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Which of the following statements is CORRECT?

a. Corporations of all types are subject to the corporate income tax .

b. One of the disadvantages of a sole proprietorship is that the proprietor is exposed to unlimited liability .

c. One of the advantages of a corporation from a social standpoint is that every stockholder has equal voting rights, i.e. one person, one vote.

d. One of the advantages of the corporate form of organization is that it avoids double taxation.

e. It is easier to transfer one’s ownership interest in a partnership than in a corporation.

Question 2

Relaxant Inc. operates as a partnership. Now the partners have decided to convert the business into a corporation. Which of the following statements is CORRECT?

a. The firm will find it more difficult to raise additional capital to support its growth.

b. Relaxant’s shareholders (the ex-partners) will now be exposed to less liability.

c. Assuming the firm is profitable, none of its income will be subject to federal income taxes.

d. The firm’s investors will be exposed to less liability, but they will find it more difficult to transfer their ownership.

e. The company will probably be subject to fewer regulations and required disclosures.

Question 3

Which of the following statements is CORRECT?

a. Restrictions can be included in credit agreements, but these restrictions can do nothing to protect bondholders from conflicts of interest between them and the firm’s managers and stockholders.

b. Compensating managers with stock options can help reduce conflicts of interest between stockholders and managers, but if the options are all exercisable on a specific date in the near future, this can motivate managers to do something other than try to maximize the stock’s intrinsic value.

c. The threat of takeovers reduces conflict of interest problems, but only between bondholders and stockholders.

d. Conflicts would not exist if the Security and Exchange Commission were abolished.

e. Compensating managers with stock options can do nothing to help eliminate potential conflicts between stockholders and managers.

Question 4

Which of the following statements would most people in business agree with?

a. Whistle blowers, because of the courage it takes to blow the whistle, are generally promoted more rapidly than other employees.

b. A corporation’s short-run profits will almost always increase if the firm takes actions that the government has determined are in the best interests of the nation.

c. Although people’s moral characters are probably developed before they are admitted to a business school, it is still useful for business schools to cover ethics, if only to give students an idea about the adverse consequences of unethical behavior to themselves, their firms, and the nation.

d. It is not useful for large corporations to develop a formal set of rules defining ethical and unethical behavior.

e. Firms and government agencies almost always agree with one another regarding the restrictions that should be placed on hiring and firing employees.

Question 5

Which of the following statements is CORRECT?

a. In a competitive industry, if one group of firms is socially conscious and takes costly actions designed to improve social welfare, but other firms do not, then most investors will flock to the socially conscious firms, thus enhancing their ability to attract capital. Eventually, these firms must dominate the industry.

b. Any action that would maximize a firm’s stock price must be consistent with the maximization of social welfare.

c. Decisions regarding social and ethical behavior have no effect, either positive or negative, on firms’ stock prices.

d. The ability of firms in competitive industries to voluntarily undertake socially beneficial but costly projects is constrained by competition and the need to attract capital.

e. Even if the government did not mandate some actions deemed to be socially responsible, such as those relating to fair hiring and environmentally sound practices, most firms in competitive markets would still pursue these policies.

Question 6

Which of the following statements is CORRECT?

a. Potential conflicts of interest can exist between stockholders and managers, and also between stockholders and bondholders.

b. The proper goal of the financial manager should be to maximize the firm’s expected cash flows, because this will add the most wealth to each of the individual shareholders (owners) of the firm.

c. The riskiness inherent in a firm’s earnings per share (EPS) depends on the characteristics of the projects the firm selects, which means it depends upon the firm’s assets, but EPS does not depend on the manner in which those assets are financed.

d. Large, publicly-owned firms like AT&T and GM, are controlled by their management teams. Ownership is generally widely dispersed, hence managers have great freedom in how they manage the firm. Managers may operate in stockholders’ best interests, but they may also operate in their own personal best interests. As long as managers stay within the law. there are no effective tools that can be used to motivate them to take actions that are in the stockholders’ best interests.

e. The financial manager should seek that combination of assets, liabilities. and capital that will generate the largest expected after-tax income over the relevant time horizon.

Question 7

Which of the following actions would be most likely to reduce conflicts between stockholders and bondholders?

a. The passage of laws that make it harder for hostile takeovers to succeed.

b. Compensating managers with more stock options and less cash income.

c. The firm begins to use only long-term debt, e.g. debt that matures in 30 years or more, rather than debt that matures in less than one year.

d. Including restrictive covenants in the company’s bond indenture (which is the contract between the company and its bondholders).

e. A government regulation that banned the use of convertible bonds .

Question 8

Which of the following actions would be most likely to reduce potential conflicts of interest between stockholders and managers?

a. Change the corporation’s formal documents to make it easier for outside investors to acquire a controlling interest in the firm through a hostile takeover.

b. For a firm that compensates managers with stock options, reduce the time before options are vested, i.e. the time before options can be exercised and the shares that are received can be sold.

c. Beef up the restrictive covenants in the firm’s debt agreements.

d. Pay managers large cash salaries and give them no stock options.

e. Eliminate a requirement that members of the board of directors must hold a high percentage of their personal wealth in the firm’s stock.

Question 9

Which of the following statements is CORRECT?

a. The efficiency of the U.S. economy would probably be increased if hostile takeovers were absolutely forbidden.

b. Stockholders in general would be better off if managers never disclosed favorable events and therefore caused the price of the firm’s stock to sell at a price below its intrinsic value.

c. Hostile takeovers are most likely to occur when a firm’s stock sells at a price above its intrinsic value because its management has been issuing overly optimistic statements about its likely future performance.

d. In general, it is more in bondholders’ interests than stockholders’ interests for a firm to shift its investment focus away from safe, stable investments and into risky investments, especially those that involve primarily research and development.

e. Hostile takeovers are most likely to occur when a firm’s stock is selling below its intrinsic value as a result of poor management.

Question 10

Which of the following statements is CORRECT?

a. One advantage of operating a business as a corporation is that stockholders can deduct their pro rata share of the taxes the firm pays, thereby eliminating the double taxation investors would face in a partnership.

b. One drawback of forming a corporation is that you lose the limited liability that you would otherwise receive as a sole proprietor.

c. Potential conflicts between stockholders and bondholders are increased if a firm’s bonds are convertible into its common stock.

d. Since bondholders receive fixed payments, they do not share in the gains if risky projects turn out to be highly successful. However, they do share in the losses if risky projects fail and drive the firm into bankruptcy. Therefore, bondholders generally prefer to see corporate managers invest in low risk/low return projects rather than high risk/high return projects.

e. Since in bankruptcy they must be paid in full before stockholders receive anything, corporate bondholders generally prefer to see corporate managers invest in high risk/high return projects rather than low risk/low return projects.

Question 11

Which of the following statements is CORRECT?

a. Corporate shareholders are exposed to unlimited liability, but this factor is offset by the tax advantages of incorporation.

b. If a corporation elects to be taxed as an S corporation, then both it and its stockholders can avoid all Federal taxes. This provision was put into the Federal Tax Code in order to encourage the formation of small businesses .

c. The more capital a firm is likely to require, the smaller the probability that it will be organized as a corporation.

d. One danger of starting a proprietorship is that you may be exposed to personal liability if the business goes bankrupt. This problem would be avoided if you formed a corporation to operate the business.

e. It is generally easier to transfer one’s ownership interest in a partnership than in a corporation.

Question 12

Which of the following statements is CORRECT?

a. The efficiency of the U.S. economy would probably be increased if hostile takeovers were absolutely forbidden.

b. Takeovers are most likely to be attempted if the target firm’s stock price is above its intrinsic value.

c. Stockholders in general would be better off if managers never disclosed favorable events and therefore caused the price of the firm’s stock to sell at a price below its intrinsic value.

d. Well designed bond covenants are useful for reducing agency conflicts between stockholders and managers.

e. The bid price in a hostile takeover is generally above the price before the takeover attempt is announced, because otherwise there would be no incentive for the stockholders to sell to the hostile bidder and the takeover attempt would probably fail.

Question 13

Which of the following statements is CORRECT?

a. One disadvantage of operating as a corporation rather than as a partnership is that corporate shareholders are exposed to more personal liability than are partners.

b. Stockholders should generally be happier than bondholders to have managers invest in risky projects with high potential returns as opposed to safe projects with lower expected returns.

c. Relative to sole proprietorships, corporations generally face fewer regulations, and they also find it easier to raise capital.

d. There is no good reason to expect a firm’s stockholders and bondholders to react differently to the types of assets in which it invests.

e. Bondholders should generally be happier than stockholders to have managers invest in risky projects with high potential returns as opposed to safe projects with lower expected returns.

Question 14

Which of the following statements is CORRECT?

a. While the two frequently perform similar functions, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise large blocks of capital from investors.

b. The NYSE does not exist as a physical location. Rather it represents a loose collection of dealers who trade stock electronically.

c. An example of a primary market transaction would be your uncle transferring 100 shares of Wal-Mart stock to you as a birthday gift.

d. If your uncle in New York sold 100 shares of Microsoft through his broker to an investor in Los Angeles, this would be a primary market transaction.

e. Capital market instruments include both long-term debt and common stocks.

Question 15

Which of the following is a primary market transaction?

a. IBM sells 2,000,000 shares of treasury stock to its employees when they exercise options that were granted in prior years.

b. You sell 200 shares of IBM stock on the NYSE through your broker.

c. IBM issues 2,000,000 shares of new stock and sells them to the public through an investment banker.

d. One financial institution buys 200,000 shares of IBM stock from another institution. An investment banker arranges the transaction.

e. You buy 200 shares of IBM stock from your brother. The trade is not made through a broker—you just give him cash and he gives you the stock.

Question 16

Which of the following is an example of a capital market instrument?

a. U.S. Treasury bills.

b. Money market mutual funds.

c. Preferred stock.

d. Commercial paper.

e. Banker’s acceptances.

Money markets are markets for

a. Common stocks.

b. Consumer automobile loans.

c. Foreign currencies.

d. Long-term bonds.

e. Short-term debt securities such as Treasury bills and commercial paper .

Question 18

Which of the following statements is CORRECT?

a. Hedge funds have more in common with commercial banks than with any other type of financial institution.

b. Hedge funds are legal in the United States, but they are not permitted to operate in Europe or Asia.

c. Hedge funds have more in common with investment banks than with any other type of financial institution.

d. Hedge funds are not as highly regulated as most other types of financial institutions. The justification for this light regulation is that only sophisticated investors (i.e. those with high net worths and high incomes) are permitted to invest in these funds, and such investors supposedly can do any necessary due diligence on their own rather than have it done by the SEC or some other regulator.

e. Hedge funds are legal in Europe and Asia, but they are not permitted to operate in the United States.

Question 19

Which of the following statements is CORRECT?

a. If General Electric were to issue new stock this year, this would be considered a secondary market transaction since the company already has stock outstanding.

b. Money market transactions do not involve securities denominated in currencies other than the U.S. dollar.

c. Both Nasdaq dealers and specialists on the NYSE hold inventories of stocks.

d. Capital market transactions involve only preferred stock or common stock.

e. The most important difference between spot markets versus futures markets is the maturity of the instruments that are traded. Spot market transactions involve securities that have maturities of less than one year whereas futures markets transactions involve securities with maturities greater than one year.

Question 20

Which of the following statements is NOT CORRECT?

a. Going public establishes a firm’s true intrinsic value and ensures that a liquid market will always exist for the firm’s shares.

b. When a corporation’s shares are owned by a few individuals, we say that the firm is closely, or privately, held.

c. It is possible for a firm to go public and yet not raise any additional new capital for the firm itself.

d. When stock in a closely held corporation is offered to the public for the first time, the transaction is called going public, or an IPO , and the market for such stock is called the new issue or IPO market.

e. The stock of publicly owned companies must generally be registered with and reported to a regulatory agency such as the SEC.

Question 1

Which of the following would, generally, indicate an IMPROVEMENT in a company’s financial position, holding other things constant?

a. The total assets turnover decreases.

d. The TIE declines.

e. The DSO increases.

Question 2

A firm wants to strengthen its financial position. Which of the following actions would INCREASE its current ratio?

a. Use cash to repurchase some of the company’s own stock.

b. Use cash to increase inventory holdings.

c. Issue new stock, then use some of the proceeds to purchase additional inventory and hold the remainder as cash.

d. Reduce the company’s days’ sales outstanding to the industry average and use the resulting cash savings to purchase plant and equipment.

e. Borrow using short-term debt and use the proceeds to repay debt that has a maturity of more than one year.

Question 3

Casey Communications recently issued new common stock and used the proceeds to pay off some of its short-term notes payable. This action had no effect on the company’s total assets or operating income. Which of the following effects would occur as a result of this action?

a. The company’s current ratio increased.

b. The company’s times interest earned ratio decreased.

c. The company’s debt ratio increased.

d. The company’s equity multiplier increased.

e. The company’s basic earning power ratio increased.

Question 4

Which of the following statements is CORRECT?

a. There is no relationship between the days’ sales outstanding (DSO) and the average collection period (ACP). These ratios measure entirely different things.

b. If a security analyst saw that a firm’s days’ sales outstanding (DSO) was higher than the industry average, and was increasing and trending still higher, this would be interpreted as a sign of strength.

c. A high average DSO indicates that none of its customers are paying on time. In addition, it makes no sense to evaluate the firm’s DSO with the firm’s credit terms.

d. If a firm increases its sales while holding its accounts receivable constant, then, other things held constant, its days’ sales outstanding will decline.

e. A reduction in accounts receivable would have no effect on the current ratio, but it would lead to an increase in the quick ratio.

Question 5

Which of the following statements is CORRECT?

a. If two firms differ only in their use of debt?i.e. they have identical assets, sales, operating costs, interest rates on their debt, and tax rates?but one firm has a higher debt ratio, the firm that uses more debt will have a lower profit margin on sales and a lower return on assets .

b. The debt ratio as it is generally calculated makes an adjustment for the use of assets leased under operating leases. so the debt ratios of firms that lease different percentages of their assets are still comparable.

c. If two firms differ only in their use of debt?i.e. they have identical assets, sales, operating costs, and tax rates?but one firm has a higher debt ratio, the firm that uses more debt will have a higher operating margin and return on assets.

d. A firm’s use of debt will have no effect on its profit margin .

e. If one firm has a higher debt ratio than another, we can be certain that the firm with the higher debt ratio will have the lower TIE ratio, as that ratio depends entirely on the amount of debt a firm uses.

Question 6

Which of the following statements is CORRECT?

a. An increase in a firm’s debt ratio, with no changes in its sales or operating costs, could be expected to lower its net profit margin.

b. If two firms have the same ROA. the firm with the most debt can be expected to have the lower ROE .

c. An increase in the DSO, other things held constant, could be expected to increase the total assets turnover ratio.

d. The ratio of long-term debt to total capital is more likely to experience seasonal fluctuations than is either the DSO or the inventory turnover ratio.

e. An increase in the DSO, other things held constant, could be expected to increase the ROE.

Question 7

Companies HD and LD have the same sales, tax rate, interest rate on their debt, total assets, and basic earning power. Both companies have positive net incomes. Company HD has a higher debt ratio and, therefore, a higher interest expense. Which of the following statements is CORRECT?

a. Company HD has a lower equity multiplier .

b. Company HD has more net income.

c. Company HD has a higher ROA.

d. Company HD has a higher times-interest-earned (TIE) ratio.

e. Company HD pays less in taxes.