Chapter 01 Test Bank - Static
Chapter 01 Test Bank - Static
Chapter 01 Test Bank - Static
A. individuals.
B. individuals and pension funds.
C. pension funds.
D. individuals, pension funds, and insurance companies.
A. managers.
B. board of directors and shareholders.
C. shareholders.
D. managers, board of directors, and shareholders.
A. is a legal entity.
B. has the same ownership and management.
C. has limited liability.
D. is closely regulated.
A. sole proprietorships.
B. partnerships.
C. corporations.
D. both partnerships and corporations.
A. Production machinery
B. Factories
C. Trademarks
D. Office equipment
A. financing decision.
B. liquidity decision.
C. capital budgeting decision.
D. leasing decision.
Accessibility: Keyboard Navigation
Difficulty: Intermediate
A. Common stock
B. Bank loans
C. Preferred stock
D. Buildings
A. Providing financing
B. Providing financing and liquidity
C. Providing financing, providing liquidity, reducing risk, and providing information
D. Providing information
A. agency costs.
B. double taxation.
C. cost of managing the corporation.
D. all of the options.
14. Costs associated with the conflicts of interest between the bondholders and the shareholders of a corporation
are called
A. legal costs.
B. bankruptcy costs.
C. administrative costs.
D. agency costs.
A. managers may not attempt to maximize the value of the firm to shareholders.
B. shareholders incur monitoring costs.
C. of the separation of ownership and management.
D. all of the responses are correct.
16. The following groups are some of the claimants to a firm's income stream
A. maximize profits.
B. maximize sales.
C. maximize the value of the firm for the shareholders.
D. maximize managers' benefits.
A. machinery only.
B. machinery and office buildings only.
C. training courses for employees only.
D. machinery, office buildings, and warehouses only.
25. Mr. Free has $100 income this year and zero income next year. The market interest rate is 10 percent per year.
If Mr. Free consumes $30 this year and invests the rest in the market, what will be his consumption next year?
A. $50
B. $55
C. $77
D. $100
A. $80
B. $82
C. $100
D. $102
27. Ms. Venus has $100 income this year and $110 next year. The market interest rate is 10 percent per
year. Suppose Ms. Venus consumes $60 this year. What will be her consumption next year?
A. $120
B. $154
C. $170
D. 210
28. Mr. Thomas has $100 income this year and zero income next year. The market interest rate is 10 percent per
year. Mr. Thomas also has an investment opportunity in which he can invest $50 this year and receive $80 next
year. Suppose Mr. Thomas consumes $50 this year and invests in the project. What will be his consumption next
year?
A. $50
B. $55
C. $80
D. $110
29. Mr. Dell has $100 income this year and zero income next year. The expected return from investing in the
stock market is 10 percent a year. Mr. Dell also has an investment opportunityhaving the same risk as the
market in which he can invest $50 this year and receive $80 next year. Suppose Mr. Dell consumes $50 this year
and invests in the project. What is the NPV of the investment opportunity?
A. $0
B. $5
C. $22.73
D. None of the options
30. Ms. Anderson has $60,000 income this year and $40,000 next year. The market interest rate is 10 percent
per year. Suppose Ms. Anderson consumes $80,000 this year. What will be her consumption next year?
A. $18,000
B. $30,000
C. $60,000
D. $70,000
31. The line that connects the maximum that one can consume this year (now, on the horizontal axis) and
the maximum one can consume next year
32. Ms. Newcastle has $60,000 income this year and $40,000 next year. The market interest rate is 10 percent
per year. Suppose Ms. Newcastle wishes to consume $62,000 next year. What will be her consumption this
year?
A. $19,000
B. $40,000
C. $60,000
D. $70,000
33. Mr. Smith has an income of $40,000 this year and $60,000 next year. He can invest in a project that costs
$30,000 this year, which generates an income of $36,000 next year. The market interest rate is 10 percent. What
will be his consumption next year if Mr. Smith invests in the project and consumes $50,000 this year?
A. $40,000
B. $52,000
C. $60,000
D. $62,000
34. The board of directors is ultimately responsible for all large investment decisions.
TRUE
35. A corporation has a legal existence of its own and is based on "articles of incorporation.
TRUE
FALSE
FALSE
38. Managers, shareholders, and the firm's debtholders have identical information about the value of the firm.
FALSE
A corporation is a legal entity and has an existence of its own. Generally, large businesses are organized as
corporations.
Difficulty: Basic
The shareholders of a corporation cannot be held personally responsible for the debts 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 investors.
Difficulty: Intermediate
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.
Difficulty: Intermediate
42. Briefly explain the sequence of cash flows between financial markets and the firm.
Cash is invested in the firm's operation and used to purchase real assets.
providing information.
Difficulty: Intermediate
Chief financial officer (CFO): Supervises the treasurer and the controller in a large corporation. The CFO is
involved in corporate planning and financial policy.
Treasurer: Is responsible for obtaining funds and managing cash, banking relationships, and investor
relationships.
Agency costs arise in a corporation as a result of principalagent problems. For example, managers may not act in
the best interests of shareholders while making decisions. Hence, shareholders incur monitoring costs that are
called agency costs. Agency costs also arises as a result of informational asymmetry between managers and other
stakeholders of a firm. Agency costs tend to reduce the value of a firm.
Difficulty: Intermediate
46. Briefly discuss principalagent problems as related to a corporation.
Principalagent 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, shareholders incur
monitoring and bonding costs, which are a part of agency costs. It also arises as a result of informational
asymmetry between managers and other stakeholders of a firm. Agency costs tend to reduce the value of a firm.
Difficulty: Intermediate
47. Explain why maximization of shareholders' wealth is the appropriate ultimate long-term goal of the firm.
Under perfect market conditions, everyone can borrow or lend at the same interest rate. This implies that
differences in consumption patterns can be adjusted in the financial markets. Given this, all investors will agree
that they are better off if the firm maximizes their current wealth (i.e., maximizing shareholders' wealth).
Difficulty: Challenge
48. Briefly explain some of the institutional arrangements that ensure that managers work toward increasing the
value of a firm.
Incentive schemes that are closely tied to the value of the firm like stock options
Difficulty: Intermediate
49. Briefly explain how individuals can adjust their current and future consumption according to their preferences.
Individuals can adjust their preferences for consumption by borrowing or lending in the financial market. The
appropriate balance between present and future consumption that each individual will choose depends on
personal preferences. Nevertheless, individuals with different preferences can adjust their preferences using the
financial market. Individuals desiring current consumption can borrow from future income. Meanwhile, individuals
favoring future consumption can refrain from current consumption and invest in the same financial market.
Difficulty: Challenge
# of
Category Questions
Accessibility: Keyboard Navigation 38
Difficulty: Basic 11
Difficulty: Challenge 13
Difficulty: Intermediate 25