders sale price is lo , this indirectly reflects on the reputation of the managers, as ell as potentially impacting their standing in the employment mar!et. &lternatively, if the sale price is high, this indicates that the mar!et believes current management is increasing firm value, and therefore doing a good ,ob.

CHAPTER 1 TRANSFER OF OWNERSHIP IN A CORPORATION %%. /ne thing lenders sometimes re#uire hen loaning money to a small corporation is an assignment of the common stoc! as collateral on the loan. Then, if the business fails to repay its loan, the o nership of the stoc! certificates can be transferred directly to the lender. .hy might a lender ant such an assignment7 .hat advantage of the corporate form of organi)ation comes into play here7 8n the event of a loan default, a lender may ish to li#uidate the business. /ften it is time consuming and difficult to ta!e title of all of the business assets individually. ;y ta!ing control of the stoc!, the lender is able to sell the business simply by reselling the stoc! in the business. This illustrates once again the ease of transfer of o nership of a corporation. EXCHANGE LISTINGS %'. .hy might a corporation ish to list its shares on a national exchange such as the 1>2? as opposed to a regional exchange or 1&23&47 ;eing listed on a regional exchange effectively limits the capital access for the business. <lus, there is a prestige factor in being listed on one of the national exchanges. There is still a prestige factor in moving from 1&23&4 to the 1>2? since the 1>2? has more restrictive membership re#uirements. 9o ever, the lure of greater prestige certainly hasnt prompted some ma,or corporations, such as @icrosoft, to move to the 1>2?.