CHAPTER1

The primary operating goal of a publicly-owned firm trying to best serve its stockholders should be to
Answer
Use a well-structured managerial compensation package to reduce conflicts that may exist between stockholders and managers.
In most corporations, the CFO ranks under the CEO.
True
Which of the following statements is CORRECT?
One advantage of forming a corporation is that equity investors are usually exposed to less liability than they would be in a partnership
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.
Answer
TRUE
The more capital a firm is likely to require, the greater the probability that it will be organized as a corporation
TRUE
Some partners in a partnership may have different rights, privileges, and responsibilities than other partners.
Answer
TRUE
In order to maximize its shareholders’ value, a firm’s management must attempt to maximize the expected EPS
FALSE
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
TRUE
Which of the following statements is CORRECT?
It is usually easier to transfer ownership in a corporation than in a partnership
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
TRUE
Partnerships and proprietorships generally have a tax advantage over corporations.
Answer
TRUE
New Business is just being formed by 10 investors, each of whom will own 10% of the business. The firm is expected to earn $1,000,000 before taxes each year. The corporate tax rate is 34% and the personal tax rate for the firm’s investors is 35%. The firm does not need to retain any earnings, so all of its after-tax income will be paid out as dividends to its investors. The investors will have to pay personal taxes on whatever they receive. How much additional spendable income will each investor have if the business is organized as a partnership rather than as a corporation?
Answer
22,100
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.
FALSE
Which of the following statements is CORRECT?
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
Which of the following statements is CORRECT?
Answer
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.
Which of the following statements is CORRECT?
Since bondholders receive fixed payments, they do not share in the gains if risky projects turn out to be highly successful. However, they do share in the losses if risky projects fail and drive the firm into bankruptcy. Therefore, bondholders generally prefer to see corporate managers invest in low risk/low return projects rather than high risk/high return projects
Which of the following actions would be likely to reduce potential conflicts of interest between stockholders and managers?
Answer
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
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
FALSE
Which of the following mechanisms would be most likely to help motivate managers to act in the best interests of shareholders?
Increase the proportion of executive compensation that comes from stock options and reduce the proportion that is paid as cash salaries.
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?
Relaxant’s shareholders (the ex-partners) will now be exposed to less liability