Multiple Choice Questions (Circle the correct answer)
1) Joe is deciding whether or not to invest $10,000 in a business that has pending law- suits against it. If Joe invests and the business loses the lawsuits, the most Joe can lose is
a. $10,000 plus his share of the lawsuits if Joe is a limited partner. b. $10,000 if Joe is a limited partner. c. $10,000 if Joe is a general partner. d. $10,000 is Joe is a sole proprietor.
2) Which of the following statements about the corporate form of business organization is true?
a. The corporate form has the disadvantage of double taxation relative to a sole propri- etorship. b. The corporate form is preferred over the sole proprietorship because a corporation is easier to form and faces less regulation. c. The corporate form has the advantage of unlimited liability. d. Sole proprietorships are the most common form of business organization because li- ability is limited to the amount invested in the business by the sole proprietor.
3) Which of the following categories of owners have unlimited liability?
a. general partners in a limited partnership b. sole proprietors c. shareholders of a corporation d. both A and B
4) A corporation has an average tax rate of 25% and a marginal tax rate of 39%. The corporation can invest in a tax-free project with an expected before-tax return of 6.8% or in a taxable project with an expected before-tax return of 10%. The corpora- tion should
a. Invest in the taxable project because the return is greater. b. Be indifferent between the two investments because the after-tax returns are the same. c. Invest in the tax-free project because the after-tax return is greater. d. Invest in the taxable project because the after-tax return is greater.
5) When evaluating an investment project, which of the following best describes the financial information needed by the decision maker?
a. After-tax accounting profits b. Pre-tax accounting profits adjusted for any accounting method changes c. After-tax incremental cash flows to the company as a whole d. Incremental cash flows before taxes so the decision will not be biased by a tax code that may change in the future
Self Test
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Introduction to Financial Management
6) A corporation may normally exclude what percentage of dividend income received from another corporation?
a. 70% b. 30% c. 35% d. 50%
7) Company A reports sales of $100,000 and net income of $15,000. Company B re- ports sales of $100,000 and net income of $10,000. Therefore:
a. Company A’s cash flow is $5,000 more than Company B’s cash flow. b. Company B is creating less value for its shareholders than Company A. c. Company A’s cash flow may be higher or lower than Company B’s cash flow even though A’s net income is higher. d. Company B’s accounts receivable must be higher than Company A’s accounts receiv- able.
8) Profits are down so the controller decides to change the corporation’s accounting policy relating to inventory costing. The change will allow the corporation to report higher income and higher assets, although the physical inventory has not changed. Which of the following statements is most correct?
a. If the stock price increases, the stock market is efficient. b. The stock price is likely to decrease because reported inventory is higher. c. The stock price is likely to increase because income is higher. d. The stock price is likely to be unaffected because the stock market is efficient.
9) John invested $1,000 in a risky investment and Bill invested $1,000 in a less risky investment. One year later, Bill’s investment is worth $1,030. Which of the following statements is most correct?
a. If John’s investment is worth more than $1,030, then Bill was irrational to invest in the less risky investment. b. If John’s investment is worth less than $1,030, then John was irrational to invest in the risky project. c. John’s investment must be worth more than $1,030 because of the risk-return tradeoff, given that John’s investment was more risky. d. The worth of John’s investment cannot be determined with the information given.
10) High Tech Corp. cut its research and development budget in 2008 by $4,000,000 in order to improve its cash flow for the year. Which of the following statements is most correct? a. The change will have no impact on stock price because the company’s profits will not change in 2008.
Self Test
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Introduction to Financial Management
b. The stock price will increase only if reported profits in 2009 are also higher than profits reported in 2007. c. The stock price will likely increase because the value of stock is based on reported cash flow. d. The stock price may decrease because investors may predict that future cash flows will decrease due to the lack of innovation and new products.