CHAPTER 1.

INTRODUCTION TO CORPORATE FINANCE

A. True/False Questions (5)

1. The primary goal of financial management is to minimize the corporate tax

liability.F
2. When owners are managers (such as in a sole proprietorship), a firm will have
agency costs. F
3. A goal or objective is a necessary first step for effective financial management.-T
4. Deciding on the total amount of assets needed by the firm is a key step in the
investment decision. - T
5. The goal of the firm should be to maximize earnings per share.-F

B. Multiple Choice Questions (25)

1. A business owned by a solitary individual who has unlimited liability for its debt is
called a:
A. corporation.
B. sole proprietorship.
C. general partnership.
D. limited partnership.

2. A business formed by two or more individuals who each have unlimited liability for
all of the firm's business debts is called a:
A. corporation.
B. sole proprietorship.
C. general partnership.
D. limited liability company.

3.A business partner whose potential financial loss in the partnership will not exceed
his or her investment in that partnership is called a:
A. generally partner.
B. sole proprietor.
C. limited partner.
D. corporate shareholder.

4.Which one of the following terms is defined as a conflict of interest between the
corporate shareholders and the corporate managers?
A. articles of incorporation
B. corporate breakdown
C. agency problem
D. legal liability
5.Which of the following questions are addressed by financial managers?
I. How should a product be marketed?
II. Should customers be given 30 or 45 days to pay for their credit purchases?
III. Should the firm borrow more money?
IV. Should the firm acquire new equipment?
A. I and IV only
B. II and III only
C. I, II, and III only
D. II, III, and IV only

6. Which one of the following functions should be the responsibility of the controller
rather than the treasurer?
A. daily cash deposit
B. income tax returns
C. equipment purchase analysis
D. customer credit approval

7. Which one of the following statements concerning a sole proprietorship is

correct?
A. A sole proprietorship is designed to protect the personal assets of the owner.
B. The profits of a sole proprietorship are subject to double taxation.
C. The owner of a sole proprietorship is personally responsible for all of the
company's debts.
D. A sole proprietorship is structured the same as a limited liability company.

8.Which of the following individuals have unlimited liability based on their ownership
interest?
I. general partner
II. sole proprietor
III. stockholder
IV. limited partner
A. II only
B. I and II only
C. II and IV only
D. I, II, and III only
9.Which one of the following is a primary market transaction?
A. sale of currently outstanding stock by a dealer to an individual investor
B. sale of a new share of stock to an individual investor
C. stock ownership transfer from one shareholder to another shareholder
D. gift of stock from one shareholder to another shareholder
E. gift of stock by a shareholder to a family member

10. Which one of the following best describes the primary advantage of being a
limited partner instead of a general partner?
A. tax-free income
B. active participation in the firm's activities
C. no potential financial loss
D. maximum loss limited to the capital invested

11.A general partner:

A. is solely responsible for all the partnership debts.
B. has no say over a firm's daily operations.
C. faces double taxation whereas a limited partner does not.
D. has a maximum loss equal to his or her equity investment.

12.A limited partnership:

A. has an unlimited life.
B. can opt to be taxed as a corporation.
C. terminates at the death of any limited partner.
D. has a greater ability to raise capital than a sole proprietorship.

13. Which of the following apply to a partnership that consists solely of general
partners?
I. double taxation of partnership profits
II. limited partnership life
III. active involvement in the firm by all the partners
IV. unlimited personal liability for all partnership debts
A. II only
B. I and II only
C. I, II, and IV only
D. II, III, and IV only

14. Which of the following are advantages of the corporate form of business
ownership?
I. limited liability for firm debt
II. double taxation
III. ability to raise capital
IV. unlimited firm life
A. I and II only
B. III and IV only
C. I, III, and IV only
D. II, III, and IV only
15 .Shareholder A sold 500 shares of ABC stock on the Stock Exchange. This
transaction:
A. took place in the primary market.
B. occurred in a dealer market.
C. was facilitated in the secondary market.
D. involved a proxy.

16. Which one of the following business types is best suited to raising large amounts
of capital?
A. sole proprietorship
B. limited liability company
C. corporation
D. general partnership
E. limited partnership

17. Which one of the following best states the primary goal of financial
management?
A. maximize current dividends per share
B. maximize the current value per share
C. increase cash flow and avoid financial distress
D. minimize operational costs while maximizing firm efficiency

18. Decisions made by financial managers should primarily focus on increasing which
one of the following?
A. size of the firm
b. gross profit per unit produced
C. market value per share of outstanding stock
D. total sales

19. Which form of business structure is most associated with agency problems?
A. sole proprietorship
B. limited partnership
C. corporation
D. limited liability company

20. Which one of the following is an agency cost?

A. accepting an investment opportunity that will add value to the firm
B. increasing the quarterly dividend
C. investing in a new project that creates firm value
D. hiring outside accountants to audit the company's financial statements
21. Which one of the following parties has ultimate control of a corporation?
A. chairman of the Board
B. board of directors
C. shareholders
D. chief executive officer

22. Which of the following are cash flows from a corporation into the financial
markets?
I. repayment of long-term debt
II. payment of government taxes
III. payment of loan interest
IV. payment of quarterly dividend
A. I and II only
B. I and III only
C. II and IV only
D. I, III, and IV only

23.Daily activites of Financial Manager include:

I. Credit Management
II. Invetory Management
III. Capital Budgeting
IV. Cpital Structure

A.I and II
B.II
C.II and III
D.I,II,IV
24. Sam, Alfredo, and Juan want to start a small U.S. business. Juan will fund the
venture but wants to limit his liability to his initial investment and has no interest in
the daily operations. Sam will contribute his full efforts on a daily basis but has
limited funds to invest in the business. Alfredo will be involved as an active
consultant and manager and will also contribute funds. Sam and Alfredo are willing
to accept liability for the firm's debts as they feel they have nothing to lose by doing
so. All three individuals will share in the firm's profits and wish to keep the initial
organizational costs of the business to a minimum. Which form of business entity
should these individuals adopt?
A. sole proprietorship
B. limited partnership
C. general partnership
D. corporation

25. Sally and Alicia currently are general partners in a business located in Atlanta,
Georgia. They are content with their current tax situation but are both very
uncomfortable with the unlimited liability to which they are each subjected. Which
form of business entity should they consider to replace their general partnership
assuming they wish to remain the only two owners of their business? Whichever
organization they select, they wish to be treated equally.
A. sole proprietorship
B. limited partnership
C. limited liability company
D. corporation

26. Which of the following statements is CORRECT?

A. Corporations generally are subject to fewer regulations and more favorable tax
treatment than sole proprietorships and partnerships. This 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 purpose
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. Bond covenants are an effective way to resolve conflicts between shareholders
and managers

27. Which of the following statements is CORRECT?

A. One of the disadvantages of a sole proprietorship is that the proprietor is
exposed to unlimited liability
B. It is generally easier to transfer one’s ownership interest in a partnership than in a
corporation
C. One of the advantages of the corporate form of organization is that it avoids
double taxation
D. 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”.
C. Short answer (5)

1. List and briefly describe the three general areas of responsibility for a financial
manager.

The three basic areas are:

1. capital budgeting: the identification of investment opportunities that have a
positive net value
2. capital structure: the mix of long-term debt and equity used to finance a firm's
operations
3. working capital management: the daily control of a firm's short-term assets and
short-term liabilities

2.Why are so many businesses structured as sole proprietorships when the

corporate form of business offers more advantages?

A significant advantage of the sole proprietorship is that it is inexpensive and easy to

form. If the sole proprietor has limited capital to start with, it may not be desirable to
spend part of that capital forming a corporation. Also, limited liability for business
debts may not be a significant advantage if the proprietor has most of his or her
personal assets tied up in the business already. Finally, for a typical small firm, having
an unlimited life for the business has no real advantage since the heart and soul of
the business is the person who founded it, thereby effectively limiting the life of the
business to that of its founder.

3. From a liability point of view, what is the difference between investing in a sole
proprietorship and a general partnership?

Both a sole proprietor and a general partner have unlimited liability for the firm's
debts. However, as a sole proprietor you should be totally aware of all the business
dealings of the firm. In a general partnership, you may or may not handle the
financial transactions and thus are accepting the responsibility for actions taken not
only by yourself, but those of your partners.
4. Give some examples of ways in which manager's goals can differ from those of
shareholders.

The primary goal of a financial manager should be to maximize the current value of
the outstanding stock. This goal focuses on enhancing the returns to stockholders
who are the owners of the firm. However, managers frequently are more concerned
with their personal benefits from employment, the prestige of their position, and the
perks to which they feel entitled. There are numerous examples, some of which are
excessive compensation packages, large corporate offices, excessive staffing, and
first-class travel and conference locations, to name a few.

5. Who owns a corporation? Describe the process whereby the owners control the
firm’s management. What is the main reason that an agency relationship exists in
the corporate form of organization? In this context, what kinds of problems can
arise? ( Ross)
In the corporate form of ownership, the shareholders are the owners of the firm. The
shareholders elect the directors of the corporation, who in turn appoint the firm’s
management. This separation of ownership from control in the corporate form of
organization is what causes agency problems to exist. Management may act in its
own or someone else’s best interests, rather than those of the shareholders. If such
events occur, they may contradict the goal of maximizing the share price of the
equity of the firm.

D. Excersice: 0