Question 1

All of the following statements about agency problems are true except:

Accepted Answer

Agency costs are not paid by the managers who do not act in the shareholders' best interest, but by the shareholders themselves. The managers who do not act in the shareholders' best interest, however, may benefit from those costs.

Question 2

Project A is expected to generate positive cash flow of $1 million in 10 years while Project B is expected to generate $500,000 in 5 years.Therefore,

Accepted Answer

The choice between the two projects depends on the opportunity cost of money. If the opportunity cost of money is high enough, it may be more beneficial to choose Project B as it generates cash flow sooner. However, if the opportunity cost of money is lower, then Project A may be preferred as it generates a higher cash flow over a longer period of time. Therefore, the best choice between the two options is D.

Question 3

A corporate manager decides to build a new store on a lot owned by the corporation that could be sold to a local developer for $250,000.The lot was purchased for $50,000 twenty years ago.When determining the value of the new store project,

Accepted Answer

The opportunity cost of using the lot for the new store is $250,000, the amount the corporation could have received from selling it to a developer. This represents the foregone benefit of the next best alternative use of the lot and should be included in the project's valuation.

Question 4

A financial manager is evaluating a project which is expected to generate profits of $100,000 per year for the next 10 years.The project should be accepted if

Accepted Answer

The best way to evaluate the profitability of a project is to compare the present value of its cash inflows with the present value of its cash outflows (i.e., using discounted cash flow analysis). If the present value of cash inflows is greater than the present value of cash outflows, then the project is expected to generate a positive net present value and should be accepted. Therefore, the correct choice is D. Choices A and C do not take into account the profitability of the project, while B is not a meaningful criterion for decision-making as it is equivalent to saying the project should be accepted if the cost is less than $614,506.

Question 5

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

Cutting research and development budget can signal to investors that the company may have a lack of innovation and new products in the future, which can result in lower cash flows and lower profits. This can lead to a decrease in the stock price. The stock price is not solely based on reported cash flow and profits, but also on investors' expectations for future growth and profitability.

Question 6

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 decision on which investment to choose depends on the opportunity cost of money, which is influenced by factors such as interest rates, inflation, and alternative investment opportunities. If the opportunity cost of money is low or if there are no alternative investments with higher returns, the investor may choose investment A as it provides cash earlier. However, if the opportunity cost of money is high or if there are alternative investments with higher returns, the investor may choose investment B as it provides a higher total return over time. Therefore, the investor may select investment A or B depending on the opportunity cost of money.

Question 7

The principle of risk-return tradeoff means that

Accepted Answer

The principle of risk-return tradeoff suggests that investors will only take on higher levels of risk if they believe that they will be compensated with higher returns. This means that a rational investor will not take on more risk than is necessary to achieve their desired level of return. The other options are incorrect as they do not accurately reflect the principle of risk-return tradeoff.

Question 8

The expected return on a riskless asset is greater than zero due to

Accepted Answer

The expected return on a riskless asset is greater than zero due to an expected return for delaying consumption. This is because individuals are willing to forgo consumption today in exchange for receiving a return on their investment in the future.

Question 9

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, the stock price will reflect all available information, including the accounting change. Since the change does not affect cash flows, it is unlikely to have a significant impact on the stock price. Therefore, the stock price will not be affected by the accounting change.

Question 10

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

Accepted Answer

The most important financial information needed by the decision maker when evaluating an investment project is the after-tax incremental cash flows to the company as a whole. This allows the decision maker to accurately assess the impact of the investment on the organization's bottom line. After-tax incremental cash flows take into account the cash revenues generated by the investment as well as the additional costs associated with it. This information helps decision makers determine whether the investment is worthwhile or not. Pre-tax or after-tax accounting profits may be useful in some cases, but they do not provide the complete picture and may be affected by accounting methods or changes. Incremental cash flows before taxes may also be useful, but they do not take into account the impact of taxes on the investment, which can be significant.

Question 11

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 CEO's decision may have been optimal because it's possible that without the expansion, JLI's stock price would have fallen more than 5%. Additionally, it's important to note that stock prices can be influenced by many factors beyond just company profits or CEO decisions, such as overall market trends and investor sentiment. Therefore options A and B are not correct, and option D is too extreme in its assertion that CEO decisions are irrelevant.

Question 12

To measure value,the concept of time value of money is used

Accepted Answer

The time value of money refers to the fact that money today is worth more than the same amount of money in the future, due to the potential to earn interest over time. Therefore, the concept is used to bring the future cash flows of a project back to the present, allowing for a comparison of the project's expected profitability with its current costs and benefits. This process is essential for making investment decisions and evaluating the value of potential projects. Option A is incorrect because the interest rate on corporate debt is determined by a variety of factors, not just the time value of money. Option B is incorrect because it refers to profits rather than cash flows, which do not necessarily reflect the timing of cash inflows and outflows in a project. Option D is also incorrect because the goal of investment is generally to maximize expected future profits, not just ensure that they are higher than current profits.

Question 13

Joe,a risk-averse investor,is trying to choose between investment A and investment B.If investment A is riskier than investment B and Joe selects investment A anyway,then

Accepted Answer

As Joe is a risk-averse investor, it is unlikely that he would choose investment A if the expected return for investment B was higher. Therefore, we can assume that the expected return for investment A is higher than the expected return for investment B. However, if Joe chooses investment A despite it being riskier, it is possible that the actual return for investment B could be higher than the actual return for investment A, leading to option D being the correct answer.

Question 14

A corporate financial manager trying to maximize shareholder value

Accepted Answer

A corporate financial manager's goal is to maximize shareholder value, but unethical behavior can destroy trust, which is essential for business function. Therefore, ethical behavior is important for maintaining trust and achieving the goal of maximizing shareholder value in the long term. Additionally, unethical behavior can lead to legal consequences, so the manager must also act ethically to avoid legal issues. Choices A and B are incorrect, as they suggest that ethics can be ignored, which is not acceptable or legal in business. Choice C is partially correct, as unethical behavior can indeed lead to legal consequences, but it is not the only reason why ethical behavior is important.

Question 15

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

Accepted Answer

Providing managers with an option to buy the company's stock aligns their interests with those of the shareholders since they will benefit from any increase in the company's stock price. This can motivate managers to make decisions that benefit the company in the long-term rather than focusing solely on short-term results that may be detrimental in the long run. Options can also be structured in a way that imposes restrictions on when the manager can exercise them, further aligning their interests with those of the shareholders. Other compensation methods like fixed salary or bonuses based on profitability or sales may not necessarily align the goals of managers with those of the shareholders.

Question 16

Company A reports sales of $100,000 and net income of $15,000.Company B reports sales of $100,000 and net income of $10,000.Therefore,

Accepted Answer

Net income does not directly indicate cash flow, as there may be various non-cash expenses such as depreciation that affect net income. Therefore, while Company A's net income is higher, its cash flow may still be lower or higher than Company B's cash flow.

Question 17

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?

Accepted Answer

The stock market is considered efficient, meaning that it quickly incorporates all available information into stock prices. Therefore, a change in accounting policy that does not reflect a real change in the company's economic situation is unlikely to affect the stock price.

Question 18

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 have no information about the performance of John's investment, and the fact that Bill's investment earned more does not necessarily mean John's investment was irrational or that Bill's investment was irrational. We cannot draw any conclusions about John's investment based on this information alone.

Question 19

Investors want a return that satisfies the following expectations:

Accepted Answer

Investors expect a return for delaying their consumption, which is represented by the time value of money. They also expect an additional return for taking on risk because investing involves uncertainty about future returns. Therefore, both A and B are the correct choices. While some investors may prefer dividends over capital gains, this is not a universal expectation, so C is not necessary to satisfy all investors.

Question 20

All of the following contributed to recent financial crises except:

Accepted Answer

Relying on the efficiency of financial markets is not typically cited as a direct cause of recent financial crises. However, the other options (focusing on earnings over cash flow, focusing on the short run, and excessive risk taking due to underestimation of risk) are commonly cited as factors that led to financial crises in the past.

Quiz 1: An Introduction to the Foundations of Financial Management