(Test Bank) Essentials of Financial Management

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CHAPTER 01—AN OVERVIEW OF FINANCIAL MANAGEMENT Cengage Learning Testing, Powered by Cognero Page 1 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 1. In most corporations, the CFO ranks under the CEO. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-1 What Is Finance? TOPICS: Role of finance KEYWORDS: Bloom’s: Knowledge 2. The Chairman of the Board must also be the CEO. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-1 What Is Finance? TOPICS: Role of finance KEYWORDS: Bloom’s: Knowledge 3. 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. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-1 What Is Finance? TOPICS: Role of finance KEYWORDS: Bloom’s: Knowledge 4. Partnerships and proprietorships generally have a tax advantage over corporations. a. True b. False ANSWER: True POINTS: 1 CHAPTER 01—AN OVERVIEW OF FINANCIAL MANAGEMENT Cengage Learning Testing, Powered by Cognero Page 2 DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization TOPICS: Forms of organization KEYWORDS: Bloom’s: Knowledge 5. 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. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization TOPICS: Forms of organization KEYWORDS: Bloom’s: Knowledge 6. An advantage of the corporate form of organization is that corporations are generally less highly regulated than proprietorships and partnerships. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization TOPICS: Forms of organization KEYWORDS: Bloom’s: Knowledge 7. Some partners in a partnership may have different rights, privileges, and responsibilities than other partners. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization TOPICS: Forms of organization KEYWORDS: Bloom’s: Knowledge 8. One advantage of the corporate form of organization is that it avoids double taxation. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization TOPICS: Forms of organization CHAPTER 01—AN OVERVIEW OF FINANCIAL MANAGEMENT Cengage Learning Testing, Powered by Cognero Page 3 KEYWORDS: Bloom’s: Knowledge 9. It is generally harder to transfer one's ownership interest in a partnership than in a corporation. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization TOPICS: Forms of organization KEYWORDS: Bloom’s: Knowledge 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. False ANSWER: True POINTS: 1 DIFFICULTY: EASY TOPICS: Forms of organization KEYWORDS: Bloom’s: Knowledge 11. If a corporation elects to be taxed as an S corporation, then it can avoid the corporate tax. However, its stockholders will have to pay personal taxes on the firm's net income. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY TOPICS: Forms of organization KEYWORDS: Bloom’s: Knowledge 12. If a corporation elects to be taxed as an S corporation, then both it and its stockholders can avoid all Federal taxes. This provision was put into the Federal Tax Code in order to encourage the formation of small businesses. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization TOPICS: Forms of organization KEYWORDS: Bloom’s: Knowledge 13. It is generally less expensive to form a corporation than a proprietorship because, with a proprietorship, extensive legal documents are required. CHAPTER 01—AN OVERVIEW OF FINANCIAL MANAGEMENT Cengage Learning Testing, Powered by Cognero Page 4 a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization TOPICS: Forms of organization KEYWORDS: Bloom’s: Knowledge 14. The more capital a firm is likely to require, the greater the probability that it will be organized as a corporation. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization TOPICS: Forms of organization KEYWORDS: Bloom’s: Knowledge 15. One disadvantage of forming a corporation rather than a partnership is that this makes it more difficult for the firm's investors to transfer their ownership interests. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization TOPICS: Forms of organization KEYWORDS: Bloom’s: Knowledge 16. Organizing as a corporation makes it easier for the firm to raise capital. This is because corporations' stockholders are not subject to personal liabilities if the firm goes bankrupt and also because it is easier to transfer shares of stock than partnership interests. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization TOPICS: Forms of organization KEYWORDS: Bloom’s: Knowledge 17. In order to maximize its shareholders' value, a firm's management must attempt to maximize the stock price in the long run, or the stock's "intrinsic value." a. True CHAPTER 01—AN OVERVIEW OF FINANCIAL MANAGEMENT Cengage Learning Testing, Powered by Cognero Page 5 b. False ANSWER: True POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-4 The Main Financial Goal: Creating Value for Investors TOPICS: Intrinsic values KEYWORDS: Bloom’s: Knowledge 18. If management operates in a manner designed to maximize the firm's expected profits for the current year, this will also maximize the stockholders' wealth as of the current year. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-4 The Main Financial Goal: Creating Value for Investors TOPICS: Intrinsic values KEYWORDS: Bloom’s: Knowledge 19. In order to maximize its shareholders' value, a firm's management must attempt to maximize the expected EPS. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-7 Balancing Shareholder Interests and the Interests of Society TOPICS: Shareholder interests KEYWORDS: Bloom’s: Knowledge 20. In order to maximize its shareholders' value, a firm's management must attempt to maximize the stock price on a specific target date. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-7 Balancing Shareholder Interests and the Interests of Society TOPICS: Shareholder interests KEYWORDS: Bloom’s: Knowledge 21. As a result of financial scandals occurring during the past decade, there has been a strong push to improve business ethics. a. True b. False ANSWER: True CHAPTER 01—AN OVERVIEW OF FINANCIAL MANAGEMENT Cengage Learning Testing, Powered by Cognero Page 6 POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-8 Business Ethics TOPICS: Business ethics KEYWORDS: Bloom’s: Knowledge 22. There are many types of unethical business behavior. One example is where executives provide information that they know is incorrect to banks and to stockholders. It is illegal to provide such information to banks, but it is not illegal to provide it to stockholders because they are the owners of the firm, not outsiders. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-8 Business Ethics TOPICS: Business ethics KEYWORDS: Bloom's: Comprehension 23. A stock's market price would equal its intrinsic value if all investors had all the information that is available about the stock. In this case the stock's market price would equal its intrinsic value. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 1-4 The Main Financial Goal: Creating Value for Investors TOPICS: Intrinsic values KEYWORDS: Bloom's: Comprehension 24. If a stock's market price is above its intrinsic value, then the stock can be thought of as being undervalued, and it would be a good buy. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 1-4 The Main Financial Goal: Creating Value for Investors TOPICS: Intrinsic values KEYWORDS: Bloom's: Comprehension 25. If a stock's intrinsic value is greater than its market price, then the stock is overvalued and should be sold. a. True b. False ANSWER: False POINTS: 1 CHAPTER 01—AN OVERVIEW OF FINANCIAL MANAGEMENT Cengage Learning Testing, Powered by Cognero Page 7 DIFFICULTY: MODERATE REFERENCES: 1-4 The Main Financial Goal: Creating Value for Investors TOPICS: Intrinsic values KEYWORDS: Bloom's: Comprehension 26. For a stock to be in equilibrium as the book defines it, its market price should exceed its intrinsic value. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 1-4 The Main Financial Goal: Creating Value for Investors TOPICS: Intrinsic values KEYWORDS: Bloom’s: Knowledge 27. The term "marginal investor" means an investor who is active in the market and would tend to buy a stock if its price fell and sell it if it rose, barring any new information coming out about the stock. It is the "marginal investor" who determines the actual stock price. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 1-4 The Main Financial Goal: Creating Value for Investors TOPICS: Intrinsic values KEYWORDS: Bloom’s: Knowledge 28. Managers always attempt to maximize the long-run value of their firms' stocks, or the stocks' intrinsic values. This is exactly what stockholders desire. Thus, conflicts between stockholders and managers are not possible. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 1-5 Stockholder-Manager Conflicts TOPICS: Stockholder/manager conflicts KEYWORDS: Bloom's: Comprehension 29. A hostile takeover is said to occur when another corporation or group of investors gains voting control over a firm and replaces the old managers. If the old managers were managing the firm inefficiently, then hostile takeovers can improve the economy. However, hostile takeovers are controversial, and legislative actions have been taken to make them more difficult to undertake. a. True b. False ANSWER: True CHAPTER 01—AN OVERVIEW OF FINANCIAL MANAGEMENT Cengage Learning Testing, Powered by Cognero Page 8 POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 1-5 Stockholder-Manager Conflicts TOPICS: Stockholder/manager conflicts KEYWORDS: Bloom's: Comprehension 30. If a lower level person in a firm does something illegal, like "cooking the books," to understate costs and thereby increase profits above the correct profits because he or she was told to do so by a superior, the lower level person cannot be prosecuted but the superior can be prosecuted. a. True b. False ANSWER: False POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 1-8 Business Ethics TOPICS: Business ethics KEYWORDS: Bloom's: Comprehension 31. If someone deliberately understates costs and thereby increases profits, this can cause the stock price to rise above its intrinsic value. The stock price will probably fall in the future. Also, those who participated in the fraud can be prosecuted, and the firm itself can be penalized. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 1-8 Business Ethics TOPICS: Business ethics KEYWORDS: Bloom's: Comprehension 32. If a firm's board of directors wants to maximize value for its stockholders in general (as opposed to some specific stockholders), it should design an executive compensation system whose focus is on the firm's long-term value. a. True b. False ANSWER: True POINTS: 1 DIFFICULTY: CHALLENGING REFERENCES: 1-4 The Main Financial Goal: Creating Value for Investors TOPICS: Intrinsic values KEYWORDS: Bloom's: Comprehension Multiple Choice: Conceptual Please note that some of the answer choices, or answers that are very close, are used in different questions. This has caused us no difficulties, but please take this into account when you make up exams. CHAPTER 01—AN OVERVIEW OF FINANCIAL MANAGEMENT Cengage Learning Testing, Powered by Cognero Page 9 33. Which of the following statements is CORRECT? a. One of the disadvantages of incorporating your business is that you could become subject to the firm's liabilities in the event of bankruptcy. b. Proprietorships are subject to more regulations than corporations. c. In any partnership, every partner has the same rights, privileges, and liability exposure as every other partner. d. Corporations of all types are subject to the corporate income tax. e. Proprietorships and partnerships generally have a tax advantage over corporations. ANSWER: e RATIONALE: Some corporations (S corporations) are able to avoid the corporate income tax. Proprietorships and partnerships pay personal income tax, but they avoid the corporate income tax. POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization TOPICS: Forms of organization KEYWORDS: Bloom’s: Knowledge OTHER: Multiple Choice: Conceptual 34. Which of the following statements is CORRECT? a. One of the advantages of the corporate form of organization is that it avoids double taxation. b. It is easier to transfer one's ownership interest in a partnership than in a corporation. c. One of the disadvantages of a proprietorship is that the proprietor is exposed to unlimited liability. 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." e. Corporations of all types are subject to the corporate income tax. ANSWER: c POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization TOPICS: Forms of organization KEYWORDS: Bloom’s: Knowledge OTHER: Multiple Choice: Conceptual 35. Which of the following statements is CORRECT? a. One advantage of forming a corporation is that equity investors are usually exposed to less liability than they would be in a partnership. b. Corporations face fewer regulations than proprietorships. c. One disadvantage of operating a business as a proprietor is that the firm is subject to double taxation, because taxes are levied at both the firm level and the owner level. d. It is generally less expensive to form a corporation than a proprietorship because, with a proprietorship, extensive legal documents are required. e. If a partnership goes bankrupt, each partner is exposed to liabilities only up to the amount of his or her investment in the business. ANSWER: a RATIONALE: Corporations have limited liability; however, they face more regulations than the other forms of organization. Proprietorships do not pay corporate taxes. CHAPTER 01—AN OVERVIEW OF FINANCIAL MANAGEMENT Cengage Learning Testing, Powered by Cognero Page 10 POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization TOPICS: Forms of organization KEYWORDS: Bloom’s: Knowledge OTHER: Multiple Choice: Conceptual 36. Relaxant Inc. operates as a partnership. Now the partners have decided to convert the business into a corporation. Which of the following statements is CORRECT? a. Relaxant's shareholders (the ex-partners) will now be exposed to less liability. b. The company will probably be subject to fewer regulations and required disclosures. c. Assuming the firm is profitable, none of its income will be subject to federal income taxes. d. The firm's investors will be exposed to less liability, but they will find it more difficult to transfer their ownership. e. The firm will find it more difficult to raise additional capital to support its growth. ANSWER: a POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization TOPICS: Forms of organization KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual 37. Which of the following statements is CORRECT? a. Corporations generally face fewer regulations than proprietorships. b. Corporate shareholders are exposed to unlimited liability. c. It is usually easier to transfer ownership in a corporation than in a partnership. d. Corporate shareholders are exposed to unlimited liability, but this factor is offset by the tax advantages of incorporation. e. There is a tax disadvantage to incorporation, and there is no way any corporation can escape this disadvantage, even if it is very small. ANSWER: c RATIONALE: If ownership in a proprietorship or partnership is transferred, the basic documents under which the firm operates must be rewritten, whereas for a corporation the seller simply sells shares to a buyer. POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization TOPICS: Forms of organization KEYWORDS: Bloom’s: Knowledge OTHER: Multiple Choice: Conceptual 38. Which of the following could explain why a business might choose to operate as a corporation rather than as a proprietorship or a partnership? a. Corporations generally face fewer regulations. b. Less of a corporation's income is generally subject to federal taxes. CHAPTER 01—AN OVERVIEW OF FINANCIAL MANAGEMENT Cengage Learning Testing, Powered by Cognero Page 11 c. Corporate shareholders are exposed to unlimited liability, but this factor is offset by the tax advantages of incorporation. d. Corporate investors are exposed to unlimited liability. e. Corporations generally find it easier to raise large amounts of capital. ANSWER: e RATIONALE: Outsiders thinking about investing in a business are generally not willing to be subjected to unlimited liability, and they also want to be able to sell their shares should they choose to do so. Corporations provide these advantages; hence, firms that need large amounts of capital that must be raised in capital markets generally choose to incorporate. POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-3 Forms of Business Organization TOPICS: Forms of organization KEYWORDS: Bloom’s: Knowledge OTHER: Multiple Choice: Conceptual 39. The primary operating goal of a publicly-owned firm interested in serving its stockholders should be to a. Maximize its expected total corporate income. b. Maximize its expected EPS. c. Minimize the chances of losses. d. Maximize the stock price per share over the long run, which is the stock's intrinsic value. e. Maximize the stock price on a specific target date. ANSWER: d RATIONALE: The primary operating goal should be to maximize the long-run stock price, or the intrinsic value. POINTS: 1 DIFFICULTY: EASY REFERENCES: 1-4 The Main Financial Goal: Creating Value for Investors TOPICS: Intrinsic values KEYWORDS: Bloom’s: Knowledge OTHER: Multiple Choice: Conceptual 40. Which of the following statements is CORRECT? a. In most corporations, the CFO ranks above the CEO. b. By law in most states, the chairman of the board must also be the CEO. c. 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. d. The CFO generally reports to the firm's chief accounting officer, who is normally the controller. e. The CFO is responsible for raising capital and for making sure that capital expenditures are desirable, but he or she is not responsible for the validity of the financial statements, as the controller and the auditors have that responsibility. ANSWER: c POINTS: 1 CHAPTER 01—AN OVERVIEW OF FINANCIAL MANAGEMENT Cengage Learning Testing, Powered by Cognero Page 12 DIFFICULTY: MODERATE REFERENCES: 1-1 What Is Finance? TOPICS: Role of finance KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual 41. Which of the following statements is CORRECT? a. One drawback of forming a corporation is that it generally subjects the firm to additional regulations. b. One drawback of forming a corporation is that it subjects the firm's investors to increased personal liabilities. c. One drawback of forming a corporation is that it makes it more difficult for the firm to raise capital. d. One advantage of forming a corporation is that it subjects the firm's investors to fewer taxes. e. One disadvantage of forming a corporation is that it is more difficult for the firm's investors to transfer their ownership interests. ANSWER: a RATIONALE: Corporations have to do more reporting to state and federal agencies than other businesses. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 1-3 Forms of Business Organization TOPICS: Forms of organization KEYWORDS: Bloom’s: Knowledge OTHER: Multiple Choice: Conceptual 42. Which of the following statements is CORRECT? a. If a corporation elects to be taxed as an S corporation, then both it and its stockholders can avoid all Federal taxes. This provision was put into the Federal Tax Code in order to encourage the formation of small businesses. b. The more capital a firm is likely to require, the smaller the probability that it will be organized as a corporation. c. It is generally easier to transfer one's ownership interest in a partnership than in a corporation. d. 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. e. Corporate shareholders are exposed to unlimited liability, but this factor is offset by the tax advantages of incorporation. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 1-3 Forms of Business Organization TOPICS: Forms of organization KEYWORDS: Bloom’s: Knowledge OTHER: Multiple Choice: Conceptual 43. Which of the following statements is CORRECT? a. Due to limited liability, unlimited lives, and ease of ownership transfer, the vast majority of U.S. businesses (in terms of number of businesses) are organized as corporations. b. Most businesses (by number and total dollar sales) are organized as proprietorships or partnerships because it CHAPTER 01—AN OVERVIEW OF FINANCIAL MANAGEMENT Cengage Learning Testing, Powered by Cognero Page 13 is easier to set up and operate one of these forms rather than as a corporation. However, if the business gets very large, it becomes advantageous to convert to a corporation, primarily because corporations have important tax advantages over proprietorships and partnerships. c. Due to legal considerations related to ownership transfers and limited liability, which affect the ability to attract capital, most business (measured by dollar sales) is conducted by corporations in spite of large corporations' less favorable tax treatment. d. Large corporations are taxed more favorably than proprietorships. e. Corporate stockholders are exposed to unlimited liability. ANSWER: c POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 1-3 Forms of Business Organization TOPICS: Forms of organization KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual 44. Which of the following statements is CORRECT? a. A hostile takeover is the main method of transferring ownership interest in a corporation. b. A corporation is a legal entity created by a state, and it has a life and existence that is separate from the lives and existence of its owners and managers. c. Unlimited liability and limited life are two key advantages of the corporate form over other forms of business organization. d. Limited liability is an advantage of the corporate form of organization to its owners (stockholders), but corporations have more trouble raising money in financial markets because of the complexity of this form of organization. e. Although the stockholders of the corporation are insulated by limited legal liability, the legal status of the corporation does not protect the firm's managers in the same way, i.e., bondholders can sue the firm's managers if the firm defaults on its debt. ANSWER: b POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 1-3 Forms of Business Organization KEYWORDS: Bloom’s: Knowledge OTHER: Multiple Choice: Conceptual 45. Which of the following statements is CORRECT? a. In a typical partnership, liability for other partners' misdeeds is limited to the amount of a particular partner's investment in the business. b. In a limited partnership, the limited partners have voting control, while the general partner has operating control over the business, and the limited partners are individually responsible, on a pro rata basis, for the firm's debts in the event of bankruptcy. c. A slow-growth company, with little need for new capital, would be more likely to organize as a corporation than would a faster growing company. d. Partnerships have more difficulty attracting large amounts of capital than corporations because of such factors as unlimited liability, the need to reorganize when a partner dies, and the illiquidity (difficulty buying and selling) of partnership interests. e. A major disadvantage of a partnership relative to a corporation is the fact that federal income taxes must be CHAPTER 01—AN OVERVIEW OF FINANCIAL MANAGEMENT Cengage Learning Testing, Powered by Cognero Page 14 paid by the partners rather than by the firm itself. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 1-3 Forms of Business Organization TOPICS: Partnership form KEYWORDS: Bloom’s: Knowledge OTHER: Multiple Choice: Conceptual 46. The primary operating goal of a publicly-owned firm trying to best serve its stockholders should be to a. Maximize managers' own interests, which are by definition consistent with maximizing shareholders' wealth. b. Maximize the firm's expected EPS, which must also maximize the firm's price per share. c. Minimize the firm's risks because most stockholders dislike risk. In turn, this will maximize the firm's stock price. d. Use a well-structured managerial compensation package to reduce conflicts that may exist between stockholders and managers. e. Since it is impossible to measure a stock's intrinsic value, the text states that it is better for managers to attempt to maximize the current stock price than its intrinsic value. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 1-4 The Main Financial Goal: Creating Value for Investors TOPICS: Value and compensation KEYWORDS: Bloom’s: Knowledge OTHER: Multiple Choice: Conceptual 47. Which of the following actions would be most likely to reduce potential conflicts of interest between stockholders and managers? a. Pay managers large cash salaries and give them no stock options. b. Change the corporation's formal documents to make it easier for outside investors to acquire a controlling interest in the firm through a hostile takeover. c. Beef up the restrictive covenants in the firm's debt agreements. d. Eliminate a requirement that members of the board of directors must hold a high percentage of their personal wealth in the firm's stock. e. For a firm that compensates managers with stock options, reduce the time before options are vested, i.e., the time before options can be exercised and the shares that are received can be sold. ANSWER: b RATIONALE: Corporate takeovers are most likely to occur when a firm is underperforming. Managers who fear losing their jobs will try to maximize shareholder wealth. POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 1-5 Stockholder-Manager Conflicts TOPICS: Stockholder/manager conflicts KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual CHAPTER 01—AN OVERVIEW OF FINANCIAL MANAGEMENT Cengage Learning Testing, Powered by Cognero Page 15 48. Which of the following actions would be likely to reduce potential conflicts of interest between stockholders and managers? a. Congress passes a law that severely restricts hostile takeovers. b. A firm's compensation system is changed so that managers receive larger cash salaries but fewer long-term options to buy stock. c. The company changes the way executive stock options are handled, with all options vesting after 2 years rather than having 20% of the options awarded vest every 2 years over a 10-year period. d. The company's outside auditing firm is given a lucrative year-by-year consulting contract with the company. e. The composition of the board of directors is changed from all inside directors to all outside directors, and the directors are compensated with stock rather than cash. ANSWER: e POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 1-5 Stockholder-Manager Conflicts TOPICS: Stockholder/manager conflicts KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual 49. Which of the following mechanisms would be most likely to help motivate managers to act in the best interests of shareholders? a. Decrease the use of restrictive covenants in bond agreements. b. Take actions that reduce the possibility of a hostile takeover. c. Elect a board of directors that allows managers greater freedom of action. d. Increase the proportion of executive compensation that comes from stock options and reduce the proportion that is paid as cash salaries. e. Eliminate a requirement that members of the board of directors have a substantial investment in the firm's stock. ANSWER: d POINTS: 1 DIFFICULTY: MODERATE REFERENCES: 1-5 Stockholder-Manager Conflicts TOPICS: Stockholder/manager conflicts KEYWORDS: Bloom's: Comprehension OTHER: Multiple Choice: Conceptual 50. Which of the following actions would be likely to encourage a firm's managers to make decisions that are in the best interests of shareholders? a. The percentage of executive compensation that comes in the form of cash is increased and the percentage coming from long-term stock options is reduced. b. The state legislature passes a law that makes it more difficult to successfully complete a hostile takeover. c. The percentage of the firm's stock that is held by institutional investors such as mutual funds, pension funds, and hedge funds rather than by small individual investors rises from 10% to 80%. d. The firm's founder, who is also president and chairman of the board, sells 90% of her shares. e. The firm's board of directors gives the firm's managers greater freedom to take whatever actions they think best without obtaining board approval. ANSWER: c