Course name: Foundations of Financial Management (10248) – Fall I, 2013
Assignment name: Week 1 Questions
1. Suppose the U.S. Treasury announces plans to issue $50 billion of new bonds. Assuming the announcement was not expected, what effect, other things held constant, would that have on bond prices and interest rates?
a. There would be no changes in either prices or interest rates.
b. Prices would decline and interest rates would rise.
c. Prices and interest rates would both rise.
d. Prices would rise and interest rates would decline.
e. Prices and interest rates would both decline.
2. Which of the following statements is CORRECT?
a. Shareholders in a regular corporation (not an S corporation) pay higher taxes than owners of an otherwise identical proprietorship.
b. Corporate shareholders are exposed to unlimited liability.
c. Corporations generally face fewer regulations than sole proprietorships.
d. Corporate shareholders are exposed to unlimited liability, and this factor may be compounded by the tax disadvantages of incorporation.
e. It is usually easier to transfer ownership in a corporation than it is to transfer ownership in a sole proprietorship.
3. Jane Doe, who has substantial personal wealth and income, is considering the possibility of starting a new business in the chemical waste management field. She will be the sole owner, and she has enough funds to finance the operation. The business will have a relatively high degree of risk, and it is expected that the firm will incur losses for the first few years. However, the prospects for growth and positive future income look good, and Jane plans to have the firm pay out all of its income as dividends to her once it is well established. Which of the legal forms of business organization would probably best suit her needs?
a. Regular corporation, because of the limited liability.
b. Partnership, but only if she needs additional capital.
c. S corporation, to gain some tax advantages and also to obtain limited liability.
d. In this situation, the various forms of organization seem equally desirable.
e. Proprietorship, because of ease of entry.
4. Which of the following statements is CORRECT?
a. Sole proprietorships and partnerships generally have a tax advantage over many corporations, especially large ones.
b. Sole proprietorships are subject to more regulations than corporations.
c. One of the disadvantages of incorporating a business is that the owners then become subject to liabilities in the event the firm goes bankrupt.
d. Corporations of all types are subject to the corporate income tax.
e. In any type of partnership, every partner has the same rights, privileges, and liability exposure as every other partner.
5. Which of the following statements is CORRECT?
a. A fast-growth company would be more likely to set up as a partnership for its business organization than would a slow-growth company.
b. Corporations are at a disadvantage relative to partnerships because they have to file more reports to state and federal agencies, including the Securities and Exchange Administration, even if they are not publicly owned.
c. Partnerships have difficulty attracting capital in part because of their unlimited liability, the lack of impermanence of the organization, and difficulty in transferring ownership.
d. A major disadvantage of a partnership relative to a corporation as a form of business organization is the high cost and practical difficulty of its formation.
e. In a regular partnership, liability for the firm’s debts is limited to the amount a particular partner has invested in the business.
6. Which of the following statements is CORRECT?
a. While the distinctions are blurring as investment banks are today buying commercial banks, and vice versa, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise capital from other parties.
b. Consumer automobile loans are evidenced by legal documents called “promissory notes,” and these individual notes are traded in the money market.
c. Capital market transactions involve only the purchase and sale of equity securities, i.e., common stocks.
d. The New York Stock Exchange is an auction market with a physical location.
e. If an investor sells shares of stock through a broker, then this would be a primary market transaction.
7. Which of the following is a primary market transaction?
a. You sell 200 shares of IBM stock on the NYSE through your broker.
b. IBM issues 2,000,000 shares of new stock and sells them to the public through an investment banker.
c. You buy 200 shares of IBM stock from your brother. The trade is not made through a broker?you just give him cash and he gives you the stock.
d. One financial institution buys 200,000 shares of IBM stock from another institution. An investment banker arranges the transaction.
e. You invest $10,000 in a mutual fund, which then uses the money to buy $10,000 of IBM shares on the NYSE.
8. Which of the following statements is CORRECT?
a. 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.
b. Potential agency problems can arise between stockholders and managers, because managers hired as agents to act on behalf of the owners may instead make decisions favorable to themselves rather than the stockholders.
c. The proper goal of the financial manager should be to attempt to maximize the firm’s expected cash flows, because this will add the most to the wealth of the individual shareholders.
d. 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.
e. Large, publicly-owned firms like AT&T and GM are controlled by their management teams. Ownership is generally widely dispersed, hence managers have great freedom in how they manage the firm. Managers may operate in stockholders’ best interests, but they may also operate in their own personal best interests. As long as managers stay within the law, there is no way to either force or motivate them to act in the stockholders’ best interests.
9. Which of the following would be most likely to lead to higher interest rates on all debt securities in the economy?
a. Households start saving a larger percentage of their income.
b. The level of inflation begins to decline.
c. The economy moves from a boom to a recession.
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.
10. Which of the following could explain why a business might choose to operate as a corporation rather than as a sole proprietorship or a partnership?
a. 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.
b. Corporations generally face relatively few regulations.
c. Corporate investors are exposed to unlimited liability.
d. Corporations generally find it relatively difficult to raise large amounts of capital.
e. Less of a corporation’s income is generally subjected to taxes than would be true if the firm were a partnership.