Chapter 1
Multiple Choice Questions
1. This book is mainly about
A) financial decisions made by households
B) financial decisions made by corporations
C) financial decisions made by governments
D) none of the above
Answer: B
Type: Easy
Page: 3
2. Finance, generally, deals with
A) money
B) markets
C) people
D) all of the above
Answer: D
Type: Easy
Page: 3
3. The following are examples of the United States-based corporations except:
A) General Motors
B) Microsoft
C) Bank of America
D) Unilever
Answer: D
Type: Easy
Page: 3
4. The following are examples of foreign-based corporations except:
A) British Petroleum
B) Volkswagen
C) General Electric
D) Sony
Answer: C
Type: Easy
Page: 3
5. Businesses can be organized as
A) sole proprietorships
B) partnerships
C) corporations
D) any of the above
Answer: D
Type: Easy
Page: 3
6. Generally, a corporation is owned by the:
A) Managers
B) Board of Directors
C) Shareholders
D) All of the above.
Answer: C
Type: Easy
Page: 3
7. Limited liability is an important feature of:
A) Sole proprietorships
B) Partnerships
C) Corporations
D) All of the above
Answer: C
Type: Easy
Page: 4
8. Corporations, potentially, have infinite life because:
A) of limited liability
B) of separation of ownership and management
C) it is a legal entity
D) none of the above
Answer: C
Type: Medium
Page: 4
9. The main disadvantage of organizing a business as a corporation in the United States is:
A) Limited liability
B) Separation of ownership and management
C) Double taxation.
D) None of the above
Answer: C
Type: Medium
Page: 4
10. A large number of United States corporations are incorporated in:
A) New York
B) California
C) Delaware
D) None of the above
Answer: C
Type: Easy
Page: 4
11. The following are examples of real assets except:
A) Machinery
B) Common stock
C) Office buildings
D) Inventory
Answer: B
Type: Medium
Page: 5
12. The following are examples of intangible assets except:
A) Machinery
B) Trade marks
C) Patents
D) Technical expertise
Answer: A
Type: Medium
Page: 5
13. The following are examples of financial assets except:
A) Common stocks
B) Bonds
C) Patents
D) Preferred stocks
Answer: C
Type: Medium
Page: 5
14. A firm's investment decision is also called the:
A) Financing decision
B) Capital budgeting decision
C) Liquidity decision
D) None of the above
Answer: B
Type: Medium
Page: 5
15. In finance, "short-term" means
A) less than three months
B) less than six months
C) less than one year
D) less than five years
Answer: C
Type: Easy
Page: 5
16. The following cities are also important financial centers of the world:
A) New York
B) London
C) Tokyo
D) All of the above
Answer: D
Type: Easy
Page: 6
17. The treasurer usually oversees the following functions of a corporation except:
A) Preparation of financial statements
B) Investor relationships
C) Cash management
D) Obtaining finances
Answer: A
Type: Difficult
Page: 6
18. The treasurer is usually responsible the following functions of a corporation except:
A) Raising new capital
B) Cash management
C) Banking relationships
D) Internal accounting
Answer: D
Type: Difficult
Page: 6
19. The controller is usually responsible for the following functions of a corporation except:
A) Preparation of financial statements
B) Internal accounting
C) Raising new capital
D) Taxes
Answer: C
Type: Difficult
Page: 6
20. The controller usually oversees the following functions of a corporation except:
A) Cash management
B) Tax management
C) Internal accounting
D) Preparation of financial statements
Answer: A
Type: Difficult
Page: 6
21. The Chief Financial Officer (CFO) of a corporation oversees:
A) Treasurer's functions
B) Controller's functions
C) Both A and B
D) None of the above
Answer: C
Type: Easy
Page: 7
22. The following are advantages of separation of ownership and management of corporations except:
A) Corporations can exist forever.
B) Facilitate transfer of ownership without affecting the operations of the firm.
C) Hire professional managers
D) Incur agency costs
Answer: D
Type: Medium
Page: 7
23. Conflicts of interest between shareholders and managers of a firm result in:
A) Principal-agent problem
B) Increased agency costs
C) Both A and B
D) None of the above
Answer: C
Type: Medium
Page: 8
24. The financial goal of a corporation is to:
A) Maximize sales
B) Maximize profits
C) Maximize the value of the firm for the shareholders
D) Maximize managers' benefits
Answer: C
Type: Difficult
Page: 8
25. Agency costs are incurred by a corporation because:
A) managers may not attempt to maximize the value of the firm to shareholders
B) shareholders incur monitoring cost
C) separation of ownership and management
D) all of the above
Answer: D
Type: Medium
Page: 8
26. In the principal-agent framework:
A) Shareholders are the principals
B) Managers are the agents
C) Shareholders are the agents
D) Managers are the principals
E) A and B
Answer: E
Type: Medium
Page: 8
27. Costs associated with the conflicts of interest between the bondholders and a shareholders of a corporation is called:
A) Legal costs
B) Agency costs
C) Administrative costs
D) Bankruptcy costs
Answer: B
Type: Difficult
Page: 8
28. The following groups are some of the claimants to a firm's income stream:
A) Shareholders
B) Bondholders
C) Government
D) Employees
E) All of the above
Answer: E
Type: Medium
Page: 8
29. Informational asymmetry refers to the differences in information regarding the value of a firm among:
A) Shareholders
B) Managers
C) Bondholders
D) All of the above.
Answer: D
Type: Medium
Page: 8
True/False Questions
T F 30. A corporation has a legal existence of its own and is based on "articles of incorporation."
Answer: True
Type: Easy
Page: 4
T F 31. The board of directors is ultimately responsible for all large investment decisions.
Answer: True
Type: Medium
Page: 5
T F 32. In large firms, there is usually a Chief Financial Officer (CFO) who oversees both the treasurer's and controller's work.
Answer: True
Type: Easy
Page: 6
T F 33. The controller's responsibilities include banking relations and cash management.
Answer: False
Type: Medium
Page: 6
T F 34. The treasurer's responsibilities include preparation of financial statements.
Answer: False
Type: Medium
Page: 6
T F 35. One distinctive feature of a corporation is that there is no separation of ownership and control.
Answer: False
Type: Medium
Page: 7
T F 36. In a sole proprietorship, the owner is also the manager, and hence, agency costs are at a minimum.
Answer: True
Type: Medium
Page: 8
Short Answer Questions
37. Explain the term "corporation."
Answer: A corporation is a legal entity and has an existence of its own. Generally, large businesses are organized as corporations.
Type: Easy
Page: 4
38. Briefly explain the advantages of a corporation as a form of business organization.
Answer:
· Corporations have infinite life.
· Corporations have very many owners called shareholders and therefore corporations can raise
funds more easily than other forms of business.
· There is a separation of ownership and management that is helpful in running the corporation
on a day-to-day basis.
· It is very easy to transfer ownership in a corporation.
· Corporations have limited liability.
Type: Medium
Page: 4
39. Briefly explain the term limited liability.
Answer: The shareholders of a corporation cannot be held personally responsible for the debt of the corporation. This is called limited liability. Hence a shareholder's loss is limited to the amount he or she has invested in a corporation. This is an attractive feature for the investors.
Type: Medium
Page: 4
40. Briefly explain why a large number of corporations are incorporated in the state of Delaware:
Answer: Delaware has a well-developed system of corporate law. It is very supportive of corporations.
Type: Medium
Page: 4
41. Briefly explain the sequence flow of cash between financial markets and the firm.
Answer:
· Cash is raised by selling financial assets to investors.
· Cash is invested in the firm's operation and used to purchase real assets.
· Cash is generated by the firm's operations.
· Cash is reinvested or returned to investors.
Type: Medium
Page: 6
42. Briefly discuss the role of the financial manager.
Answer:
Chief Financial Officer (CFO): Supervises the treasurer and the controller in a large corporation. CFO is involved in corporate planning and financial policy.
Treasurer: Is responsible for obtaining funds, managing cash, banking relationships and investor relationships.
Controller: Is responsible for accounting functions, payroll and taxes.
Type: Medium
Page: 7
43. Briefly discuss principal - agent problems as related to a corporation
Answer: Principal-agent problems arise in a corporation as a result of the separation of ownership and management. Managers may not act in the best interests of the shareholders while making decisions. Hence the shareholders incur monitoring and bonding costs which are a part of agency costs. It also arises as result of informational asymmetry between managers and other stakeholders of a firm. Agency costs tend to reduce the value of a firm.
Type: Medium
Page: 8
44. Briefly explain the term "web of contracts" in the context of a corporation
Answer: A corporation is a complex organization. All the claimants to the value of a corporation are called stakeholders of a corporation. They are; shareholders, bondholders, employees, managers, suppliers, customers, government and the community. A complex set interrelated contracts governs their relationships. These contracts could be formal or informal. This complex set of contracts can be thought of as "web of contracts."
Type: Medium
Page: 8
45. Briefly explain the term "Agency costs" as related to a corporation
Answer: Agency costs arise in a corporation as a result of principal-agent problems. For example; managers may not act in the best interests of the shareholders while making decisions. Hence the shareholders incur monitoring costs that are called agency costs. It also arises as result of informational asymmetry between managers and other stakeholders of a firm. Agency costs tend to reduce the value of a firm.
Type: Medium
Page: 8
Chapter 2
Multiple Choice Questions
1. The following are examples of tangible assets except:
A) Machinery
B) Warehouse
C) Office buildings
D) Patents
Answer: D
Type: Easy
Page: 13
2. The following are examples of intangible assets except:
A) Machinery
B) Trade marks
C) Patents
D) Technical expertise
Answer: A
Type: Easy
Page: 13
3. The following are examples of real assets except:
A) Machinery
B) Common stock
C) Inventory
D) Warehouse
Answer: B
Type: Easy
Page: 13
4. Present value of $110,000 expected to be received one year from today at an interest rate (discount rate) of 10% per year is:
A) $121,000
B) $100,000
C) $110,000
D) None of the above
Answer: B
Type: Easy
Page: 14
Response: PV = (110,000) / (1.1) = 100,000
5. One year discount factor at a discount rate of 10% per year is:
A) 1.1
B) 1.0
C) 0.909
D) None of the above
Answer: C
Type: Easy
Page: 14
Response: Discount Factor = 1/1.1 = 0.909
6. Present Value of $100,000 expected to be received at the end of one year at a discount rate of 100% per year is:
A) $50,000
B) $200,000
C) $100,000
D) None of the above
Answer: A
Type: Easy
Page: 14
Response: PV = (100,000) / (1+1) = 50,000
7. The one-year discount factor at an interest rate of 25% per year is:
A) 1.25
B) 0.8
C) 0.25
D) None of the above
Answer: B
Type: Easy
Page: 14
Response: Discount factor = 1/(1.25) = 0.8
8. If the one-year discount factor is 0.7692, what is the discount rate (interest rate) per year?
A) 10%
B) 20%
C) 30%
D) None of the above
Answer: C
Type: Medium
Page: 14
Response: 1+r = 1/(0.7692) = 1.30; r = 30%
9. If the present value of $444 to be paid at the end of one year is $400, what is the one-year discount factor?
A) 0.901
B) 1.11
C) 0.11
D) None of the above
Answer: A
Type: Medium
Page: 14
Response: Discount factor is = 400/444 = 0.901
10. If the one-year discount factor is 0.85, what is the present value of $120 to be received one year from today?
A) $100
B) $102
C) $141.18
D) None of the above
Answer: B
Type: Medium
Page: 14
Response: PV = (120)(0.85) = 102
11. If the present value of $480 expected to be received one year from today is $400, what is the discount rate?
A) 10%
B) 20%
C) 30%
D) None of the above
Answer: B
Type: Medium
Page: 14
Response: 1+r = 480 /400 = 1.2; r = 20%
12. If the present value of $300 expected to be received one year from today is $240, what is the one year discount rate?
A) 15%
B) 20%
C) 25%
D) 30%
Answer: C
Type: Medium
Page: 14
Response: 1+r = (300)/(240) = 1.25; r = 25 %
13. The rate of return is also called:
A) Discount rate
B) Hurdle rate
C) Opportunity cost of capital
D) All of the above.
Answer: D
Type: Easy
Page: 15
14. The present value formula for one period cash flow is:
A) PV = C1(1 + r)
B) PV = C1/r
C) PV = C1/(1 + r)
D) None of the above
Answer: C
Type: Medium
Page: 15
15. The net present value formula for one period is:
A) NPV = PV cash flows/initial investment
B) NPV = C0/C1
C) NPV = C0+[C1/(1 + r)]
D) None of the above
Answer: C
Type: Medium
Page: 15
16. If the present value of a cash flow generated by an initial investment of $100,000 is $120,000, what is the NPV of the project?
A) $120,000
B) $20,000
C) $100,000
D) None of the above
Answer: B
Type: Easy
Page: 15
Response: NPV= -100,000 + 120,000 = 20,000
17. An initial investment of $400,000 will produce an end of year cash flow of $450,000. What is the NPV of the project at a discount rate of 10%?