FINA 3332: Exam 1 Practice Questions
and All Solved Solutions Graded A+
What are the main advantages of organizing a firm as a corporation? - Answer 1. There is no
limit on the number of owners a corporation may have, thus allowing the corporation to raise
substantial amounts of capital.
2. The life of the business can continue beyond the death of any of the owners.
3. The liability of the owners is limited to the amount of their investments in the firm.
What are the main disadvantages of organizing a firm as a corporation? - Answer 1. Income
to a corporation is subject to double taxation, once at the corporate level and again when
received by the owners in the form of a dividend.
2. The corporation is more complicated and more expensive to set up than other business
entities.
Which organization forms give their owners limited liability? **** - Answer Limited
partnership for limited partners only.
Corporation.
What is the most important difference between a corporation and all other organizational
forms? - Answer 1. An important difference amount the types of corporate organizational
forms is the way they are taxed. Shareholders of a corporation pay taxes twice.
2. This system is sometimes referred to as double taxation
What does the phrase limited liability mean in a corporate context? - Answer Owners' liability
IS limited to the amount they invested in the firm. Stockholders ARE NOT responsible for any
encumbrances of the firm; in particular, they CANNOT be required to pay back any debts
incurred by the firm.
Explain the difference between an S and a C corporation. - Answer The profits and losses of
the S corporation are passed directly to shareholders and are not subject to corporate taxes,
while the C corporation must first pay taxes on any profits before passing the after-tax profits on
to shareholders. In addition, the S corporation can have no more than 100 shareholders, all of
whom must be US citizens or residents. The C corporation does not have any such restrictions
on its shareholders.
, What is the most important type of decision that the financial manager makes? - Answer The
financial manager's most important job is to make the firm's investment decisions.
Why do all shareholders agree on the same goal for the financial manager? - Answer 1. All of
the decisions by the financial manager are made within the context of the overriding goal of
financial management - to maximize the wealth of the owners, the stockholders.
2. The stockholders have invested in the corporation, putting their money at risk to become the
owners of the corporation.
Corporate managers work for the owners of the corporation. Consequently, they should make
decisions that are in the interests of the owners,rather than in their own interests. What
strategies are available to shareholders to help ensure that managers are motivated to act this
way? - Answer 1. Mount hostile takeovers.
2. Write contracts that ensure that the interests of the managers and shareholders are closely
aligned.
3. Ensure that employees are paid with company stock and/or stock options.
4. Ensure that underperforming managers are fired.
Recall the last time you ate at an expensive restaurant where you paid the bill. Now think about
the last time you ate at a similar restaurant, but your parents paid the bill. Did you order more
food (or more expensive food) when your parents paid?
Explain how this relates to the agency problem in corporations. - Answer 1. The agency
problem leads an individual (in your case) and corporate managers (in the corporate setting) to
put their own self-interest ahead of the interests of the shareholders (your parents in your
case).
2. In both situations there may be a lack of interest in controlling costs if those costs are not
borne directly by the person making the decision.
Suppose you are considering renting an apartment. You, the renter, can be viewed as an agent
while the company that owns the apartment can be viewed as the principal. What agency
conflicts do you anticipate? Suppose, instead, that you work for the apartment company. What
features would you put into the lease that would give the renter incentives to take good care of
the apartment? - Answer The agent (renter) will not take the same care of the apartment as
the principal (owner), because the renter does not share in the costs of fixing damages to the
apartment. To mitigate this problem, having the renter pay a deposit should motivate the renter
to keep damages to a minimum. The deposit forces the renter to share in the costs of fixing any
and All Solved Solutions Graded A+
What are the main advantages of organizing a firm as a corporation? - Answer 1. There is no
limit on the number of owners a corporation may have, thus allowing the corporation to raise
substantial amounts of capital.
2. The life of the business can continue beyond the death of any of the owners.
3. The liability of the owners is limited to the amount of their investments in the firm.
What are the main disadvantages of organizing a firm as a corporation? - Answer 1. Income
to a corporation is subject to double taxation, once at the corporate level and again when
received by the owners in the form of a dividend.
2. The corporation is more complicated and more expensive to set up than other business
entities.
Which organization forms give their owners limited liability? **** - Answer Limited
partnership for limited partners only.
Corporation.
What is the most important difference between a corporation and all other organizational
forms? - Answer 1. An important difference amount the types of corporate organizational
forms is the way they are taxed. Shareholders of a corporation pay taxes twice.
2. This system is sometimes referred to as double taxation
What does the phrase limited liability mean in a corporate context? - Answer Owners' liability
IS limited to the amount they invested in the firm. Stockholders ARE NOT responsible for any
encumbrances of the firm; in particular, they CANNOT be required to pay back any debts
incurred by the firm.
Explain the difference between an S and a C corporation. - Answer The profits and losses of
the S corporation are passed directly to shareholders and are not subject to corporate taxes,
while the C corporation must first pay taxes on any profits before passing the after-tax profits on
to shareholders. In addition, the S corporation can have no more than 100 shareholders, all of
whom must be US citizens or residents. The C corporation does not have any such restrictions
on its shareholders.
, What is the most important type of decision that the financial manager makes? - Answer The
financial manager's most important job is to make the firm's investment decisions.
Why do all shareholders agree on the same goal for the financial manager? - Answer 1. All of
the decisions by the financial manager are made within the context of the overriding goal of
financial management - to maximize the wealth of the owners, the stockholders.
2. The stockholders have invested in the corporation, putting their money at risk to become the
owners of the corporation.
Corporate managers work for the owners of the corporation. Consequently, they should make
decisions that are in the interests of the owners,rather than in their own interests. What
strategies are available to shareholders to help ensure that managers are motivated to act this
way? - Answer 1. Mount hostile takeovers.
2. Write contracts that ensure that the interests of the managers and shareholders are closely
aligned.
3. Ensure that employees are paid with company stock and/or stock options.
4. Ensure that underperforming managers are fired.
Recall the last time you ate at an expensive restaurant where you paid the bill. Now think about
the last time you ate at a similar restaurant, but your parents paid the bill. Did you order more
food (or more expensive food) when your parents paid?
Explain how this relates to the agency problem in corporations. - Answer 1. The agency
problem leads an individual (in your case) and corporate managers (in the corporate setting) to
put their own self-interest ahead of the interests of the shareholders (your parents in your
case).
2. In both situations there may be a lack of interest in controlling costs if those costs are not
borne directly by the person making the decision.
Suppose you are considering renting an apartment. You, the renter, can be viewed as an agent
while the company that owns the apartment can be viewed as the principal. What agency
conflicts do you anticipate? Suppose, instead, that you work for the apartment company. What
features would you put into the lease that would give the renter incentives to take good care of
the apartment? - Answer The agent (renter) will not take the same care of the apartment as
the principal (owner), because the renter does not share in the costs of fixing damages to the
apartment. To mitigate this problem, having the renter pay a deposit should motivate the renter
to keep damages to a minimum. The deposit forces the renter to share in the costs of fixing any
