Financial Management Exam #1

True or False: The financial manager must execute his or her duties independent of the other activities of the firm in order to properly maximize the value of the firm. - correct answer False; the financial manager must coordinate with all functional areas of the company in order to do their job well. True or False: Deciding upon the form of organization for a business is an important financial decision with potentially significant consequences for the future wealth of the owners. - correct answer True; the organizational form that is selected will determine how the company and the owners are taxed. This in turn will have significant impact on their future wealth. True or False: The proper goal of the financial manager should be to maximize the firm's expected profit (or net income), since this will add the most wealth to each of the individual shareholders (owners) of the firm. - correct answer False; profit measures are backward. Maximizing a backward looking measure can lead to improper management decisions. True or False: Maximizing Earnings Per Share (EPS) is an example of maximizing shareholder wealth. - correct answer False; net income is a measurement of profit so EPS is also a measure of profit. Profit is a backward is a backward looking statistic, so EPS maximization should not be the primary goal of the firm. True or False: An agency relationship between stockholders and managers. - correct answer True; the managers may have other agendas like personal free-time or improving their own quality of life at the expense of the shareholders. True or False: An agency relationship exists when one or more persons hire another person to perform some service but withhold decision-making authority from that person. - correct answer False; an agent (managers for example) have a considerable decision-making authority; exist when a principal (stockholder (stockholder) hires an agent (manager) to act on their behalf. Which of the following is not one of the things that cause a corporation to have a significant advantage over a partnership or a proprietorship? (A) limited liability (B) ease of transfer of ownership interest (C) unlimited life (D) elimination of double taxation (E) ability to retain earnings and thus convert income from personal income to capital gains. - correct answer D; corporations subject shareholders to double taxation so that is a disadvantage of the corporate form of business. Which of the following statements is true? (A) one of the benefits of incorporating your business is that you are entitled to receive unlimited liability. (B) Sole proprietorship's are subject to more regulations than corporations are subject to. (C) Sole proprietorship's do not have to pay corporate tax. (D) All of the above are correct. (E) None of the answers above is correct. - correct answer C. Which of the following mechanisms is not used by shareholders to get managers to act in shareholders' best interests? a. Threat of firing b. Properly structured managerial compensation c. Higher cash salaries d. Threat of takeover e. Answers b and c above - correct answer c; higher cash salaries could potentially encourage more agency problems since they are not directly tied to firm performance. Which of the following statements is most correct? a. A good goal for a corporate manager is maximization of expected EPS. b. Most business in the U.S. is conducted by corporations; corporations' popularity results primarily from their favorable tax treatment. c. A good example of an agency relationship is the one between stockholders and managers. d. Corporations and partnerships have an advantage over proprietorship's because a sole proprietor is subject to unlimited liability but investors in the other types of business are not. e. Firms in highly competitive industries find it easier to exercise "social responsibility" than do firms in less competitive industries. - correct answer c. Which of the following is an example of an area of business where use of "questionable" ethics is considered a necessity? a. Attracting and sustaining new customers b. Hiring and keeping skilled employees c. Keeping up with competition d. Dealing with firms who use "questionable" ethics e. None of the above - correct answer e; if an activity requires questionable ethics, it should be avoided. True or False: By maximizing the earnings of the firm we will ensure that the price per share of common stock is maximized, hence shareholders' wealth will also be maximized. - correct answer False; earnings (profit) maximization does not ensure that the stock price will be maximized. Which of the following statements is most correct? A. Agency conflicts between stockholders and managers are not really a problem when outsiders (i.e., non-managers) own shares in a corporation. B. Managers may operate in the stockholders' best interests, or managers may operate in their own personal best interest. As long as managers stay within the law, there are no effective controls that stockholders can implement to control managerial decision making. C. One mechanism that helps reconcile managers' goals with those of the shareholders is the threat of being fired. D. An agency relationship exists when one or more persons hire another person to perform some service but withhold decision-making authority from that person. E. All of the statements above are false. - correct answer C; Which of the following actions are likely to reduce agency conflicts between stockholders and managers? A. Paying managers a large fixed salary. B. The threat of firing. C. Placing restrictive covenants in debt agreements. - correct answer B. True or False: If an individual investor buys and sells existing stock through a broker, these are primary market transactions. - correct answer False; all transactions after the one between the company and the investment banker are secondary market transactions.