Exam 1: An Overview of Financial Management and the Financial Environment

A) Corporations generally are subject to more favorable tax treatment and fewer regulations than partnerships and sole proprietorships, which is why corporations do most of the business in the United States.
B) Managers who face the threat of hostile takeovers are less likely to pursue policies that maximize shareholder value than are managers who do not face the threat of hostile takeovers.
C) One advantage of the corporate form of organization is that liability of the owners of the firm is limited to their investment in the firm.
D) Because of their simplified organization, it is easier for sole proprietorships and partnerships to raise large amounts of outside capital than it is for corporations.
E) Bond covenants are an effective way to resolve conflicts between shareholders and managers.

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A) Assuming Cheers is profitable, less of its income will be subject to federal income taxes.
B) Cheers will now be subject to fewer regulations.
C) Cheers' shareholders (the ex-partners) will now be exposed to less liability.
D) Cheers' investors will be exposed to less liability, but they will find it more difficult to transfer their ownership.
E) Cheers will find it more difficult to raise additional capital.

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A) If expected inflation increases, interest rates are likely to increase.
B) If individuals in general increase the percentage of their income that they save, interest rates are likely to increase.
C) If companies have fewer good investment opportunities, interest rates are likely to increase.
D) Interest rates on all debt securities tend to rise during recessions because recessions increase the possibility of bankruptcy, hence the riskiness of all debt securities.
E) Interest rates on long-term bonds are more volatile than rates on short-term debt securities like T-bills.

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A) Corporations generally find it relatively difficult to raise large amounts of capital.
B) Less of a corporation's income is generally subjected to taxes than would be true if the firm were a partnership.
C) Corporate shareholders escape liability for the firm's debts, but this factor may be offset by the tax disadvantages of the corporate form of organization.
D) Corporate investors are exposed to unlimited liability.
E) Corporations generally face relatively few regulations.

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C

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A) In a regular partnership, liability for other partners' misdeeds is limited to the amount of a particular partner's investment in the business.
B) Attracting large amounts of capital is more difficult for partnerships than for corporations because of such factors as unlimited liability, the need to reorganize when a partner dies, and the illiquidity (difficulty buying and selling) of partnership interests.
C) A slow-growth company, with little need for new capital, would be more likely to organize as a corporation than would a faster growing company.
D) The limited partners in a limited partnership have voting control, while the general partner has operating control over the business. Also, the limited partners are individually responsible, on a pro rata basis, for the firm's debts in the event of bankruptcy.
E) A major disadvantage of all partnerships compared to all corporations is the fact that federal income taxes must be paid by the partners rather than by the firm itself.

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A) Proprietorship, because of ease of entry.
B) S corporation, to gain some tax advantages and also to obtain limited liability.
C) Partnership, but only if she needs additional capital.
D) Regular corporation, because of the limited liability.
E) In this situation, the various forms of organization seem equally desirable.

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A) Households start saving a larger percentage of their income.
B) The economy moves from a boom to a recession.
C) The level of inflation begins to decline.
D) Corporations step up their expansion plans and thus increase their demand for capital.
E) The Federal Reserve uses monetary policy in an attempt to stimulate the economy.

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A) Most businesses (by number and total dollar sales) are organized as partnerships or proprietorships because it is easier to set up and operate in one of these forms rather than as a corporation. However, if the business gets very large, it becomes advantageous to convert to a corporation, mainly because corporations have important tax advantages over proprietorships and partnerships.
B) Due to limited liability, unlimited lives, and ease of ownership transfer, the vast majority of U.S. businesses (in terms of number of businesses) are organized as corporations.
C) Most business (measured by dollar sales) is conducted by corporations in spite of large corporations' often less favorable tax treatment, due to legal considerations related to ownership transfers and limited liability.
D) Large corporations are taxed more favorably than sole proprietorships.
E) Corporate stockholders are exposed to unlimited liability.

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True

A) This is an example of an exchange of physical assets.
B) This is an example of a primary market transaction.
C) This is an example of a direct transfer of capital.
D) This is an example of a money market transaction.
E) This is an example of a derivatives market transaction

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A) Maximize the stock price per share over the long run, which is the stock's intrinsic value.
B) Maximize the firm's expected EPS.
C) Minimize the chances of losses.
D) Maximize the firm's expected total income.
E) Maximize the stock price on a specific target date.

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A

A) The corporate bylaws are a standard set of rules established by the state of incorporation. These rules are identical for all corporations in the state, and their purpose is to ensure that the firm's managers run the firm in accordance with state laws.
B) The corporate charter is a standard document prescribed by the state of incorporation, and its purpose is to ensure that the firm's managers run the firm in accordance with state laws. Procedures for electing corporate directors are contained in bylaws, while the declaration of the activities that the firm will pursue and the number of directors are included in the corporate charter.
C) Companies must establish a home office, or domicile, in a particular state, and that state must be the one in which most of their business (sales, manufacturing, and so forth) is conducted.
D) Attorney fees are generally involved when a company develops its charter and bylaws, but since these documents are voluntary, a new corporation can avoid these costs by deciding not to have either a charter or bylaws.
E) The corporate charter is concerned with things like what business the company will engage in, whereas the bylaws are concerned with things like procedures for electing the board of directors.

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A) The financial manager's proper goal should be to attempt to maximize the firm's expected cash flows, since that will add the most to the individual shareholders' wealth.
B) The financial manager should seek that combination of assets, liabilities, and capital that will generate the largest expected projected after-tax income over the relevant time horizon, generally the coming year.
C) The riskiness inherent in a firm's earnings per share (EPS) depends on the characteristics of the projects the firm selects, and thus on the firm's assets. However, EPS is not affected by the manner in which those assets are financed.
D) Potential agency problems can arise between managers and stockholders, because managers hired as agents to act on behalf of the owners may instead make decisions favorable to themselves rather than the stockholders.
E) Large, publicly owned firms like IBM and GE are controlled by their management teams. Ownership is generally widely dispersed; hence managers have great freedom in how they run the firm. Managers may operate in stockholders' best interests, but they also may operate in their own personal best interests. As long as they stay within the law, there is no way to either force or motivate managers to act in the stockholders' best interests.

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A) One of the disadvantages of incorporating a business is that the owners then become subject to liabilities in the event the firm goes bankrupt.
B) Sole proprietorships are subject to more regulations than corporations.
C) In any type of partnership, every partner has the same rights, privileges, and liability exposure as every other partner.
D) Sole proprietorships and partnerships generally have a tax advantage over many corporations, especially large ones.
E) Corporations of all types are subject to the corporate income tax.

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A) It is generally more expensive to form a proprietorship than a corporation because, with a proprietorship, extensive legal documents are required.
B) Corporations face fewer regulations than sole proprietorships.
C) One disadvantage of operating a business as a sole proprietorship is that the firm is subject to double taxation, at both the firm level and the owner level.
D) One advantage of forming a corporation is that equity investors are usually exposed to less liability than in a regular partnership.
E) If a regular partnership goes bankrupt, each partner is exposed to liabilities only up to the amount of his or her investment in the business.

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