CHAPTER 01—AN OVERVIEW OF FINANCIAL MANAGEMENT Note that there is an overlap between the T/F and multiple-choice questions, as some of the T/F statements are used in multiple-choice questions Multiple Choice: True/False In most corporations, the CFO ranks under the CEO a True b Fals e ANSWER: True POINTS: DIFFICULTY: EASY REFERENCES: 1-1 What Is Finance? LEARNING OBJECTIVES: FOFM.BRIG.16.01.01 - What Is Finance? NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.06 - Finance function Cengage Learning Testing, Powered by Cognero Page CHAPTER 01—AN OVERVIEW OF FINANCIAL MANAGEMENT TOPICS: Role of finance KEYWORDS: Bloom’s: Knowledge The Chairman of the Board must also be the CEO a True b Fals e ANSWER: False POINTS: DIFFICULTY: EASY REFERENCES: 1-1 What Is Finance? LEARNING OBJECTIVES: FOFM.BRIG.16.01.01 - What Is Finance? NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.06 - Finance function Cengage Learning Testing, Powered by Cognero Page CHAPTER 01—AN OVERVIEW OF FINANCIAL MANAGEMENT TOPICS: Role of finance KEYWORDS: Bloom’s: Knowledge The board of directors is the highest ranking body in a corporation, and the chairman of the board is the highest ranking individual The CEO generally works under the board and its chairman, and the board generally has the authority to remove the CEO under certain conditions The CEO, however, cannot remove the board, but he or she can endeavor to have the board voted out and a new board voted in should a conflict arise It is possible for a person to simultaneously serve as CEO and chairman of the board, though many corporate control experts believe it is bad to vest both offices in the same person a True b Fals e ANSWER: True POINTS: DIFFICULTY: EASY REFERENCES: 1-1 What Is Finance? LEARNING OBJECTIVES: FOFM.BRIG.16.01.01 - What Is Finance? NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking Cengage Learning Testing, Powered by Cognero Page CHAPTER 01—AN OVERVIEW OF FINANCIAL MANAGEMENT STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.06 - Finance function TOPICS: Role of finance KEYWORDS: Bloom’s: Knowledge Partnerships and proprietorships generally have a tax advantage over corporations a True b Fals e ANSWER: True POINTS: DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization LEARNING OBJECTIVES: FOFM.BRIG.16.01.03 - Forms of Business Organization NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.06 - Finance function Cengage Learning Testing, Powered by Cognero Page CHAPTER 01—AN OVERVIEW OF FINANCIAL MANAGEMENT TOPICS: Forms of organization KEYWORDS: Bloom’s: Knowledge A disadvantage of the corporate form of organization is that corporate stockholders are more exposed to personal liabilities in the event of bankruptcy than are investors in a typical partnership a True b Fals e ANSWER: False POINTS: DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization LEARNING OBJECTIVES: FOFM.BRIG.16.01.03 - Forms of Business Organization NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.06 - Finance function TOPICS: Forms of organization Cengage Learning Testing, Powered by Cognero Page CHAPTER 01—AN OVERVIEW OF FINANCIAL MANAGEMENT KEYWORDS: Bloom’s: Knowledge An advantage of the corporate form of organization is that corporations are generally less highly regulated than proprietorships and partnerships a True b Fals e ANSWER: False POINTS: DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization LEARNING OBJECTIVES: FOFM.BRIG.16.01.03 - Forms of Business Organization NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.06 - Finance function TOPICS: Forms of organization Cengage Learning Testing, Powered by Cognero Page CHAPTER 01—AN OVERVIEW OF FINANCIAL MANAGEMENT KEYWORDS: Bloom’s: Knowledge Some partners in a partnership may have different rights, privileges, and responsibilities than other partners a True b Fals e ANSWER: True POINTS: DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization LEARNING OBJECTIVES: FOFM.BRIG.16.01.03 - Forms of Business Organization NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.06 - Finance function TOPICS: Forms of organization Cengage Learning Testing, Powered by Cognero Page CHAPTER 01—AN OVERVIEW OF FINANCIAL MANAGEMENT KEYWORDS: Bloom’s: Knowledge One advantage of the corporate form of organization is that it avoids double taxation a True b Fals e ANSWER: False POINTS: DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization LEARNING OBJECTIVES: FOFM.BRIG.16.01.03 - Forms of Business Organization NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.06 - Finance function TOPICS: Forms of organization KEYWORDS: Bloom’s: Knowledge Cengage Learning Testing, Powered by Cognero Page CHAPTER 01—AN OVERVIEW OF FINANCIAL MANAGEMENT It is generally harder to transfer one's ownership interest in a partnership than in a corporation a True b Fals e ANSWER: True POINTS: DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization LEARNING OBJECTIVES: FOFM.BRIG.16.01.03 - Forms of Business Organization NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.06 - Finance function TOPICS: Forms of organization KEYWORDS: Bloom’s: Knowledge Cengage Learning Testing, Powered by Cognero Page CHAPTER 01—AN OVERVIEW OF FINANCIAL MANAGEMENT 10 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 a True b Fals e ANSWER: True POINTS: DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization LEARNING OBJECTIVES: FOFM.BRIG.16.01.03 - Forms of Business Organization NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.06 - Finance function TOPICS: Forms of organization KEYWORDS: Bloom’s: Knowledge Cengage Learning Testing, Powered by Cognero Page 10 CHAPTER 01—AN OVERVIEW OF FINANCIAL MANAGEMENT POINTS: DIFFICULTY: MODERATE REFERENCES: Comprehensive LEARNING OBJECTIVES: FOFM.BRIG.16.01.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.06 - Finance function TOPICS: Miscellaneous concepts KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual 60 Which of the following statements is CORRECT? a Hostile takeovers are most likely to occur when a firm's stock is selling below its intrinsic value as a result of poor management b The efficiency of the U.S economy would probably be increased if hostile takeovers were absolutely forbidden c The managers of established, stable companies sometimes attempt to get their state Cengage Learning Testing, Powered by Cognero Page 71 CHAPTER 01—AN OVERVIEW OF FINANCIAL MANAGEMENT legislatures to remove rules that make it more difficult for raiders to succeed with hostile takeovers 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 primarily involve research and development e 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 ANSWER: a RATIONALE: If a firm's stock is undervalued relative to its potential, then someone can profit by taking the firm over and doing a better job running it POINTS: DIFFICULTY: MODERATE REFERENCES: Comprehensive LEARNING OBJ FOFM.BRIG.16.01.00 - Comprehensive ECTIVES: NATIONAL STA United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking NDARDS: STATE STANDA United States - OH - DISC.FOFM.BRIG.16.06 - Finance function RDS: Cengage Learning Testing, Powered by Cognero Page 72 CHAPTER 01—AN OVERVIEW OF FINANCIAL MANAGEMENT TOPICS: Miscellaneous concepts KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual 61 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 Relative to proprietorships, corporations generally face fewer regulations, and they also find it easier to raise capital c 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 d 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 e 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 ANSWER: d POINTS: Cengage Learning Testing, Powered by Cognero Page 73 CHAPTER 01—AN OVERVIEW OF FINANCIAL MANAGEMENT DIFFICULTY: MODERATE REFERENCES: Comprehensive LEARNING OBJECTIVES: FOFM.BRIG.16.01.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.06 - Finance function TOPICS: Miscellaneous concepts KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual 62 Which of the following statements is CORRECT? a Because bankruptcy requires that corporate bondholders be paid in full before stockholders receive anything, bondholders generally prefer to see corporate managers invest in high risk/high return projects rather than low risk/low return projects b Since bondholders receive fixed payments, they not share in the gains if risky projects turn out to be highly successful However, they 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 Cengage Learning Testing, Powered by Cognero Page 74 CHAPTER 01—AN OVERVIEW OF FINANCIAL MANAGEMENT c 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 d One drawback of forming a corporation is that you lose the limited liability that you would otherwise receive as a proprietor e Potential conflicts between stockholders and bondholders are increased if a firm's bonds are convertible into its common stock ANSWER: b POINTS: DIFFICULTY: MODERATE REFERENCES: Comprehensive LEARNING OBJECTIVES: FOFM.BRIG.16.01.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.06 - Finance function TOPICS: Miscellaneous concepts KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual Cengage Learning Testing, Powered by Cognero Page 75 CHAPTER 01—AN OVERVIEW OF FINANCIAL MANAGEMENT 63 Which of the following statements is CORRECT? a Corporations face few regulations and more favorable tax treatment than proprietorships and partnerships b Managers who face the threat of hostile takeovers are less likely to pursue policies that maximize shareholder value compared to managers who not face the threat of hostile takeovers c Bond covenants are an effective way to resolve conflicts between shareholders and managers d Because of their simplified organization, it is easier for proprietors and partnerships to raise large amounts of outside capital than it is for corporations e One advantage to forming a corporation is that the owners of the firm have limited liability ANSWER: e POINTS: DIFFICULTY: MODERATE REFERENCES: Comprehensive LEARNING OBJECTIVES: FOFM.BRIG.16.01.00 - Comprehensive Cengage Learning Testing, Powered by Cognero Page 76 CHAPTER 01—AN OVERVIEW OF FINANCIAL MANAGEMENT NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.06 - Finance function TOPICS: Miscellaneous concepts KEYWORDS: Bloom’s: Knowledge OTHER: Multiple Choice: Conceptual Multiple Choice: Problems 64 New Business is just being formed by 10 investors, each of whom will own 10% of the business The firm is expected to earn $1,000,000 before taxes each year The corporate tax rate is 34% and the personal tax rate for the firm's investors is 35% The firm does not need to retain any earnings, so all of its after-tax income will be paid out as dividends to its investors The investors will have to pay personal taxes on whatever they receive How much additional spendable income will each investor have if the business is organized as a partnership rather than as a corporation? a $20,384 b $20,800 c $21,225 Cengage Learning Testing, Powered by Cognero Page 77 CHAPTER 01—AN OVERVIEW OF FINANCIAL MANAGEMENT d $21,658 e $22,100 ANSWER: e RATIONALE: Business income: Number of investors (N): $1,000,000 10 Corporate tax rate (TC): 34% Personal tax rate (TP): 35% Corporation: Corporate taxes $ 340,000 Income after corporate tax, paid to investors (stockholders) as dividends 660,000 Tax on dividends 231,000 Spendable income $ 429,000 Cengage Learning Testing, Powered by Cognero Page 78 CHAPTER 01—AN OVERVIEW OF FINANCIAL MANAGEMENT Partnership: Taxes paid by business $ Income received by investors (partners) 1,000,000 Taxes paid by partners as personal income Spendable income Difference in spendable income: total gain from being a partnership Individual investor gain POINTS: DIFFICULTY: EASY 650,000 $ 350,000 $ 221,000 $ 22,100 REFERENCES: 1-3 Forms of Business Organization Cengage Learning Testing, Powered by Cognero Page 79 CHAPTER 01—AN OVERVIEW OF FINANCIAL MANAGEMENT LEARNING OBJ FOFM.BRIG.16.01.03 - Forms of Business Organization ECTIVES: NATIONAL STA United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills NDARDS: STATE STANDA United States - OH - DISC.FOFM.BRIG.16.06 - Finance function RDS: TOPICS: Tax effects of organization KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem 65 Assume that the corporate tax rate is 34% and the personal tax rate is 35% The founders of a newly formed business are debating between setting up the firm as a partnership versus a corporation The firm will not need to retain any earnings, so all of its after-tax income will be paid out to its investors, who will have to pay personal taxes on whatever they receive What is the difference in the percentage of the firm's pre-tax income that investors actually receive and can spend under the corporate and partnership forms of organization? a 20.4 % b 20.8% c 21.2 % d 21.7 Cengage Learning Testing, Powered by Cognero Page 80 CHAPTER 01—AN OVERVIEW OF FINANCIAL MANAGEMENT % e 22.1 % ANSWER: e RATIONALE: Corporate tax rate (TC): 34% Personal tax rate (TP): 35% Corporation: Corporate net = Business pre-tax income (1 − TC) Investors' net = Corporate net (1 − TP) = Business pre-tax net (1 − TC)(1 − TP) = Business pre-tax net × 66% × 65% 42.9% Partnership: The business pays no tax, but investors pay tax on business income Investors' net = Business pre-tax net (1 − TP) = Business pre-tax net (1 − TP) Difference Cengage Learning Testing, Powered by Cognero 65% 22.1% Page 81 CHAPTER 01—AN OVERVIEW OF FINANCIAL MANAGEMENT POINTS: DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization LEARNING OBJEC FOFM.BRIG.16.01.03 - Forms of Business Organization TIVES: NATIONAL STANDA United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills RDS: STATE STANDARDS United States - OH - DISC.FOFM.BRIG.16.06 - Finance function : TOPICS: Tax effects of organization KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem 66 Charleston Corporation (CC) now operates as a "regular" corporation, but it is considering a switch to S Corporation status CC is owned by 100 stockholders who each hold 1% of the stock, and each faces a personal tax rate of 35% The firm earns $2,000,000 per year before taxes, and since it has no need for retained earnings, it pays out all of its earnings as dividends Assume that the corporate tax rate is 34% and the personal tax rate is 35% How much more (or less) spendable income would each stockholder have if the firm elected S Corporation status? Cengage Learning Testing, Powered by Cognero Page 82 CHAPTER 01—AN OVERVIEW OF FINANCIAL MANAGEMENT a $ 2,565 b $ 4,420 c $ 8,580 d $11,150 e $13,000 ANSWER: b RATIONALE: Business income: Number of investors (N): $2,000,000 100 Corporate tax rate (TC): 34% Personal tax rate (TP): 35% Corporation: Corporate taxes Income after corporate tax, paid to investors (stockholders) as dividends $ 680,000 1,320,000 Tax on dividends 462,000 Spendable income, total $ 858,000 Spendable income, each (100 investors) $ Cengage Learning Testing, Powered by Cognero 8,580 Page 83 CHAPTER 01—AN OVERVIEW OF FINANCIAL MANAGEMENT S Corporation: Taxes paid by business $ Income received by investors 2,000,000 Taxes paid by investors as personal income 700,000 Spendable income, total $1,300,000 Spendable income, each (100 investors) $ 13,000 $ 4,420 Difference in spendable income: gain from being an S Corporation POINTS: DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization Cengage Learning Testing, Powered by Cognero Page 84 CHAPTER 01—AN OVERVIEW OF FINANCIAL MANAGEMENT LEARNING OBJE FOFM.BRIG.16.01.03 - Forms of Business Organization CTIVES: NATIONAL STAND United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills ARDS: STATE STANDARD United States - OH - DISC.FOFM.BRIG.16.06 - Finance function S: TOPICS: Tax effects of organization KEYWORDS: Bloom's: Application OTHER: Multiple Choice: Problem Cengage Learning Testing, Powered by Cognero Page 85 ... function Cengage Learning Testing, Powered by Cognero Page CHAPTER 01—AN OVERVIEW OF FINANCIAL MANAGEMENT TOPICS: Role of finance KEYWORDS: Bloom’s: Knowledge The board of directors is the highest... United States - OH - DISC.FOFM.BRIG.16.06 - Finance function Cengage Learning Testing, Powered by Cognero Page CHAPTER 01—AN OVERVIEW OF FINANCIAL MANAGEMENT TOPICS: Forms of organization KEYWORDS:... States - OH - DISC.FOFM.BRIG.16.06 - Finance function TOPICS: Forms of organization Cengage Learning Testing, Powered by Cognero Page CHAPTER 01—AN OVERVIEW OF FINANCIAL MANAGEMENT KEYWORDS: