Principles of Managerial Finance, 14e, Global Edition (Gitman/Zutter)

Chapter 1 The Role of Managerial Finance

1.1 Define finance and the managerial finance function.

1) A financial analyst is responsible for maintaining and controlling a firm's daily cash balances.

2) Finance is concerned with the process institutions, markets, and instruments involved in the
transfer of money among and between individuals, businesses, and government.

3) Financial managers administer the financial affairs of all types of businesses such as private
and public, large and small, and profit seeking and not for profit.

4) Financial managers perform different tasks developing a financial plan or budget, extending
credit to customers, evaluating proposed large expenditures, and raising money to fund a firm's
operations.

5) A capital expenditures analyst/manager is responsible for the evaluation and recommendation

of proposed asset investments.

6) A controller administers a firm's credit policy by analyzing or managing the evaluation of

credit applications, extending credit, and monitoring and collecting accounts receivable.

7) In large companies, CEOs are legally responsible for coordinating the assets and liabilities of
the employees' pension fund.

8) A controller typically handles the accounting activities, such as tax management, data
processing, financial accounting, and cost accounting
.
9) Managerial finance is concerned with design and delivery of advice and financial products to
individuals, businesses, and governments.

10) ________ is concerned with design and delivery of advice and financial products to
individuals, businesses, and governments.
A) Managerial finance
B) Auditing services
C) Financial services
D) Cost accounting

11) Managerial finance ________.

A) involves tasks such as budgeting, financial forecasting, cash management, and funds
procurement
B) involves the design and delivery of advice and financial products
C) recognizes funds on an accrual basis
D) devotes the majority of its attention to the collection and presentation of financial data

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12) Finance is ________.
A) the system of verifying, analyzing, and recording business transactions
B) the science of the production, distribution, and consumption of goods and services
C) the art and science of managing money
D) the art of merchandising products and services

13) Which of the following is an area of career opportunities in financial services?

A) supply chain management
B) personal financial planning
C) auditing of financial statements
D) production planning

14) Which of the following is an area of career opportunities in managerial finance?

A) investment
B) real estate and insurance
C) capital expenditures management
D) personal financial planning

15) Which of the following is a duty of a financial manager in a business firm?

A) developing marketing plans
B) controlling the stock price
C) raising financial resources
D) auditing financial records

16) A ________ is responsible for evaluating and recommending proposed long-term

investments.
A) financial analyst
B) credit manager
C) pension fund manager
D) capital expenditures manager

1.2 Describe the legal forms of business organization.

1) In partnerships, owners have unlimited liability and may have to cover debts of other less
financially sound partners.

2) In partnerships, partners can readily transfer their wealth to other partners.

3) A sole proprietor has unlimited liability; his or her total investment in the business, but not his
or her personal assets, can be taken to satisfy creditors.
4) In a limited partnership, all partners' liabilities are limited to their investment in the
partnership.
5) A treasurer is responsible for the firm's accounting activities, such as corporate accounting, tax
management, financial accounting, and cost accounting.

6) Which of the following legal forms of organization is most expensive to organize?

A) sole proprietorships
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B) partnerships
C) corporations
D) limited partnership

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7) Which of the following legal forms of organization has the ease of dissolution?
A) sole proprietorships
B) partnerships
C) limited partnerships
D) corporations

8) Under which of the following legal forms of organization is ownership readily transferable?
A) sole proprietorships
B) partnerships
C) limited partnerships
D) corporations
9) Which of the following forms of organizations is the easiest to form?
A) sole proprietorships
B) limited liability corporation
C) limited partnership
D) S-corporations

10) A major weakness of a partnership is ________.

A) the difficulty in maintaining owners' control
B) the difficulty in liquidating or transferring ownership
C) the double taxation of income
D) its high organizational costs

11) Which of the following is a strength of a corporation?

A) low taxes
B) limited liability
C) low organization costs
D) less government regulation

12) Which of the following legal forms of organizations is characterized by unlimited liability?
A) sole proprietorship
B) limited partnership
C) corporation
D) C-corporation

13) Which of the following is the purest and most basic form of corporate ownership?
A) bond
B) notes
C) common stock
D) preferred stock

14) Which of the following is true of a partnership and a corporation?

A) In a corporation, income is taxed at the corporate level; whereas, in a partnership, income is
taxed twice.
B) In a partnership, income is taxed at the corporate level; whereas, in a corporation, income is
taxed twice.
C) Income from both forms of organizations are double-taxed.
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D) In a partnership, income is exempted from tax up to $10 million; whereas, in a corporation,
income is taxed twice.

15) Which of the following is true of sole proprietorships and corporations?

A) It is difficult to transfer ownership of corporations compared to that of sole proprietorships.
B) Income from both forms of organizations are taxed only at the corporate level.
C) Both sole proprietorships and corporations are equally scrutinized and regulated by
government bodies.
D) In sole proprietorships, owners have unlimited liability; whereas, in corporations, owners
have limited liability.

1.3 Describe the goal of the firm, and explain why maximizing the value of the firm is an
appropriate goal for a business.

1) High net cash flow with fixed risk is generally associated with a higher share price.
2) When considering a firm's financial decision alternative, financial managers should accept
only those actions that are expected to increase the firm's profitability.
3) To achieve the goal of profit maximization for each alternative being considered, a financial
manager would select the one that is expected to result in the highest return.
4) Dividend payments change directly with changes in earnings per share.
5) The wealth of corporate owners is measured by the share price of the stock.

6) Risk, the magnitude and timing of cash flows are the key determinants of share price, which
represent the wealth of the owners in the firm.

7) A higher earnings per share (EPS) does not necessarily translate into a higher stock price.

8) The profit maximization goal ignores the timing of returns, does not directly consider cash
flows, and ignores risk.

9) When considering a firm's financial decision alternative, financial managers should accept
only those actions that are expected to maximize shareholder value.

10) An increase in a firm's risk will always result in a higher share price since the stockholder
must be compensated for the greater risk.

11) Stockholders expect to earn higher rates of return on investments with lower risk and lower
rates of return on investments with higher risk.

12) The goal of business ethics is to motivate business and market participants to adhere to both
the letter and the spirit of laws and regulations in all aspects of business and professional
practice.

13) The primary goal of a financial manager is ________.

A) minimizing risk
B) maximizing profit
C) maximizing wealth
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D) minimizing return

14) Corporate owners receive return ________.

A) by realizing gains through increases in share price and interest earnings
B) by realizing gains through increases in share price and cash dividends
C) through capital appreciation and retained earnings
D) through interest earnings and earnings per share

15) The wealth of the owners of a corporation is represented by ________.

A) profits
B) earnings per share
C) share value
D) cash flow
16) Wealth maximization as the goal of a firm implies enhancing the wealth of ________.
A) the auditors
B) the creditors
C) the federal reserve
D) the firm's stockholders

17) The amount earned during the accounting period on each outstanding share of common stock
is called ________.
A) dividend per share
B) earnings per share
C) net profits after taxes
D) book value per share

18) Which of the following is the best measure of profit maximization goal?
A) retained earnings
B) risk of the investment
C) earnings per share
D) timing of the returns

19) Profit maximization as a goal is ideal because it directly considers ________.

A) risk and book value of assets
B) timing and cash flow
C) timing and risk
D) EPS and stock price.

20) Profit maximization as the goal of the firm is not ideal because ________.
A) profits are only accounting measures
B) cash flows are more representative of financial strength
C) profit maximization does not consider risk
D) profits today are less desirable than profits earned in future years

21) Which of the following is a measure of profit maximization to shareholders?

A) the timing of returns
B) earnings per share
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C) current assets
D) market risk premium

22) The key variables in the owner wealth maximization process are ________.
A) market risk premium and risk
B) cash flows and risk
C) risk-free rate and share price
D) total assets and risk

23) Cash flows and risk are the key determinants in share price. Increased cash flow results in
________, other things remaining the same.
A) a lower share price
B) a higher share price
C) an unchanged share price
D) an undetermined share price

24) Cash flows and risk are the key determinants in share price. Increased risk, other things
remaining the same, results in ________.
A) a lower share price
B) a higher share price
C) an unchanged share price
D) an undetermined share price
25) Financial managers evaluating decision alternatives or potential actions must consider
________.
A) only risk
B) only return
C) either risk or return
D) risk, return, and the impact on share price

26) An ethics program is expected to have ________ impact on a firm's share price.
A) a positive
B) a negative
C) no impact
D) an unpredictable

27) Which of the following is true of cash flows and risk?

A) Low cash flow and low risk result in an increase in share price.
B) High cash flow and low risk result in an increase in share price.
C) High cash flow and high risk result in an increase in share price.
D) Lo cash flow and high risk result in an increase in share price.

28) As the risk of a stock investment increases, investors' ________.

A) return will increase
B) return will decrease
C) required rate of return will decrease
D) required rate of return will increase
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29) If the CEO of a company were to pass away, what do you think would happen to price of the
stock?
A) It would decrease because of the perceived increased risk due of lack of near-term leadership.
B) It would increase because of the perceived increased risk due of lack of near-term leadership.
C) It would decrease because of the perceived decreased risk due of lack of near-term leadership.
D) It would increase because of the perceived decreased risk due of lack of near-term leadership.
30) Which of the following is true of a cash flow?
A) Profits do not necessarily result in cash flows available to the stockholders.
B) It is guaranteed that the board of directors will increase dividends when net cash flows
increase.
C) A firm's income statement will never show a positive profit when its cash outflows exceed its
cash inflows.
D) An increase in revenue will always result in an increase in cash flow.

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31) A financial manager must choose between four alternative Assets: 1, 2, 3, and 4. Each asset
costs $35,000 and is expected to provide earnings over a three-year period as described below.

Based on the wealth maximization goal, the financial manager would choose ________.
A) Asset 1
B) Asset 2
C) Asset 3
D) Asset 4

32) A financial manager must choose between three alternative investments. Each asset is
expected to provide earnings over a three-year period as described below. Based on the wealth
maximization goal, the financial manager would ________.

A) choose Asset 1
B) choose Asset 2
C) choose Asset 3
D) be indifferent between Asset 1 and Asset 2
33) Which of the following is true of stakeholders?
A) They are the owners of a firm.
B) They are groups to whom a firm has financial obligations.
C) They are groups having a direct economic link to a firm.
D) They include only the bondholders, common stockholders, and preferred stockholders.

34) Which of the following is an example of a firm's stakeholder?

A) suppliers
B) Federal reserve
C) media
D) competitors

35) Which of the following is considered as a violation of business ethics?

A) earnings management
B) repurchase of shares
C) using the call option on a callable bond when the interest rate is low
D) paying a high amount of dividends every year

36) Which of the following is one of the positive benefits of an effective ethics program?
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A) reduce potential litigation and judgment costs
B) maintain and build competitor confidence
C) gain the loyalty, commitment, and respect of the firm's competitors
D) making sure violations are penalized, while at the same time not subjecting the employee to
publicity
37) The implementation of a pro-active ethics program is expected to result in ________.
A) a positive corporate image and increased respect, but is not expected to affect cash flows
B) an increased share price resulting from a decrease in risk, but is not expected to affect cash
flows
C) a positive corporate image and increased respect, but is not expected to affect share price
D) a positive corporate image and increased respect, a reduction in risk, and enhanced cash flow
resulting in an increase in share price
38) An effective ethics program ________.
A) can weaken corporate value
B) has no effect on a corporation's value
C) can enhance a corporation's value
D) will result in high employee attrition rate
39) Corporate ethics policies typically apply to ________ in dealing with ________.
A) employee actions; customers and creditors
B) employee actions; customers, vendors, and regulators
C) management actions; all corporate constituents
D) employee actions; all corporate constituents
1.4 Describe how the managerial finance function is related to economics and accounting.

1) Marginal cost-benefit analysis states that financial decisions should be made and actions
should be taken only when the added benefits exceed the added costs.

2) The treasurer typically manages a firm's cash, investing surplus funds when available and
securing outside financing when needed.

3) A corporate treasurer's focus tends to be more external, while the controller's focus is more
internal.
4) The accrual method recognizes revenue at the point of sale and recognizes expenses when
incurred.
5) A corporate controller is an officer responsible for a firm's financial activities such as financial
planning and fund raising, making capital expenditure decisions, and managing cash, credit, the
pension fund, and foreign exchange.

6) A corporate treasurer typically handles both the cost accounting and financial accounting.
7) The accountant of a firm evaluates financial statements, develops additional data, and makes
decisions based on his or her assessment of the associated returns and risks.

8) The financial manager of a firm prepares financial statements that recognize revenue at the
point of sale and expenses when incurred.
9) Using certain standardized and generally accepted principles, an accountant prepares financial
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statements that recognize revenue at the point of sale and expenses when incurred.
10) The financial manager must look beyond financial statements to obtain insight into
developing or existing problems since the accrual accounting data do not fully describe the
circumstances of a firm.
11) An accountant's primary function is ________.
A) the evaluation of the financial statements
B) making decisions based on financial data
C) the collection and presentation of financial data
D) the planning of cash flows
12) A treasurer is commonly responsible for handling ________.
A) tax management
B) corporate accounting
C) investing surplus funds
D) cost accounting
13) A controller is commonly responsible for ________.
A) managing cash
B) financial accounting
C) managing credit activities
D) financial planning

14) A ________ is responsible for a firm's financial activities such as financial planning and fund
raising, making capital expenditure decisions, and managing cash, credit, the pension fund, and
foreign exchange.
A) treasurer
B) controller
C) foreign exchange manager
D) pension fund manager
15) A ________ is responsible for the firm's accounting activities, such as corporate accounting,
tax management, financial accounting, and cost accounting.
A) treasurer
B) controller
C) foreign exchange manager
D) pension fund manager
Answer: B
16) Which of the following is true of accrual basis accounting?
A) Expenses are recognized either when they are incurred or cash is paid.
B) Revenue is recognized when a customer pays cash.
C) Expenses are recognized when they are incurred.
D) Revenue is recognized when a customer pays cash or shows interest to purchase the product
or service.

17) Which of the e following is true of cash basis accounting?

A) All credit sales will be recorded as revenue.
B) Revenue is recognized when a customer pays cash.
C) Expenses are recognized when they are incurred.
D) Accounts receivable and accounts payable can never be zero.
18) A financial manager is interested in the cash inflows and outflows of a firm, rather than the
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accounting data, in order to ________.
A) ensure profitability
B) maintain healthy public relations
C) ensure timely payment of taxes
D) maintain an optimum solvency level

19) Which of the following is the responsibility of a finance manager?

A) processing purchase orders and invoices
B) ensuring accounts payable are paid on time
C) preparing the monthly income statement
D) analyzing the capital needs of the firm

20) Economic theories that a financial manager must ensure for efficient business operations,
include ________.
A) supply-and-demand analysis
B) asset pricing theory
C) Porter's theory of five forces
D) Monte Carlo simulation
21) The primary economic principle used in managerial finance is ________.
A) purchase power parity
B) asset pricing theory
C) Porter's theory of five forces
D) marginal cost-benefit analysis

22) Johnson, Inc. has just ended the calendar year making a sale in the amount of $10,000 of
merchandise purchased during the year at a total cost of $7,000. Although the firm paid in full
for the merchandise during the year, it is yet to collect at year end from the customer. The net
profit and cash flow from this sale for the year are ________.
A) $3,000 and $10,000, respectively
B) $3,000 and -$7,000, respectively
C) $7,000 and -$3,000, respectively
D) $3,000 and $7,000, respectively
23) A firm has just ended its calendar year making a sale in the amount of $150,000 of
merchandise purchased during the year at a total cost of $112,500. Although the firm paid in full
for the merchandise during the year, it is yet to collect at year end from the customer. The net
profit and cash flow from this sale for the year are ________.
A) $0 and $150,000, respectively
B) $37,500 and -$150,000, respectively
C) $37,500 and -$112,500, respectively
D) $150,000 and $112,500, respectively

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24) ________ is one of the primary responsibilities of a financial manager.
A) Monitoring quarterly tax payments
B) Analyzing budget and performance reports
C) Determining the audit policy
D) Preparing income statements

25) By concentrating on cash flows within a firm, the financial manager should be able to
________.
A) prepare tax returns
B) control the share price
C) avoid insolvency
D) maintain public relations
26) Marginal analysis states that financial decisions should be made and actions should be taken
only when ________.
A) marginal revenue equals marginal cost
B) benefits equal costs
C) added benefits exceed added costs
D) added benefits are greater than zero
27) A firm has just ended its calendar year making a sale in the amount of $200,000 of
merchandise purchased during the year at a total cost of $150,500. Although the firm paid in full
for the merchandise during the year, it is yet to collect at year end from the customer. The
possible problem this firm may face is ________.
A) high taxes
B) lack of cash flow
C) inability to receive credit
D) high leverage

1.5 Identify the primary activities of the financial manager.

1) A financial manager's primary activities include making investment and financing decisions.

2) Financing decisions deal with the left-hand side of the firm's balance sheet.

3) Which of the following line items in a balance sheet is considered the most for making a
financing decision?
A) current assets
B) long-term liabilities
C) revenue
D) cost of goods sold
4) Investment decisions generally refer to the items that appear on the ________.
A) left-hand side of the balance sheet, and financing decisions relate to the items on the right-
hand side
B) right-hand side of the balance sheet, and financing decisions relate to the items on the left-
hand side
C) right-hand side of the balance sheet, and financing decisions relate to the items on the income
statement
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D) left-hand side of the balance sheet, and financing decisions relate to the items on the income
statement

5) Which of the following is one of the key activities of a financial manager?

A) making financing decisions
B) managing cost accounting
C) managing financial accounting
D) making legal policy decisions
Answer: A
6) The primary activity of a financial manager is ________.
A) analyzing accrued earnings
B) making an investment decision
C) preparing organization charts
D) auditing financial statements

7) Which of the following activities of a finance manager determines the types of assets the firm
holds?
A) budget allocation
B) investment decisions
C) financing decisions
D) analyzing and planning cash flows
8) Making financing decisions includes ________.
A) determining the appropriate mix of short-term and long-term financing
B) deciding on which individual securities to select for investment
C) analyzing quarterly budget and performance reports
D) improving the productivity of manufacturing products

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9) Making investment decisions includes ________.
A) inventory
B) fixed assets
C) accounts receivable
D) notes payable
10) Managing a firm's assets includes ________.
A) accruals
B) notes payable
C) cash
D) accounts payable

11) Which of the following activities of a finance manager determines how the firm raises
money to pay for the assets in which it invests?
A) financial analysis and planning
B) investment decisions
C) financing decisions
D) analyzing and planning cash flows
12) A financial manager's investment decisions determine ________.
A) both the mix and the type of assets found on the firm's balance sheet
B) both the mix and the type of liabilities found on the firm's balance sheet
C) both the mix and the type of assets and liabilities found on the firm's balance sheet
D) both the mix and the type of short-term and long-term financing
13) In planning and managing the requirements of a firm, the financial manager is concerned
with ________.
A) the mix and type of assets, but not the type of financing utilized
B) the type of financing utilized, but not the mix and type of assets
C) the acquisition of fixed assets, allowing someone else to plan the level of current assets
required, and the market value of the share
D) the mix and type of assets, the type of financing utilized, and analysis in order to monitor the
financial condition

14) A financial manager's financing decisions determine ________.

A) both the mix and the type of assets found on the firm's balance sheet
B) the most appropriate mix of short-term and long-term financing
C) both the mix and the type of assets and liabilities found on the firm's balance sheet
D) the proportion of the firm's earnings to be paid as dividend

1.6 Describe the nature of the principal-agent relationship between owners and managers of a
corporation, and explain how various corporate governance mechanisms attempt to manage
agency problems.

1) Institutional investors are professional investors who work on behalf of individuals, business,
and government.

2) The board of directors is responsible for managing day-to-day operations and carrying out the
policies established by the chief executive officer.
Answer: FALSE
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3) The president or chief executive officer is elected by a firm's stockholders and has ultimate
authority to guide corporate affairs and make general policy.

4) The major purpose of the Sarbanes-Oxley Act of 2002 was to place caps on the compensation
that could be paid to corporate executives.
5) Agency problem arises when managers deviate from the goal of maximization of shareholder
wealth by placing their personal goals ahead of the goals of shareholders.
6) Agents of corporate owners are themselves owners of the firm and have been elected by all
the corporate owners to represent them in decision-making and management of the firm.
7) An agency problem occurs when a firm selects an ineffective marketing, advertising, and PR
firm to represent them.
8) Performance plans are plans that tie management compensation to measures such as EPS or
growth in EPS.

9) The board of directors is typically responsible for ________.

A) approving strategic goals and plans
B) managing day-to-day operations
C) arranging finance for approved long-term investments
D) maintaining and controlling the firm's daily cash balances

10) The Sarbanes-Oxley Act of 2002 was passed in response to ________.

A) insider trading activities
B) false disclosures in financial reporting
C) the decline in technology stocks
D) the agency issue

11) The Sarbanes-Oxley Act of 2002 resulted in ________.

A) tightened audit regulations and controls
B) toughened penalties against overcompensated executives
C) lenient penalties against executives who commit corporate fraud
D) delayed disclosure of stock sales by corporate executives
12) The true owner(s) of the corporation is (are) the ________.
A) board of directors
B) chief executive officer
C) stockholders
D) creditors

13) The ________ has/have the ultimate responsibility in guiding corporate affairs and carrying
out policies.
A) board of directors
B) chief financial officer
C) stockholders
D) creditors

14) The responsibility for managing day-to-day operations and carrying out corporate policies
belongs to the ________.
A) board of directors
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B) chief executive officer
C) stockholders
D) creditors

15) In a corporation, the board of directors are elected by the ________.

A) chief executive officer
B) creditors
C) stockholders
D) employees
16) Which of the following is an example of agency cost?
A) costs incurred for setting up an agency
B) failure of making the best investment decision
C) payment of income tax
D) payment of interest

17) Which of the following is the best measure to ensure that management decisions are in the
best interest of the stockholders?
A) fire managers who are inefficient
B) remove management's perquisites
C) tie management compensation to the performance of the company's common stock price
D) tie management compensation to the level of dividend per share

18) ________ is one of the solution to the agency problem in publicly-held corporations.
A) Stock options
B) Stock split
C) Demotion of employee designation
D) Distribution of dividends

19) Incentive plans usually tie management compensation to ________.

A) share price
B) dividends
C) coupon payments
D) inventory turnover
20) If managers are not owners of their company, then they are ________.
A) dealers
B) agents
C) bondholders
D) brokers

21) The conflict between the goals of a firm's owners and the goals of its non-owner managers is
________.
A) the agency problem
B) incompatibility
C) serious only when profits decline
D) the window-dressing
22) The agency problem may result from a manager's concerns about ________.
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A) job security
B) maximizing shareholder value
C) corporate goals
D) increasing credit worthiness
23) Which of the following is an example of agency costs?
A) cost of labor
B) raw material cost
C) monitoring expenditures cost
D) factory rent

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