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Exam 1: An Overview of Financial Management

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Question 31

True/False

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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

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Question 32

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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.

F) A) and D)
G) All of the above

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Question 33

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Charleston Corporation (CC) now operates as a "regular" corporation,but it is considering a switch to S Corporation status.CC is owned by 100 stockholders who each hold 1% of the stock,and each faces a personal tax rate of 35%.The firm earns $2,800,000 per year before taxes,and since it has no need for retained earnings,it pays out all of its earnings as dividends.Assume that the corporate tax rate is 34% and the personal tax rate is 35%.How much more (or less) spendable income would each stockholder have if the firm elected S Corporation status?

In order to maximize its shareholders' value,a firm's management must attempt to maximize the stock price on a specific target date.

It is generally harder to transfer one's ownership interest in a partnership than in a corporation.

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 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.

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.

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.

​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.

For a stock to be in equilibrium as the book defines it,its market price should exceed its intrinsic value.

It is generally less expensive to form a corporation than a proprietorship because,with a proprietorship,extensive legal documents are required.

The more capital a firm is likely to require,the greater the probability that it will be organized as a corporation.

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.

In order to maximize its shareholders' value,a firm's management must attempt to maximize the expected EPS.

Which of the following statements is CORRECT?

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.

One advantage of the corporate form of organization is that it avoids double taxation.

Which of the following statements is CORRECT?

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.