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Test Bank for Corporate Finance - Short Answer Questions 6th edition by Jonathan Berk
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Test Bank for Corporate Finance - Short Answer Questions 6th edition by Jonathan Berk
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Test Bank for Corporate Finance - ShortAnswer Questions 6th edition by
Jonathan Berk
What is the goal of financial management? - ANSThe goal of financial management is to
maximize shareholder value.
What are advantages and disadvantages of each legal form of ownership? - ANSSole
proprietorship advantages:
- Easy set up
- No double taxation
- Subject to few government regulations
Sole proprietorship disadvantages:
- Owners have unlimited liability
- Difficult to raise capital
- Low liquidity
- Difficult to transfer ownership
Partnership advantages:
- Easy set up
- No double taxation
Partnership disadvantages:
- Owners have unlimited liability
- Difficult to raise capital
Corporation advantages:
- Limited liability
- Easy to raise capital
- High liquidity
Corporation disadvantages:
- Double taxation
- Difficult to start
S Corp advantages:
- Limited liability
- No double taxation
- Can reduce self-employment taxes
S Corp disadvantages:
- Difficult to start
LLC advantages:
- Limited liability
- No double taxation
, LLC disadvantages:
- Low liquidity
- More difficult to set up than a sole proprietorship or a partnership
What is the role of the board of directors in corporate governance? - ANSThe BoD makes
decisions that represent the interests of shareholders. They are responsible for appointing and
monitoring the executive board in order to ensure that the executive board acts in the interests
of shareholders.
What is the agency problem in corporations and how can you mitigate it? - ANSThe agency
problem is the possibility of conflict of interest between stockholders and management in a
corporation.
To mitigate it firms can:
- Compensate executives in shares, bonuses and stock options. It is important to align the
incentives of managers and shareholders; therefore, compensation should be linked to the
performance of the firm, long term and relative to the industry.
- Fire executives by board or after proxy fight.
- Market for corporate control.
- Regulation.
Can a firm have a negative book value of equity, or a negative market value of equity? - ANS-
Yes, a firm can have a negative book value of equity. For example, if the company has been
losing money consistently and therefore has a declining retained earnings balance, which is a
portion of shareholders' equity, then the firm could have a negative book value of equity.
- No a firm cannot have a negative market value of equity. Market value of equity is calculated
by multiplying a firm's share price by the number of shares outstanding. Because both the share
price and the number of shares outstanding cannot be negative values, market value of equity
cannot be negative.
What is the difference between the average and the marginal tax rate? - ANS- The average tax
rate is the total taxes paid divided by total taxable income. The marginal tax rate is the amount
of tax payable on the next dollar earned. Therefore, the average tax rate is the percentage of
your income that goes to taxes while the marginal tax rate is the rate at which your next dollar is
earned.
What is the purpose of the DuPont identity? - ANSThe DuPont identity is an expression
breaking ROE into 3 parts: operating efficiency, asset use and financial leverage. Therefore, the
purpose of the DuPont identity is to illustrate the relationship between ROE, profit margin, total
asset turnover and the equity multiplier.
What is the difference between the internal and sustainable growth rates, conceptually and
numerically (which one is larger)? - ANS- The internal growth rate is the maximum possible
growth rate a firm can achieve without external financing of any kind, while the sustainable
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