Chapter 013 Introduction to Corporate Financing and Governance
True / False Questions
1. A eurobond (a bond that is sold internationally) is always denominated in euro.
FALSE
2. The issued and repurchased shares are held in a company's treasury and are known as
treasury stock.
TRUE
3. The price at which new shares are sold to investors almost always exceeds par value. The
difference is entered into the company's accounts as additional paid-in capital, or capital
surplus.
TRUE
4. In the United States just over 60 percent of common stock is held by foreign investor or U.S.
financial institutions, with pension funds and mutual funds each holding about 20 percent.
TRUE
5. In proxy contests, outsiders compete with the firm's existing management and directors for
control of the corporation.
TRUE
6. Over these 12 years, internally generated cash covered 83% of firm's capital requirements.
TRUE
7. Larry Ellison can run Oracle Corporation as he wants to and as long as he wants to because
he owns over 25 percent of the company shares and he is the company's chief executive.
TRUE
8. Ford Motor Company and Google have issued two classes of shares with different voting
rights to allow their firms obtain fresh capital without giving up their management's controlling
rights.
TRUE
9. Suppose a firm needs fresh capital, but its management does not want to give up its
controlling interest. The existing shares could be labeled Class A, and then Class B shares with
limited voting rights could be issued to outside investors.
TRUE
10. If an idle or incompetent management has a large block of votes, it may use these votes to
stay in control.
TRUE
14-1
Chapter 013 Introduction to Corporate Financing and Governance
11. For the period of 1990 through 2006, the book debt ratio exceeded the market debt ratio for
the nonfinancial corporate sector.
TRUE
12. Retained earnings will decrease when stock is repurchased as treasury stock.
TRUE
13. Differences in classes of stock often appear in their right to vote.
TRUE
14. If shareholders do not like the policies that management pursues, their easiest solution is to
vote in a different board of directors.
TRUE
15. Dividends are deductible for purposes of calculating a corporation's taxable income.
FALSE
16. Since preferred stock dividends are not deductible for tax purposes, few corporations own
preferred stock.
FALSE
17. When bonds are selling at par value, the bonds are known as fixed-rate bonds.
FALSE
18. Corporations are less likely to repurchase callable bonds when market interest rates have
risen.
TRUE
19. A corporation cannot default on debt that is funded.
FALSE
20. Debt financing is riskier than equity financing, but it does provide benefits to the firm.
TRUE
21. The price at which new shares are issued is referred to as the par value of the stock.
FALSE
22. A capital surplus is obtained when the selling price of new shares is greater than the par
value.
TRUE
23. The CEO has "ultimate"control over the company's affairs.
FALSE
14-2
Chapter 013 Introduction to Corporate Financing and Governance
24. With floating-rate preferred stock, dividends are linked to interest rates.
TRUE
25. In a situation of bankruptcy, only the funded debt will be repaid.
FALSE
26. Holders of callable bonds know that the company will wish to buy the issue back if interest
rates fall, and therefore the price of the bond will not rise above the call price.
TRUE
27. Callable bonds may be repurchased by the issuing firm before maturity at the specified call
price.
TRUE
28. The call provision of callable bonds comes at the expense of bond holders, for it limits
investors' capital gain potential.
TRUE
29. Bonds with the callable feature sell at lower prices than bonds without such a feature.
TRUE
30. Limiting the size of dividends paid is an example of a protective covenant.
TRUE
31. For most firms, the majority of their funding is generated internally.
TRUE
32. Subordinated debt is an example of short-term debt for a firm.
FALSE
33. When firms retain cash, they are generating funds internally by increasing shareholder
investment.
TRUE
34. When securities are priced fairly, then financing at current market rates is a positive NPV
transaction.
FALSE
Multiple Choice Questions
14-3
Chapter 013 Introduction to Corporate Financing and Governance
35. A stock's par value is represented by:
A. the maturity value of the stock.
B. the price at which each share is recorded.
C. the price at which an investor could sell the stock.
D. the price received by the firm when the stock was issued.
36. Additional paid-in capital refers to:
A. a firm's retained earnings.
B. a firm's treasury stock.
C. the difference between the issue price and the par value.
D. funds borrowed from a bank or bondholders.
37. Which of the following equity concepts would you expect to be least important to a
financial analyst?
A. Par value per share
B. Additional paid-in capital
C. Retained earnings
D. Net common equity
38. Any capital surplus shown by a firm on its balance sheet results from:
A. not paying out all net income as dividends.
B. repurchasing shares for treasury stock.
C. issuing stock at a price higher than par value.
D. retained earnings.
39. How much will be recorded as a firm's additional paid-in capital if it issues 1 million shares
that have a $5 par value for $15 per share?
A. $0
B. $5,000,000
C. $10,000,000
D. $15,000,000
14-4
Chapter 013 Introduction to Corporate Financing and Governance
40. What will happen to retained earnings when a corporation issues 1,000 shares of $1 par
stock for $10 per share?
A. It will increase by $1,000.
B. It will increase by $9,000.
C. It will decrease by $9,000.
D. It will remain unchanged.
41. What will be the effect on retained earnings if a firm with 5,000 shares outstanding earns
$10 per share and has a 30% plowback ratio? It will increase by:
A. $15,000.
B. $30,000.
C. $35,000.
D. $50,000.
42. What is the book value per share of equity for a firm with $1 million in net common equity,
$50,000 in authorized share capital, 25,000 shares issued, and 20,000 shares outstanding?
A. $38.00
B. $40.00
C. $47.50
D. $50.00
14-5
Chapter 013 Introduction to Corporate Financing and Governance
43. What type of voting does a corporation have if there are two directors to elect and Director
Jones received 50 votes from a shareholder who owns 100 shares?
A. Majority voting
B. Cumulative voting
C. Supermajority voting
D. Cannot tell voting type from given information.
44. If a corporation uses cumulative voting, then ______ of a shareholder's votes _____ be cast
for one candidate.
A. some; must
B. none; can
C. all; can
D. all; must
45. A proxy contest is typically one in which:
A. the Board attempts to gain control from the shareholders.
B. management attempts to gain control from the Directors.
C. outsiders attempt to gain control from management.
D. the Board attempts to gain control from the Directors.
14-6
Chapter 013 Introduction to Corporate Financing and Governance
46. A corporation's net worth is composed of the:
A. book value of common equity.
B. par value plus additional paid-in capital.
C. retained earnings less treasury stock.
D. book value of common equity plus preferred stock.
47. ABC Corporation has fallen upon hard times and dividends on their non-cumulative,
preferred stock have not been paid for three years. Which of the following is true?
A. Common shareholders must now receive three years' worth of dividends.
B. Preferred shareholders must now receive three years' worth of dividends.
C. The corporation must fold if preferred shareholders are not paid.
D. Common shareholders have not received dividends for three years.
48. What tax liability is created by a corporation in the 35% tax bracket that receives $50,000 in
preferred stock dividends?
A. $0
B. $5,250
C. $12,250
D. $17,500
$50,000 x .3 x .35 = $5,250
49. Which of the following statements about floating-rate preferred stock is correct?
A. Its dividends increase as interest rates increase.
B. Its market price increases at a set rate annually.
C. It is the only stock issued without a par value.
D. Its dividends are deductible for tax purposes by the paying corporation.
50. Funded debt refers to those liabilities that:
A. have established a sinking fund for repayment.
B. are not callable at the option of the firm.
C. are secured by specific collateral.
D. have a maturity of more than one year remaining.
51. The purpose of a sinking fund is to:
A. reduce the par value of stock over time.
B. take advantage of the tax break on preferred stock.
C. periodically retire debt prior to final maturity.
D. allow risky corporations to avoid bankruptcy.
14-7
Chapter 013 Introduction to Corporate Financing and Governance
52. Which of the following forms of debt would be likely to offer debtholders the lowest
interest rate?
A. Secured debt that is not callable.
B. Secured debt with a sinking fund.
C. Subordinated debt that is callable.
D. Subordinated debt with a sinking fund.
53. When corporations default on their debt:
A. bondholders may receive the firm's assets.
B. bondholders will suffer a loss.
C. the Board of Directors is liable for the payments.
D. the corporation is forced to default on its stock also.
14-8