Chapter 01 - Goals and Governance of the Firm
Chapter 01
Goals and Governance of the Firm
Multiple Choice Questions
1. Finance, generally, deals with:
I) Money; II) Markets; III) People
A. I only
B. I and II only
C. I and III only
D. I, II and III
2. This book is mainly about:
A. financial decisions made by households
B. financial decisions made by corporations
C. financial decisions made by governments
D. none of the above
3. The following are examples of the United States-based corporations except:
I) Boeing; II) Microsoft; III) Bank of America; IV) Sony
A. I only
B. I and II only
C. I, II, and III only
D. IV only
4. The following are examples of foreign-based corporations except:
I) British Petroleum; II) General Electric; III) Sony; IV) Volkswagen
A. I only
B. II only
C. II and III only
D. I, II, & IV only
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Chapter 01 - Goals and Governance of the Firm
5. Shareholders of a corporation may be, among others:
I) Individuals; II) Pension Funds; III) Insurance Companies
A. I only
B. I and II only
C. II only
D. I, II and III
6. Generally, a corporation is owned by the:
I) Managers; II) Board of Directors; III) Shareholders
A. I only
B. II and III
C. III only
D. I, II and III
7. Corporations, potentially, have infinite life because:
A. it is a legal entity
B. of separation of ownership and management
C. it has limited liability
D. none of the above
8. Limited liability is an important feature of:
A. Sole proprietorships
B. Partnerships
C. Corporations
D. All of the above
9. As a legal entity a corporation can perform the following functions except:
I) borrow money; II) lend money; III) sue and be sued; IV) vote
A. I and II only
B. I, II, and III only
C. IV only
D. I, II, III and IV
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Chapter 01 - Goals and Governance of the Firm
10. The following are examples of intangible assets except:
A. Building
B. Trademarks
C. Patents
D. Technical expertise
11. The following are examples of tangible assets except:
A. Machinery
B. Factories
C. Trademarks
D. Offices
12. A firm's investment decision is also called the:
A. Financing decision
B. Liquidity decision
C. Capital budgeting decision
D. None of the above
13. The following are examples of financial assets except:
A. Common stock
B. Bank loan
C. Preferred stock
D. Buildings
14. The treasurer usually oversees the following functions of a corporation except:
I) Preparation of financial statements; II) Investor relationships; III) Cash management; IV)
raising new capital
A. I only
B. I and II only
C. II, III and IV only
D. III only
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Chapter 01 - Goals and Governance of the Firm
15. The treasurer is usually responsible the following functions of a corporation:
I) Tax obligations; II) Investor relationships; III) Cash management; IV) raising new capital
A. I only
B. I and II only
C. II, III and IV only
D. I, II, III and IV
16. The controller usually oversees the following functions of a corporation:
I) Preparation of financial statements; II) Internal accounting; III) Cash management and IV)
Taxes
A. I, II and IV only
B. III only
C. I and II only
D. II and III
17. The controller is usually responsible for the following functions of a corporation except:
I) Preparation of financial statements; II) Internal accounting; III) Cash management; IV)
Taxes
A. I only
B. III only
C. I and II only
D. IV only
18. The following are important functions of financial markets:
I) Source of financing; II) Provide liquidity; III) Reduce risk; IV) Source of information
A. I only
B. I and II only
C. I, II, III, and IV
D. IV only
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Chapter 01 - Goals and Governance of the Firm
19. The Chief Financial Officer (CFO) of a corporation oversees:
A. Treasurer's functions
B. Controller's functions
C. Both A and B
D. None of the above
20. Conflicts of interest between shareholders and managers of a firm result in:
A. Principal-agent problem
B. Increased agency costs
C. Both A and B
D. Managers owning the firm
21. In the principal-agent framework:
A. Shareholders are the principals
B. Managers are the principals
C. Managers are the agents
D. A and D
22. Costs associated with the conflicts of interest between the bondholders and the
shareholders of a corporation are called:
A. Legal costs
B. Bankruptcy costs
C. Administrative costs
D. Agency costs
23. Agency costs are incurred by a corporation because:
A. managers may not attempt to maximize the value of the firm to shareholders
B. shareholders incur monitoring cost
C. separation of ownership and management
D. all of the above
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Chapter 01 - Goals and Governance of the Firm
24. The following groups are some of the claimants to a firm's income stream:
I) Shareholders; II) Bondholders; III) Employees; IV) Management and V) Government
A. I and II only
B. I, II, and III only
C. I, II, III and IV only
D. I, II, III, IV and V
25. The financial goal of a corporation is to:
A. Maximize profits
B. Maximize sales
C. Maximize the value of the firm for the shareholders
D. Maximize managers' benefits
26. The purchase of real assets is also referred to as the:
A. Capital decision
B. CFO decision
C. Financing decision
D. Investment decision
27. The sale of financial assets is also referred to as the:
A. Capital decision
B. CFO decision
C. Financing decision
D. Investment decision
28. The mixture of debt and equity, used to finance a corporation is also known as:
A. Capital budgeting
B. Capital structure
C. Investing
D. Treasury
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Chapter 01 - Goals and Governance of the Firm
29. Which of the following is not a common function of the firm's chief financial officer?
A. Hiring CEO
B. Hiring controller
C. Investing capital
D. Paying dividends
30. Of the following list, which is a stakeholder?
I) Employee; II) Customer; III) Community; IV) Supplier
A. I, II and IV only
B. III only
C. I and II only
D. All
31. The following are examples of real assets:
I) Machinery; II) Office buildings; III) Warehouse; IV) Common stock
A. I, II, and III only
B. I and II only
C. IV only
D. I only
32. The following are examples of tangible assets except:
I) Machinery; II) Office buildings; III) Warehouse; IV) Training for employees
A. I only
B. I and II only
C. IV only
D. I, II, and III only
33. The financial goal of a corporation is to:
A. Minimize stockholder wealth
B. Maximize profit
C. Maximize value of the corporation to the stockholders
D. Decrease job security
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Chapter 01 - Goals and Governance of the Firm
34. Managers' actions are monitored by:
A. The board of directors
B. Commercial banks that have loaned funds to the firm
C. The Wall Street analysts
D. All of the above
35. The following are some of the actions shareholders can take if the corporation is not
performing well:
A. Replace the board of directors in an election.
B. Force the board of directors to change the management team.
C. Sell their shares of stock in the corporation.
D. Any of the above
36. The idea of "maximizing shareholder value" is widely accepted in:
I) U.S.A.; II) U.K; III) Germany; IV) France; V) Japan
A. I only
B. I and II only
C. III, IV and V only
D. I, II, III, IV and V
37. The idea that "firms should be run for stakeholders welfare " is accepted in:
I) U.S.A.; II) U.K; III) Germany; IV) France; V) Japan
A. I only
B. I and II only
C. III, IV and V only
D. I, II, III, IV and V
38. The Sarbanes-Oxley Act of 2002 (SOX) was passed largely in response to:
A. the corporate accounting scandals of the previous years
B. the increase in the budget deficits
C. the increase in the trade deficits
D. none of the above
1-8
Chapter 01 - Goals and Governance of the Firm
39. A major advantage of the Sarbanes-Oxley Act of 2002 (SOX) is:
A. good investor protection
B. increase in compliance costs
C. that it constrains managers' ability to run the firm
D. that it may discourage development of human capital in the firm
40. Major disadvantages of the Sarbanes-Oxley Act of 2002 (SOX) are the following except:
A. good investor protection
B. increase in compliance costs
C. that it constrains managers' ability to run the firm
D. that it may discourage development of human capital in the firm
True / False Questions
41. The board of directors is ultimately responsible for all large investment decisions.
True False
42. A corporation has a legal existence of its own and is based on "articles of incorporation."
True False
43. Real assets of a corporation are claims on their financial assets.
True False
44. Since the investment and financing decisions are analyzed separately, the financial
manager can completely ignore investors and financial markets when analyzing capital
investment projects.
True False
1-9
Chapter 01 - Goals and Governance of the Firm
45. The treasurer's responsibilities include preparation of financial statements.
True False
46. In large firms, there is usually a Chief Financial Officer (CFO) who oversees both the
treasurer and controller's work.
True False
47. The controller's responsibilities include banking relations and cash management.
True False
48. A firm's overall value belongs entirely to the shareholders.
True False
49. Managers, Shareholders, and lenders of firm have identical information about the value
of the firm.
True False
Short Answer Questions
50. Explain the term "corporation."
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Chapter 01 - Goals and Governance of the Firm
51. Briefly explain the term limited liability.
52. Briefly explain the advantages of a corporation as a form of business organization.
53. Briefly explain the sequence flow of cash between financial markets and the firm.
54. Briefly explain the functions of financial markets.
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Chapter 01 - Goals and Governance of the Firm
55. Briefly discuss the role of the financial managers.
56. Briefly explain the term "Agency costs" as related to a corporation.
57. Briefly discuss principal - agent problems as related to a corporation
58. What function does the Securities and Exchange Commission play in protecting
investors?
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Chapter 01 - Goals and Governance of the Firm
59. What items of good corporate governance serve to mitigate the tension between owners
and managers?
60. Explain why "maximization of shareholders' wealth" is the appropriate goal of the firm.
61. Briefly explain some of the institutional arrangements that ensure that managers work
toward increasing the value of a firm.
62. Briefly explain different views taken in different countries about the corporation's goals.
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Chapter 01 - Goals and Governance of the Firm
63. Briefly explain the reasons for enacting the Sarbanes-Oxley Act of 2002.
64. Briefly explain the advantages and disadvantages of Sarbanes-Oxley Act of 2002 (SOX).
65. Briefly explain the major provisions of the Sarbanes-Oxley Act of 2002 (SOX).
66. What are the main purposes of the Sarbanes-Oxley Act of 2002 (SOX).
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Chapter 01 - Goals and Governance of the Firm
67. What is Toyota's business philosophy?
Multiple Choice Questions
68. Mr. Free has $100 dollars income this year and zero income next year. The market interest
rate is 10% per year. If Mr. Free consumes $30 this year, and invests the rest in the market,
what will be his consumption next year?
A. $50
B. $100
C. $77
D. $55
69. Mr. Bird has $100 income this year and zero income next year. The market interest rate is
10% per year. Mr. Bird also has an investment opportunity in which he can invest $50 today
and receive $80 next year. Suppose Mr. Bird consumes $30 this year and invests in the
project. What will be his consumption next year?
A. $88
B. $102
C. $80
D. $100
70. Ms. Venus has $100 income this year and $110 next year. The market interest rate is 10%
per year. Suppose Ms. Venus consumes $60 this year. What will be her consumption next
year?
A. $154
B. $170
C. $120
D. None of the above
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Chapter 01 - Goals and Governance of the Firm
71. Mr. Thomas has $100 income this year and zero income next year. The market interest
rate is 10% per year. Mr. Thomas also has an investment opportunity in which he can invest
$50 this year and receive $80 next year. Suppose Mr. Thomas consumes $50 this year and
invests in the project. What will be his consumption next year?
A. $55
B. $80
C. $50
D. None of the above
72. Mr. Dell has $100 income this year and zero income next year. The market interest rate is
10% per year. Mr. Dell also has an investment opportunity in which he can invest $50 this
year and receive $80 next year. Suppose Mr. Dell consumes $50 this year and invests in the
project. What is the NPV of the investment opportunity?
A. $5
B. $22.73
C. $0 (zero)
D. None of the above.
73. Ms. Anderson has $60,000 income this year and $40,000 next year. The market interest
rate is 10% per year. Suppose Ms. Anderson consumes $80,000 this year. What will be her
consumption next year?
A. $60,000
B. $30,000
C. $70,000
D. $18,000
74. The line that connects the maximum that one can consume this year (now) and the
maximum one can consume next year:
A. Has a slope of (1 + r)
B. Has a slope of -(1 + r)
C. Has a slope of r
D. Has a slope of 1/r
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Chapter 01 - Goals and Governance of the Firm
75. Ms. Newcastle has $60,000 income this year and $40,000 next year. The market interest
rate is 10% per year. Suppose Ms. Newcastle wishes to consume $62,000 next year. What will
be her consumption this year?
A. $60,000
B. $40,000
C. $70,000
D. $19,000
76. Mr. Smith has an income of $40,000 this year and $60,000 next year. He can invest in a
project that costs $30,000 this year, which generates an income of $36,000 next year. The
market interest rate is 10%. What will be his consumption next year, if Mr. Smith invests in
the project and consumes $50,000 this year?
A. $40,000
B. $52,000
C. $60,000
D. None of the above
Short Answer Questions
77. Briefly explain how individuals can adjust their preferences for current and future
consumption.
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Chapter 01 - Goals and Governance of the Firm
Chapter 01 Goals and Governance of the Firm Answer Key
Multiple Choice Questions
1. Finance, generally, deals with:
I) Money; II) Markets; III) People
A. I only
B. I and II only
C. I and III only
D. I, II and III
Type: Easy
2. This book is mainly about:
A. financial decisions made by households
B. financial decisions made by corporations
C. financial decisions made by governments
D. none of the above
Type: Easy
3. The following are examples of the United States-based corporations except:
I) Boeing; II) Microsoft; III) Bank of America; IV) Sony
A. I only
B. I and II only
C. I, II, and III only
D. IV only
Type: Easy
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Chapter 01 - Goals and Governance of the Firm
4. The following are examples of foreign-based corporations except:
I) British Petroleum; II) General Electric; III) Sony; IV) Volkswagen
A. I only
B. II only
C. II and III only
D. I, II, & IV only
Type: Easy
5. Shareholders of a corporation may be, among others:
I) Individuals; II) Pension Funds; III) Insurance Companies
A. I only
B. I and II only
C. II only
D. I, II and III
Type: Medium
6. Generally, a corporation is owned by the:
I) Managers; II) Board of Directors; III) Shareholders
A. I only
B. II and III
C. III only
D. I, II and III
Type: Easy
7. Corporations, potentially, have infinite life because:
A. it is a legal entity
B. of separation of ownership and management
C. it has limited liability
D. none of the above
Type: Medium
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Chapter 01 - Goals and Governance of the Firm
8. Limited liability is an important feature of:
A. Sole proprietorships
B. Partnerships
C. Corporations
D. All of the above
Type: Easy
9. As a legal entity a corporation can perform the following functions except:
I) borrow money; II) lend money; III) sue and be sued; IV) vote
A. I and II only
B. I, II, and III only
C. IV only
D. I, II, III and IV
Type: Medium
10. The following are examples of intangible assets except:
A. Building
B. Trademarks
C. Patents
D. Technical expertise
Type: Medium
11. The following are examples of tangible assets except:
A. Machinery
B. Factories
C. Trademarks
D. Offices
Type: Medium
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Chapter 01 - Goals and Governance of the Firm
12. A firm's investment decision is also called the:
A. Financing decision
B. Liquidity decision
C. Capital budgeting decision
D. None of the above
Type: Medium
13. The following are examples of financial assets except:
A. Common stock
B. Bank loan
C. Preferred stock
D. Buildings
Type: Medium
14. The treasurer usually oversees the following functions of a corporation except:
I) Preparation of financial statements; II) Investor relationships; III) Cash management; IV)
raising new capital
A. I only
B. I and II only
C. II, III and IV only
D. III only
Type: Difficult
15. The treasurer is usually responsible the following functions of a corporation:
I) Tax obligations; II) Investor relationships; III) Cash management; IV) raising new capital
A. I only
B. I and II only
C. II, III and IV only
D. I, II, III and IV
Type: Difficult
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Chapter 01 - Goals and Governance of the Firm
16. The controller usually oversees the following functions of a corporation:
I) Preparation of financial statements; II) Internal accounting; III) Cash management and IV)
Taxes
A. I, II and IV only
B. III only
C. I and II only
D. II and III
Type: Difficult
17. The controller is usually responsible for the following functions of a corporation except:
I) Preparation of financial statements; II) Internal accounting; III) Cash management; IV)
Taxes
A. I only
B. III only
C. I and II only
D. IV only
Type: Difficult
18. The following are important functions of financial markets:
I) Source of financing; II) Provide liquidity; III) Reduce risk; IV) Source of information
A. I only
B. I and II only
C. I, II, III, and IV
D. IV only
Type: Medium
19. The Chief Financial Officer (CFO) of a corporation oversees:
A. Treasurer's functions
B. Controller's functions
C. Both A and B
D. None of the above
Type: Easy
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Chapter 01 - Goals and Governance of the Firm
20. Conflicts of interest between shareholders and managers of a firm result in:
A. Principal-agent problem
B. Increased agency costs
C. Both A and B
D. Managers owning the firm
Type: Medium
21. In the principal-agent framework:
A. Shareholders are the principals
B. Managers are the principals
C. Managers are the agents
D. A and D
Type: Medium
22. Costs associated with the conflicts of interest between the bondholders and the
shareholders of a corporation are called:
A. Legal costs
B. Bankruptcy costs
C. Administrative costs
D. Agency costs
Type: Difficult
23. Agency costs are incurred by a corporation because:
A. managers may not attempt to maximize the value of the firm to shareholders
B. shareholders incur monitoring cost
C. separation of ownership and management
D. all of the above
Type: Medium
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Chapter 01 - Goals and Governance of the Firm
24. The following groups are some of the claimants to a firm's income stream:
I) Shareholders; II) Bondholders; III) Employees; IV) Management and V) Government
A. I and II only
B. I, II, and III only
C. I, II, III and IV only
D. I, II, III, IV and V
Type: Medium
25. The financial goal of a corporation is to:
A. Maximize profits
B. Maximize sales
C. Maximize the value of the firm for the shareholders
D. Maximize managers' benefits
Type: Difficult
26. The purchase of real assets is also referred to as the:
A. Capital decision
B. CFO decision
C. Financing decision
D. Investment decision
Type: Easy
27. The sale of financial assets is also referred to as the:
A. Capital decision
B. CFO decision
C. Financing decision
D. Investment decision
Type: Easy
1-24
Chapter 01 - Goals and Governance of the Firm
28. The mixture of debt and equity, used to finance a corporation is also known as:
A. Capital budgeting
B. Capital structure
C. Investing
D. Treasury
Type: Easy
29. Which of the following is not a common function of the firm's chief financial officer?
A. Hiring CEO
B. Hiring controller
C. Investing capital
D. Paying dividends
Type: Medium
30. Of the following list, which is a stakeholder?
I) Employee; II) Customer; III) Community; IV) Supplier
A. I, II and IV only
B. III only
C. I and II only
D. All
Type: Medium
31. The following are examples of real assets:
I) Machinery; II) Office buildings; III) Warehouse; IV) Common stock
A. I, II, and III only
B. I and II only
C. IV only
D. I only
Type: Easy
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Chapter 01 - Goals and Governance of the Firm
32. The following are examples of tangible assets except:
I) Machinery; II) Office buildings; III) Warehouse; IV) Training for employees
A. I only
B. I and II only
C. IV only
D. I, II, and III only
Type: Easy
33. The financial goal of a corporation is to:
A. Minimize stockholder wealth
B. Maximize profit
C. Maximize value of the corporation to the stockholders
D. Decrease job security
Type: Easy
34. Managers' actions are monitored by:
A. The board of directors
B. Commercial banks that have loaned funds to the firm
C. The Wall Street analysts
D. All of the above
Type: Medium
35. The following are some of the actions shareholders can take if the corporation is not
performing well:
A. Replace the board of directors in an election.
B. Force the board of directors to change the management team.
C. Sell their shares of stock in the corporation.
D. Any of the above
Type: Medium
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Chapter 01 - Goals and Governance of the Firm
36. The idea of "maximizing shareholder value" is widely accepted in:
I) U.S.A.; II) U.K; III) Germany; IV) France; V) Japan
A. I only
B. I and II only
C. III, IV and V only
D. I, II, III, IV and V
Type: Medium
37. The idea that "firms should be run for stakeholders welfare " is accepted in:
I) U.S.A.; II) U.K; III) Germany; IV) France; V) Japan
A. I only
B. I and II only
C. III, IV and V only
D. I, II, III, IV and V
Type: Medium
38. The Sarbanes-Oxley Act of 2002 (SOX) was passed largely in response to:
A. the corporate accounting scandals of the previous years
B. the increase in the budget deficits
C. the increase in the trade deficits
D. none of the above
Type: Medium
39. A major advantage of the Sarbanes-Oxley Act of 2002 (SOX) is:
A. good investor protection
B. increase in compliance costs
C. that it constrains managers' ability to run the firm
D. that it may discourage development of human capital in the firm
Type: Difficult
1-27
Chapter 01 - Goals and Governance of the Firm
40. Major disadvantages of the Sarbanes-Oxley Act of 2002 (SOX) are the following except:
A. good investor protection
B. increase in compliance costs
C. that it constrains managers' ability to run the firm
D. that it may discourage development of human capital in the firm
Type: Difficult
True / False Questions
41. The board of directors is ultimately responsible for all large investment decisions.
TRUE
Type: Medium
42. A corporation has a legal existence of its own and is based on "articles of incorporation."
TRUE
Type: Easy
43. Real assets of a corporation are claims on their financial assets.
FALSE
Type: Medium
44. Since the investment and financing decisions are analyzed separately, the financial
manager can completely ignore investors and financial markets when analyzing capital
investment projects.
FALSE
Type: Difficult
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Chapter 01 - Goals and Governance of the Firm
45. The treasurer's responsibilities include preparation of financial statements.
FALSE
Type: Medium
46. In large firms, there is usually a Chief Financial Officer (CFO) who oversees both the
treasurer and controller's work.
TRUE
Type: Easy
47. The controller's responsibilities include banking relations and cash management.
FALSE
Type: Medium
48. A firm's overall value belongs entirely to the shareholders.
FALSE
Type: Medium
49. Managers, Shareholders, and lenders of firm have identical information about the value
of the firm.
FALSE
Type: Medium
Short Answer Questions
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Chapter 01 - Goals and Governance of the Firm
50. Explain the term "corporation."
A corporation is a legal entity and has an existence of its own. Generally, large businesses are
organized as corporations.
Type: Easy
51. Briefly explain the term limited liability.
The shareholders of a corporation cannot be held personally responsible for the debt of the
corporation. This is called limited liability. Hence a shareholder's loss is limited to the amount
he or she has invested in a corporation. This is an attractive feature for the investors.
Type: Medium
52. Briefly explain the advantages of a corporation as a form of business organization.
• Corporations have infinite life.
• Corporations have very many owners called shareholders and therefore corporations can
raise funds more easily than other forms of business.
• There is a separation of ownership and management that is helpful in running the
corporation on a day-to-day basis.
• It is very easy to transfer ownership in a corporation.
• Corporations have limited liability.
Type: Medium
53. Briefly explain the sequence flow of cash between financial markets and the firm.
• Cash is raised by selling financial assets to investors.
• Cash is invested in the firm's operation and used to purchase real assets.
• Cash is generated by the firm's operations.
• Cash is reinvested or returned to investors.
Type: Medium
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Chapter 01 - Goals and Governance of the Firm
54. Briefly explain the functions of financial markets.
There are five important functions of financial markets. They are:
• a source of financing for corporations.
• provide liquidity for the investors.
• reduce risk for the investors.
• source of information.
• monitor of firms' financial performance.
Type: Medium
55. Briefly discuss the role of the financial managers.
Chief Financial Officer (CFO): Supervises the treasurer and the controller in a large
corporation. CFO is involved in corporate planning and financial policy.
Treasurer: Is responsible for obtaining funds, managing cash, banking relationships and
investor relationships.
Controller: Is responsible for accounting functions, payroll and taxes.
Type: Medium
56. Briefly explain the term "Agency costs" as related to a corporation.
Agency costs arise in a corporation as a result of principal-agent problems. For example;
managers may not act in the best interests of the shareholders while making decisions. Hence
the shareholders incur monitoring costs that are called agency costs. It also arises as result of
informational asymmetry between managers and other stakeholders of a firm. Agency costs
tend to reduce the value of a firm.
Type: Medium
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Chapter 01 - Goals and Governance of the Firm
57. Briefly discuss principal - agent problems as related to a corporation
Principal-agent problems arise in a corporation as a result of the separation of ownership and
management. Managers may not act in the best interests of the shareholders while making
decisions. Hence the shareholders incur monitoring and bonding costs, which are a part of
agency costs. It also arises as result of informational asymmetry between managers and other
stakeholders of a firm. Agency costs tend to reduce the value of a firm.
Type: Medium
58. What function does the Securities and Exchange Commission play in protecting
investors?
The U.S. Securities and Exchange Commission (SEC) sets accounting and reporting standards
for public companies to ensure consistency and transparency. The SEC also prohibits insider
trading, that is, the purchase or sale of shares based on information that is not available to
public investors.
Type: Medium
59. What items of good corporate governance serve to mitigate the tension between owners
and managers?
There are legal and regulatory requirements imposed on managers. Owners can also develop
compensation plans designed to incentivize good behavior. A board of directors, which serves
the interests of the shareholders as well as proper monitoring devices, such as audits, reduce
tensions. A well functioning capital market and the threat of hostile takeover also provides an
incentive for managers to work in harmony with shareholders.
Type: Medium
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Chapter 01 - Goals and Governance of the Firm
60. Explain why "maximization of shareholders' wealth" is the appropriate goal of the firm.
Under perfect market conditions, everyone can borrow or lend at the same interest rate. This
implies that differences in consumption patterns can be adjusted in the capital markets. Given
this, all investors will agree that they are better off if the firm maximizes their current wealth,
i.e. maximizing shareholders' wealth.
Type: Difficult
61. Briefly explain some of the institutional arrangements that ensure that managers work
toward increasing the value of a firm.
• The board of directors who are elected by the shareholders scrutinizes managers' actions.
• Competition among managers.
• The threat of takeover that brings a new management team.
• Incentive schemes that are closely tied to the value of the firm like stock options.
Type: Medium
62. Briefly explain different views taken in different countries about the corporation's goals.
The idea of maximizing the shareholder value as the goal of a corporation is widely accepted
in the U.S.A. and the U.K. In Germany, France and Japan the idea that the corporation is
responsible for all the stakeholders is prevalent.
Type: Medium
63. Briefly explain the reasons for enacting the Sarbanes-Oxley Act of 2002.
The corporate accounting scandals involving the bankruptcy of Enron and Worldcom
corporations led to the enactment of Sarbanes-Oxley Act of 2002.
Type: Medium
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Chapter 01 - Goals and Governance of the Firm
64. Briefly explain the advantages and disadvantages of Sarbanes-Oxley Act of 2002 (SOX).
The main advantage of SOX is investor protection. Disadvantages are: high cost of
compliance, constraints on the managers' ability to conduct business and might also hinder the
development of human capital in the firm.
Type: Medium
65. Briefly explain the major provisions of the Sarbanes-Oxley Act of 2002 (SOX).
Sarbanes-Oxley Act of 2002 deals with auditor oversight, accounting and reporting, and
corporate governance. An important provision deals with increased level of accountability
required of the corporate officers. The Act requires a public company's principal executive
officer (CEO) and principal financial officer (CFO) to personally certify that, to the best of
their knowledge, the company's financial statements filed with SEC are accurate and
complete. Failure to meet these requirements can lead to significant consequences for a
company's CEO and CFO. Another important provision deals with compliance. The Act
requires that managers state their responsibility for establishing and maintaining adequate
internal controls for financial reporting. The cost of compliance could be quite high.
Type: Difficult
66. What are the main purposes of the Sarbanes-Oxley Act of 2002 (SOX).
The purposes of Sarbenes-Oxley Act (SOX) are to: (1) increase the role and authority of
independent directors, (2) give shareholders more opportunity to monitor and participate in
the governance of companies, and (3) establish new controls and enforcement mechanisms.
Type: Difficult
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Chapter 01 - Goals and Governance of the Firm
67. What is Toyota's business philosophy?
Toyota's business philosophy is to achieve stable, long-term growth, through the development
of business activities that contribute to society by recognizing the importance of harmonious
relationships between individuals, society, the global environment, and the world economy. It
is also to share the benefits of growth with everyone involved with the firm, including
customers, shareholders, employees, and trading associates.
Type: Medium
Multiple Choice Questions
68. Mr. Free has $100 dollars income this year and zero income next year. The market interest
rate is 10% per year. If Mr. Free consumes $30 this year, and invests the rest in the market,
what will be his consumption next year?
A. $50
B. $100
C. $77
D. $55
Consumption next year = (100 - 30) * (1.1) = 77 (See Figure-1)
Type: Difficult
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Chapter 01 - Goals and Governance of the Firm
69. Mr. Bird has $100 income this year and zero income next year. The market interest rate is
10% per year. Mr. Bird also has an investment opportunity in which he can invest $50 today
and receive $80 next year. Suppose Mr. Bird consumes $30 this year and invests in the
project. What will be his consumption next year?
A. $88
B. $102
C. $80
D. $100
Consumption next year = (100 - 30 - 50) * 1.1 + 80 = 102
Type: Difficult
70. Ms. Venus has $100 income this year and $110 next year. The market interest rate is 10%
per year. Suppose Ms. Venus consumes $60 this year. What will be her consumption next
year?
A. $154
B. $170
C. $120
D. None of the above
Consumption next year = (100 - 60) * 1.1 + 110 = 154
Type: Difficult
71. Mr. Thomas has $100 income this year and zero income next year. The market interest
rate is 10% per year. Mr. Thomas also has an investment opportunity in which he can invest
$50 this year and receive $80 next year. Suppose Mr. Thomas consumes $50 this year and
invests in the project. What will be his consumption next year?
A. $55
B. $80
C. $50
D. None of the above
Mr. Thomas' investment this year = 100 - 50 = 50. His income next year by taking the
investment opportunity is equal to 80.
Type: Difficult
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Chapter 01 - Goals and Governance of the Firm
72. Mr. Dell has $100 income this year and zero income next year. The market interest rate is
10% per year. Mr. Dell also has an investment opportunity in which he can invest $50 this
year and receive $80 next year. Suppose Mr. Dell consumes $50 this year and invests in the
project. What is the NPV of the investment opportunity?
A. $5
B. $22.73
C. $0 (zero)
D. None of the above.
NPV = (80/1.1) - 50 = + 22.73
Type: Difficult
73. Ms. Anderson has $60,000 income this year and $40,000 next year. The market interest
rate is 10% per year. Suppose Ms. Anderson consumes $80,000 this year. What will be her
consumption next year?
A. $60,000
B. $30,000
C. $70,000
D. $18,000
Borrow $20,000 this year to consume 60,000 + 20,000 = 80,000 Consumption next year =
40,000 - (20,000 * 1.1) = 18,000
Type: Difficult
74. The line that connects the maximum that one can consume this year (now) and the
maximum one can consume next year:
A. Has a slope of (1 + r)
B. Has a slope of -(1 + r)
C. Has a slope of r
D. Has a slope of 1/r
Type: Difficult
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Chapter 01 - Goals and Governance of the Firm
75. Ms. Newcastle has $60,000 income this year and $40,000 next year. The market interest
rate is 10% per year. Suppose Ms. Newcastle wishes to consume $62,000 next year. What will
be her consumption this year?
A. $60,000
B. $40,000
C. $70,000
D. $19,000
Consumption this year = 60,000 - (22,000/1.1) = 40,000
Type: Difficult
76. Mr. Smith has an income of $40,000 this year and $60,000 next year. He can invest in a
project that costs $30,000 this year, which generates an income of $36,000 next year. The
market interest rate is 10%. What will be his consumption next year, if Mr. Smith invests in
the project and consumes $50,000 this year?
A. $40,000
B. $52,000
C. $60,000
D. None of the above
Consumption next year = [40,000 - 30,000 - 50,000] * 1.1 + (60,000 + 36,000) = 52,000
Type: Difficult
Short Answer Questions
77. Briefly explain how individuals can adjust their preferences for current and future
consumption.
Individuals can adjust their preferences for consumption by borrowing or lending in the
financial market. The appropriate balance between present and future consumption that each
individual will choose depends on personal preferences. But individuals with different
preferences can adjust their preferences using financial market.
Type: Difficult
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