Deck 1: An Introduction to the Foundations of Financial Management

Question 1

Maximization of shareholder wealth

A) represents a zero sum game in which one corporation gains at the expense of others.
B) provides benefits to society as scarce resources are directed to their most productive use.
C) is not a practical goal since it cannot be measured effectively.
D) is achieved only if cash flows exceed accounting profits.

Answer 1

represents a zero sum game in which one corporation gains at the expense of others.

Question 2

Only a firm's financial decisions affect its stock prices.

Answer 2

False

Question 3

Which of the following goals of the firm are synonymous (equivalent)to the maximization of shareholder wealth?

A) profit maximization
B) risk minimization
C) maximization of the total market value of the firm's common stock
D) none of the above

Answer 3

maximization of the total market value of the firm's common stock

Question 4

The payment of a dividend to current shareholders will have no impact on a corporation's share price because the cash paid is not available to future potential shareholders who may want to buy the corporation's stock.

Question 5

Shareholder wealth maximization means

A) maximizing earnings per share.
B) maximizing dividends per share.
C) maximizing the price of existing common stock.
D) maximizing stockholders equity.

Question 6

Corporate managers should accept investment projects that maximize profits int he short run because of the time value of money.

Question 7

The goal of the firm's financial managers should be the maximization of the total value of the firm's stock.

Question 8

The fundamental goal of a business is to maximize the retained earnings available to the corporation's shareholders.

Question 9

A financial manager is considering two projects,A and B.A is expected to add $2 million to profits this year while B is expected to add $2 million to profits this year while B is expected to add $1 million to profits this year.Which of the following statements is most correct?

A) The manager should select project A because it maximizes profits.
B) The manager should select the project that maximizes long-term profits, not just one year of profits.
C) The manager should select project A or he is irrational.
D) The manager should select the project that causes the stock price to increase the most, which could be A or B.

Question 10

Which of the following is the most important goal that a corporation should strive for?

A) Maximize current profits.
B) Maximize market share.
C) Maximize revenue.
D) Maximize shareholder wealth.

Question 11

The goal of profit maximization ignores the risk of financial decisions

Question 12

It is important to evaluate a corporate manager's financial decision by measuring the effect the decision should have on the corporation's stock price if everything else were held constant.

Question 13

The primary goal of a publicly owned corporation is to ________.

A) maximize dividends per share
B) maximize shareholder wealth
C) maximize earnings per share after taxes
D) minimize shareholder risk

Question 14

One of the causes of the recent financial crisis in the United States has been excessive risk taking due to underestimation of risk.How does this relate to financial leverage?
Can overestimation of risk also be detrimental?

Question 15

Shareholder wealth maximization means maximizing the price of the existing common stock.

Question 16

One problem with maximization of shareholder wealth as a goal is that it ignores risk taken by the firm's financial decisions.

Question 17

The goal of the firm should be

A) maximization of profits (net income per share).
B) maximization of shareholder wealth.
C) maximization of market share.
D) maximization of sales.

Question 18

Each financial decision made by a corporate manager can be evaluated by its direct impact on the corporation's stock price.

Question 19

Financial management deals with the maintenance and creation of economic value or wealth.

Question 20

Shareholders react to poor investment or dividend decisions by causing the total value of the firm's stock to fall,and they react to good decisions by bidding the price of the stock up.

Question 21

When making financial decisions,managers should always look at marginal,or incremental cash flows.

Question 22

Profits represent money that can be spent,and as such,form the basis for determining the value of financial decisions.

Question 23

Suppose XYZ Corporation is traded on the New York Stock Exchange.XYZ's closing price on Monday is $20 per share.After the market closes on Monday,XYZ makes a surprise announcement that it has obtained a major new customer.XYZ's stock will likely

A) open at $20 per share on Tuesday and then increase as more investors read the announcement in the Wall Street Journal.
B) remain at $20 per share because in efficient markets the price already reflects all information.
C) open above $20 because the positive news will result in a higher valuation even though the stock has not yet traded.
D) open below $20 because the surprise announcement creates more uncertainty.

Question 24

Documents uncovered after the Exxon Valdez oil spill in Alaska revealed that Exxon could have used double-hulled oil tankers that would have prevented the spill,but the cost of refitting their fleet of single-hulled tankers was considered too high.Exxon determined that the cost of cleaning up an oil spill would be less than the cost of refitting the ships,thus increasing shareholder value.Several years after the oil spill,however,Exxon was fined billions of dollars for the spill.How do the costs of the clean up and the fines pertain to a discussion of maximizing shareholder value and ethical responsibility?

Question 25

One of the problems associated with maximization of total current stock value is that it ignores the timing of a project's return.

Question 26

The five basic principles of finance include all of the following except:

A) Cash flow is what matters.
B) Money has a time value.
C) Risk requires a reward.
D) Incremental profits determine value.

Question 27

Shareholder selection committees select potential board of director nominees ensuring that board members will monitor management sufficiently to protect shareholder interests.

Question 28

Managers should not be concerned with business ethics because ethical behavior is inconsistent with the primary goal of maximizing shareholder value.

Question 29

The sole proprietorship has no legal business structure separate from its owner.

Question 30

An efficient market is one where the prices of the assets traded in that market fully reflect all available information at any instant in time.

Question 31

Investors will be indifferent between two investments if both investments have the same expected return.

Question 32

An investment project is acceptable if the total cash received over the life of the project exceeds the total cash spent over the life of the project.

Question 33

The risk/return tradeoff implies that the return on a riskless asset must be zero.

Question 34

The root cause of agency problems is conflicts of interest.

Question 35

If two companies have the same net income and the same level of risk,they must also have the same stock price or the market is not in equilibrium.

Question 36

If the stock market is efficient,then investors do not need to read the Wall Street Journal or research companies before they select which stocks to buy because market prices already reflect all publicly available information.

Question 37

Cash flows and profits are synonymous; in other words,higher cash flows equal higher profits.

Question 38

Giving the company's CEO stock options as part of his or her compensation package is an example of an agency cost.

Question 39

The risk-return tradeoff is seen in many areas of finance.

Question 40

The opportunity cost of any choice you make is the highest-valued alternative that you had to give up when you made the choice.

Question 41

All of the following statements about agency problems are true except:

A) Agency problems interfere with the goal of maximizing shareholder value.
B) Agency costs are paid by the managers who do not act in the shareholders' best interest.
C) Agency problems result from the separation of management and the ownership of a firm.
D) The root cause of agency problems is conflicts of interest.

Question 42

Project A is expected to generate positive cash flow of $1 million in 10 years while Project B is expected to generate $500,000 in 5 years.Therefore,

A) Project A is preferred because shareholder value is based on cash flow.
B) Project B is preferred because its cash flow is expected to be received sooner than the cash flow from Project A.
C) Both projects have equal value because they average $100,000 per year.
D) Project B may be preferred to Project A if the opportunity cost of money is high enough.

Question 43

A corporate manager decides to build a new store on a lot owned by the corporation that could be sold to a local developer for $250,000.The lot was purchased for $50,000 twenty years ago.When determining the value of the new store project,

A) the cost of the lot is zero since the corporation already owns it.
B) the opportunity cost of the lot is $250,000 and should be included in calculating the value of the project.
C) the cost of the lot for valuation purposes is $50,000 because land does not depreciate.
D) the incremental cash flow should be the $50,000 original cost less accumulated amortization.

Question 44

A financial manager is evaluating a project which is expected to generate profits of $100,000 per year for the next 10 years.The project should be accepted if

A) the cost of the project is less than $1,000,000.
B) the cost of the project is less than the present value of $100,000 per year for 10 years.
C) this project's expected profits are higher than any other projects the corporation has available.
D) the present value of the project's cash inflows exceeds the present value of the project's cash outflows.

Question 45

High Tech Corp.cut its research and development budget in 2010 by $4,000,000 in order to improve its cash flow for the year.Which of the following statements is most correct?

A) The stock price will likely increase because the value of stock is based on reported cash flow.
B) The stock price may decrease because investors may predict that future cash flows will decrease due to the lack of innovation and new products.
C) The change will have no impact on stock price because the company's profits will not change in 2010.
D) The stock price will increase only if reported profits in 2010 are also higher than profits reported in 2009.

Question 46

An investor is considering two equally risky investments.Investment A is expected to return $1,000 per year for the next 5 years.Investment B is expected to return $6,000 at the end of 5 years.Which of the following statements is most correct if both investments A and B have the same cost?

A) A risk averse investor will select investment B because it is expected to provide the most cash ($6,000 > $5,000).
B) A risk averse investor will select investment A because it provides cash earlier than investment B.
C) The investor will select investment A only if the cost is less than $1,000.
D) The investor may select investment A or investment B depending on the opportunity cost of money.

Question 47

The principle of risk-return tradeoff means that

A) higher risk investments must earn higher returns.
B) an investor who takes more risk will earn a higher return.
C) a rational investor will only take on higher risk if he expects a higher return.
D) an investor who bought stock in a small corporation five years ago has more money than an investor who bought U.S. Treasury bonds five years ago.

Question 48

The expected return on a riskless asset is greater than zero due to

A) an expected return for delaying consumption.
B) an expected return for opportunity costs.
C) an expected return for taxes.
D) irrational investors who believe risk is always present.

Question 49

The CEO of High Tech International decides to change an accounting method at the end of the current year.The change results in reported profits increasing by 5%,but the company's cash flows are not changed.If capital markets are efficient,then

A) the stock price will not be affected by the accounting change.
B) the stock price will increase due to higher profits.
C) the stock price will increase only if the accounting change will also result in higher profits in the next year.
D) the stock price will decrease because accounting method changes are not permitted under generally accepted accounting principles.

Question 50

When evaluating an investment project,which of the following best describes the financial information needed by the decision maker?

A) after-tax accounting profits
B) after-tax incremental cash flows to the company as a whole
C) incremental cash flows before taxes so the decision will not be biased by a tax code that may change in the future
D) pre-tax accounting profits adjusted for any accounting method changes

Question 51

The CEO of JLI Corp.decided to expand into a new market in 2010.At the end of 2010,JLI's stock price had decreased 5% since the beginning of the year.Which of the following statements is most correct?

A) The CEO made a poor decision to expand because the stock price decreased during the year.
B) The CEO made a poor decision to expand because the company's profits for the year obviously decreased, causing the drop in stock price.
C) The CEO's decision may have been optimal, keeping the stock price from falling more than 5% for the year.
D) CEO decisions are irrelevant because the efficient market determines the value of a company's stock.

Question 52

To measure value,the concept of time value of money is used

A) to determine the interest rate paid on corporate debt.
B) to bring the future benefits and costs of a project, measured by its expected profits, back to the present.
C) to bring the future benefits and costs of a project, measured by its cash flows, back to the present.
D) to ensure that expected future profits exceed current profits today.

Question 53

Joe,a risk-averse investor,is trying to choose between investment A and investment B.If investment A is riskier than investment B and Joe selects investment A anyway,then

A) the actual return for investment A will be higher than the actual return for investment B.
B) the actual return for investment A will be higher than the expected return for investment B.
C) the expected return for investment A will be higher than the actual return for investment B.
D) the expected return for investment A will be higher than the expected return for investment B.

Question 54

A corporate financial manager trying to maximize shareholder value

A) is not concerned with ethics but rather with writing iron-clad contracts.
B) can safely ignore ethics as long as no laws are broken.
C) must behave ethically in order to stay out of jail.
D) is concerned with ethics because unethical behavior destroys trust, and businesses cannot function without a certain degree of trust

Question 55

In order to reduce agency problems,managers may be provided compensation that includes:

A) a fixed salary so managers' pay is not at risk, allowing managers to focus on the company's business.
B) a bonus based on the level of profit achieved during the year.
C) an option to buy the company's stock.
D) incentive pay for achieving higher sales than last year.

Question 56

Company A reports sales of $100,000 and net income of $15,000.Company B reports sales of $100,000 and net income of $10,000.Therefore,

A) Company A's cash flow may be higher or lower than Company B's cash flow even though A's net income is higher.
B) Company A's cash flow is $5,000 more than Company B's cash flow.
C) Company B is creating less value for its shareholders than Company A.
D) Company B's accounts receivable must be higher than Company A's accounts receivable.

Question 57

Profits are down so the controller decides to change the corporation's accounting policy relating to inventory costing.The change will allow the corporation to report higher income and higher assets,although the physical inventory has not changed.Which of the following statements is most correct?

A) The stock price is likely to increase because income is higher.
B) The stock price is likely to be unaffected because the stock market is efficient.
C) The stock price is likely to decrease because reported inventory is higher.
D) If the stock price increases, the stock market is efficient.

Question 58

John invested $1,000 in a risky investment and BIll invested $1,000 in a less risky investment.One year later,Bill's investment is worth $1,030.Which of the following statements is most correct?

A) If John's investment is worth less than $1,030, then John was irrational to invest in the risky project.
B) John's investment must be worth more than $1,030 because of the risk-return tradeoff, given that John's investment was more risky.
C) If John's investment is worth more than $1,030, then Bill was irrational to invest in the less risky investment.
D) The worth of John's investment cannot be determined with the information given.

Question 59

Investors want a return that satisfies the following expectations:

A) A return for delaying consumption
B) An additional return for taking on risk
C) An additional return for accepting dividends rather than capital gains
D) Both A and B.

Question 60

All of the following contributed to recent financial crises except:

A) Focusing on earnings instead of cash flow.
B) Focusing on the short run.
C) Relying on the efficiency of financial markets.
D) Excessive risk taking due to underestimation of risk.

Question 61

Executive compensation in the United States

A) is dominated by performance-based compensation that ensures fair and just pay for corporate executives.
B) is dominated by performance-based compensation designed to reduce agency problems.
C) cannot be linked to stock prices as this would create a conflict of interest with existing shareholders.
D) is well below levels in Europe and Asia.

Question 62

The manager of Golden Ray Corporation receives a bonus if company profits exceed $1,000,000 this year.During the final week of the year,the manager changes an accounting policy that will increase reported profits from $950,000 to $1,025,000,triggering his bonus.The change in profits of $75,000 will reverse itself in the next year,and the accounting change has no impact on Golden Ray's cash flow.Discuss the above situation as it relates to both an agency problem and efficient markets.

Question 63

In which of the following cases will the agency problem between shareholders and managers be the greatest?

A) 100% of the common stock is owned by the founder of the company who decided to retire and hired a manager to run his business for him.
B) The Johnson family owns 50% of the common stock of the company. The other 50% is owned by 5 mutual funds.
C) The common stock of the company is owned by many diverse shareholders, with no shareholder owning more than 1% of the outstanding stock.
D) All top managers in the company own significant amounts of stock and stock options.

Question 64

The recent financial crises was exacerbated by

A) managers who overestimated risk and hence did not invest sufficient funds.
B) managers who underestimated the real risks of their decisions and borrowed excessively.
C) a lack of financial leverage that made U.S. firms less competitive in world markets.
D) extremely high interest rates in the United States that stifled investment.

Question 65

The board of directors of Wireless,Inc.is considering two compensation plans for the CEO of the company.The first would pay the CEO a salary of $250,000 for the upcoming year.The second would pay the CEO a salary of $100,000 and provide the CEO with a stock option to buy 100,000 shares of stock for $11 per share.The current price per share of Wireless,Inc.stock is $10 per share.The stock option expires at the end of the year.Why might shareholders prefer the second payment plan?
As part of your answer,calculate the breakeven point for the CEO to obtain the same compensation under option two as he or she would under option one.

Question 66

Which of the following statements best represents the "Agency Problem? "

A) Managers might attempt to benefit themselves in terms of salary and perquisites at the expense of shareholders.
B) The agency problem results from the separation of management and the ownership of the firm.
C) The agency problem may interfere with the implementation of maximizing shareholder wealth.
D) all of the above

Question 67

A corporate treasurer is typically responsible for cash management,credit management,and raising capital.

Question 68

Consider the after-tax cash flows for Project S and Project L:
A rational person would prefer ________.

A) Project S because the money can be reinvested sooner
B) Project L because they can avoid taxes by receiving cash flows later
C) information about profits instead of cash flows
D) neither investment over the other

Question 69

Assume that you went to Las Vegas and hit the jackpot for $5 million.Further assume that you were offered a choice to receive the $5 million today,or receive it in two years.According to one of the principles of finance,which would you take?

A) The $5 million in two years because you would be afraid of spending it all right away.
B) The $5 million in two years because it would be worth more than if you would receive it today.
C) You would be indifferent as to when you would receive the $5 million.
D) The $5 million today because it would be worth more than if you would receive it in two years.

Question 70

Assume that an investor is offered a choice of a risk-free government bond or a high-risk corporate stock.Further assume that the expected return is the same for both.According to one of the axioms of finance,which investment would be chosen?

A) the corporate stock
B) the government bond
C) neither, the investor would be indifferent
D) none of the above

Question 71

Assume that an investor is offered a choice of a risk-free government bond that is expected to return 3.5% or a high-risk corporate stock.According to one of the principles of finance,what would induce the investor to purchase the corporate stock?

A) a return that is substantially lower than 3.5%
B) cash dividends
C) a return that is substantially higher than 3.5%
D) none of the above

Question 72

John won the lottery on Monday and can take either $50,000 per year for 20 years,or $500,000 today.Bill won the same lottery on Tuesday and has the same options for receiving the cash.A well respected financial advisor is hired by both John and Bill.The advisor recommends that John take the $50,000 per year for 20 years but advises Bill to take the $500,000 up front payment.How is it possible to give different advice to two clients regarding the exact same cash flows?

Question 73

Short-term United States Treasury Bills are widely used as proxies for risk-free assets,yet the returns on these T-bills are consistently greater than zero.Is this consistent with the concept of a risk-return tradeoff?

Question 74

The chief financial officer (CFO)is responsible for overseeing financial planning,corporate strategic planning,and controlling the firm's cash flow.

Question 75

Ethical behavior

A) is the fifth basic principles of finance.
B) cannot be a concern to managers who are expected to maximize shareholder value.
C) in the corporate world means not breaking any laws.
D) is essential in business because unethical behavior destroys trust and business relationships.

Question 76

Your friend Ricky took a finance class and learned about the risk/return tradeoff.Wanting a high return,Ricky invested in a risky,start-up technology company.A year later the company went bankrupt and Ricky lost his entire investment.Ricky is furious with his finance professor for misleading him,claiming he was taught that higher return goes with higher risk.Explain how Ricky misinterpreted the risk/return tradeoff.

Question 77

In finance,we assume that investors are generally

A) neutral to risk.
B) averse to risk.
C) fond of risk.
D) none of the above

Question 78

Investors generally don't like risk.Therefore,a typical investor

A) will not be induced to take on any risk.
B) will only take on the least risk possible.
C) will only take on additional risk if he expects to be compensated in the form of additional return.
D) will only accept a zero return if the risk is zero.

Question 79

Assume that you won the Lotta Dough Lotto jackpot for $20 million.Further assume that you were offered a choice to receive the $20 million today,or receive it in equal installments of $1 million per year for 20 years.According to one of the principles of finance,which would you take?

A) The $20 million in equal installments of $1 million per year for 20 years because you would be afraid of spending it all right away.
B) The $20 million today because it would be worth more than if you would receive it in equal installments of $1 million per year for 20 years.
C) You would be indifferent as to when you would receive the $20 million since the total number of dollars received is the same either way.
D) The $20 million in equal installments of $1 million per year for 20 years because it would be worth more than if you would receive it today.

Question 80

Determining how a firm should raise money to fund its long-term investments is referred to as capital structure decisions.