Question 1

The CEO of High Tech International decides to change an accounting method at the end of the current year.The change results in reported profits increasing by 5%,but the company's cash flows are not changed.If capital markets are efficient,then

Accepted Answer

If capital markets are efficient, investors will understand that the change in accounting method only affects reported profits and not actual cash flows. Therefore, the stock price should not be affected by the accounting change since it does not change the underlying value of the company or its future prospects.

Question 2

Ethical behavior

Accepted Answer

Ethical behavior is essential in business because it creates a culture of trust and responsible decision-making. Unethical behavior can destroy relationships and harm a company's reputation, which can ultimately impact their financial success. It is not just about following laws, but also making moral considerations in decision-making. Managers should prioritize ethical behavior along with maximizing shareholder value to maintain long-term success.

Question 3

In order to reduce agency problems,managers may be provided compensation that includes

Accepted Answer

Providing managers with the option to buy the company's stock aligns their interests with those of the shareholders, as they will benefit financially if the company performs well in the long term. This reduces agency problems as it incentivizes managers to make decisions that benefit the company as a whole, rather than just their own personal interests. Fixed salaries (option A) may not motivate managers to perform at their best, while bonuses (option B) and incentive pay (option D) may encourage short-term decision making that prioritizes immediate profits over long-term growth.

Question 4

In which of the following cases will the agency problem between shareholders and managers be the greatest?

Accepted Answer

The agency problem between shareholders and managers is greatest when ownership is highly fragmented, as in option C, where no shareholder owns more than 1% of the stock. This dispersion makes it difficult for shareholders to monitor and influence managerial actions effectively.

Question 5

Assume that you won the Lotta Dough Lotto jackpot for $20 million.Further assume that you were offered a choice to receive the $20 million today,or receive it in equal installments of $1 million per year for 20 years.According to one of the principles of finance,which would you take?

Accepted Answer

This is because of the time value of money principle, which states that a dollar today is worth more than a dollar tomorrow due to the potential earning of interest on the dollar today. By taking the lump sum today, you could invest it and earn a return on investment, whereas if you took installment payments, you would not be able to earn as much interest. Additionally, receiving the money now would eliminate the risk of inflation devaluing the future payments. Therefore, taking the $20 million today would be the best choice.

Question 6

Investors generally don't like risk.Therefore,a typical investor

Accepted Answer

Investors generally expect to be compensated for risk with additional return. Therefore, they may be willing to take on additional risk if they believe the potential return justifies it. However, it's unlikely that they would accept zero return, even if the risk is zero, as they typically look to earn some return on their investments. Choice A is not accurate, as many investors are willing to take on some degree of risk in order to achieve higher returns. Choice B may be true for some investors, but not all.

Question 7

As of today,the most severe economic crisis to afflict the United States economy is considered to be

Accepted Answer

The Great Depression of the 1930s is widely regarded as the most severe economic crisis in the United States, characterized by unprecedented levels of unemployment and economic decline.

Question 8

Which of the following statements best represents the "Agency Problem"?

Accepted Answer

The agency problem refers to the conflict of interest that arises between the shareholders and the management of the firm. The management might attempt to benefit themselves through higher salaries, perquisites, and other measures, which could negatively impact shareholder wealth. This problem arises due to the separation of ownership and management of the firm. Therefore, all the given options represent the agency problem, making option D the correct answer.

Question 9

Executive compensation in the United States

Accepted Answer

Executive compensation in the United States is dominated by performance-based compensation designed to reduce agency problems. This is because there is a principal-agent problem in corporations where the interests of shareholders may not align with those of executives. Therefore, performance-based compensation is designed to incentivize executives to work in the best interest of shareholders.

Question 10

In finance,we assume that investors are generally

Accepted Answer

The concept of risk aversion is a cornerstone of finance. It states that investors prefer to avoid risk if possible and require higher returns to compensate them for taking on more risk. Therefore, option B is the correct answer. Options A and C are both extreme and do not accurately reflect the typical investor.

Question 11

An investor is considering two equally risky investments.Investment A is expected to return $1,000 per year for the next 5 years.Investment B is expected to return $6,000 at the end of 5 years.Which of the following statements is MOST correct if both investments A and B have the same cost?

Accepted Answer

The best choice depends on the opportunity cost of money. If the investor has alternative investment opportunities that offer a higher return than Investment A's $1,000 annual return, then Investment B may be more attractive. However, if the investor has a lower opportunity cost of money, then the early cash flows provided by Investment A may be more valuable, making it the better choice. Therefore, the investor may select either Investment A or B, depending on the opportunity cost of money.

Question 12

Consider the after-tax cash flows for Project S and Project L:

A rational person would prefer ________.

Accepted Answer

Rational individuals prefer a project with earlier cash flows over one with later cash flows because money can be reinvested sooner. Therefore, Project S is preferred over Project L.

Question 13

Assume that you went to Las Vegas and hit the jackpot for $5 million.Further assume that you were offered a choice to receive the $5 million today,or receive it in two years.According to one of the principles of finance,which would you take?

Accepted Answer

The best choice is to take the $5 million today because of the time value of money principle. Money received today is worth more than money received in the future because of the potential return that it could earn if invested. By taking the money today, you could invest it and potentially earn a return on it over the next two years, which would be more valuable than receiving the $5 million in two years.

Question 14

Assume that an investor is offered a choice of a risk-free government bond that is expected to return 3.5% or a high-risk corporate stock.According to one of the principles of finance,what would induce the investor to purchase the corporate stock?

Accepted Answer

The principle of finance that would induce the investor to purchase the high-risk corporate stock is the principle of risk versus return. Since the corporate stock is high-risk, it should have the potential to offer a higher return compared to the risk-free government bond. Therefore, a return that is substantially higher than 3.5% would be the most enticing reason for the investor to choose the corporate stock.

Question 15

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?

Accepted Answer

The worth of John's investment cannot be determined with the information given. We do not know the rate of return on John's investment or if he experienced any gains or losses. It is also possible that John's investment was worth less than $1,030. Thus, we cannot make any conclusions about the rationality of either investor based on the information provided.

Question 16

The recent financial crises was exacerbated by

Accepted Answer

The recent financial crisis was primarily caused by managers who underestimated the real risks of their decisions and borrowed excessively. This resulted in a buildup of risky assets and overly leveraged positions, leading to a market collapse. Other factors such as a lack of financial leverage and high interest rates may have played a role, but they were not the primary cause of the crisis.

Question 17

Assume that an investor is offered a choice of a risk-free government bond or a high-risk corporate stock.Further assume that the expected return is the same for both.According to one of the axioms of finance,which investment would be chosen?

Accepted Answer

One of the axioms of finance is that investors prefer higher returns with less risk. In this scenario, the government bond is perceived as less risky than the high-risk corporate stock, hence the investor would choose the government bond as it offers the same expected returns but with less risk. Therefore, the best choice would be option B) the government bond.

Question 18

When evaluating an investment project,which of the following best describes the financial information needed by the decision maker?

Accepted Answer

When evaluating an investment, decision makers should focus on the incremental cash flows that the investment will generate for the company. This means looking at the after-tax cash flows that are incremental to those that would be earned without the investment. Accounting profits alone are not sufficient because they do not consider cash flows or timing of cash flows, and pre-tax cash flows may be biased by changes in tax laws. Therefore, option B, after-tax incremental cash flows to the company as a whole, is the best choice.

Question 19

The CEO of JLI Corp.decided to expand into a new market in 2010.At the end of 2010,JLI's stock price had decreased 5% since the beginning of the year.Which of the following statements is MOST correct?

Accepted Answer

The fact that JLI's stock price only decreased 5% after expanding into a new market suggests that the CEO's decision was not necessarily a poor one. The market may have perceived the expansion as positive, which kept the stock price from falling further. Option D is incorrect because while the efficient market hypothesis suggests that stock prices reflect all available information, CEO decisions and actions can still have an impact on the market's perception of the company and its stock. Options A and B are both too simplistic and do not take into account other factors that may have affected JLI's stock price during the year.

Question 20

High Tech Corp.cut its research and development budget in 2010 by $4,000,000 in order to improve its cash flow for the year.Which of the following statements is MOST correct?

Accepted Answer

Investors may view the reduction in research and development budget as a negative signal for future growth potential and innovation, leading to a decrease in stock price. The value of stock is influenced by a variety of factors, including reported cash flow, but also earnings, growth prospects, and other fundamental and market factors. Therefore, A, C, and D are less likely to be accurate or comprehensive statements.

Quiz 1: An Introduction to the Foundations of Financial Management