Chapter 1 An Introduction to the Foundations of Financial Management
Learning Objective 1.1
1) Financial management deals with the maintenance and creation of economic value or wealth.
Answer: TRUE
Diff: 1 Page Ref: 31
Keywords: Financial Management
Learning Obj.: L.O. 1.1
AACSB: Reflective Thinking
2) Each financial decision made by a corporate manager can be evaluated by its direct impact on the
corporation's stock price.
Answer: FALSE
Diff: 1 Page Ref: 32
Keywords: Goal of the Firm
Learning Obj.: L.O. 1.1
AACSB: Reflective Thinking
3) The fundamental goal of a business is to maximize the retained earnings available to the corporation's
shareholders.
Answer: FALSE
Diff: 1 Page Ref: 31
Keywords: Goal of the Firm
Learning Obj.: L.O. 1.1
AACSB: Reflective Thinking
4) Shareholder wealth maximization means maximizing the price of the existing common stock.
Answer: TRUE
Diff: 1 Page Ref: 31
Keywords: Shareholder Wealth, Goal of the Firm
Learning Obj.: L.O. 1.1
AACSB: Reflective Thinking
5) It is important to evaluate a corporate manager's financial decision by measuring the effect the decision
should have on the corporation's stock price if everything else were held constant.
Answer: TRUE
Diff: 2 Page Ref: 32
Keywords: Goal of the Firm, Maximize Shareholder Wealth
Learning Obj.: L.O. 1.1
AACSB: Reflective Thinking
6) Corporate managers should accept investment projects that maximize profits in the short run because of the
time value of money.
Answer: FALSE
Diff: 2 Page Ref: 32
Keywords: Goal of the Firm, Profits, Time Value of Money
Learning Obj.: L.O. 1.1
AACSB: Reflective Thinking
Page 1
Copyright © 2020 Pearson Education Ltd.
, 7) The goal of the firm's financial managers should be the maximization of the total value of the firm's stock.
Answer: TRUE
Diff: 1 Page Ref: 31
Keywords: Goal of the Firm
Learning Obj.: L.O. 1.1
AACSB: Reflective Thinking
8) The payment of a dividend to current shareholders will have no impact on a corporation's share price
because the cash paid is not available to future potential shareholders who may want to buy the
corporation's stock.
Answer: FALSE
Diff: 1 Page Ref: 32
Keywords: Goal of the Firm
Learning Obj.: L.O. 1.1
AACSB: Reflective Thinking
9) One problem with maximization of shareholder wealth as a goal is that it ignores risk taken by the firm's
financial decisions.
Answer: FALSE
Diff: 1 Page Ref: 32
Keywords: Goal of the Firm
Learning Obj.: L.O. 1.1
AACSB: Reflective Thinking
10) The goal of profit maximization ignores the risk of financial decisions.
Answer: FALSE
Diff: 1 Page Ref: 32
Keywords: Goal of the Firm
Learning Obj.: L.O. 1.1
AACSB: Reflective Thinking
11) Only a firm's financial decisions affect its stock prices.
Answer: FALSE
Diff: 1 Page Ref: 32
Keywords: Determinants of Stock Price
Learning Obj.: L.O. 1.1
AACSB: Reflective Thinking
12) Shareholders react to poor investment or dividend decisions by causing the total value of the firm's stock to
fall, and they react to good decisions by bidding the price of the stock up.
Answer: TRUE
Diff: 2 Page Ref: 32
Keywords: Determinants of Stock Price
Learning Obj.: L.O. 1.1
AACSB: Reflective Thinking
Page 2
Copyright © 2020 Pearson Education Ltd.
,13) The primary goal of a publicly owned corporation is to
A) maximize dividends per share
B) maximize shareholder wealth
C) maximize earnings per share after taxes
D) minimize shareholder risk
Answer: B
Diff: 1 Page Ref: 31
Keywords: Goal of the Firm, Corporation
Learning Obj.: L.O. 1.1
AACSB: Reflective Thinking
14) Maximization of shareholder wealth
A) represents a zero sum game in which one corporation gains at the expense of others.
B) provides benefits to society as scarce resources are directed to their most productive use.
C) is not a practical goal since it cannot be measured effectively.
D) is achieved only if cash flows exceed accounting profits.
Answer: B
Diff: 1 Page Ref: 31
Keywords: Goal of the Firm, Maximize Shareholder Wealth
Learning Obj.: L.O. 1.1
AACSB: Reflective Thinking
15) A financial manager is considering two projects, A and B. A is expected to add $2 million to profits this year
while B is expected to add $1 million to profits this year. Which of the following statements is MOST correct?
A) The manager should select project A because it maximizes profits.
B) The manager should select the project that maximizes long-term profits, not just one year of profits.
C) The manager should select project A or he is irrational.
D) The manager should select the project that causes the stock price to increase the most, which could be
A or B.
Answer: D
Diff: 2 Page Ref: 32
Keywords: Goal of the Firm
Learning Obj.: L.O. 1.1
AACSB: Analytical Thinking
16) Shareholder wealth maximization means
A) maximizing earnings per share.
B) maximizing dividends per share.
C) maximizing the price of existing common stock.
D) maximizing stockholders equity.
Answer: C
Diff: 1 Page Ref: 32
Keywords: Goal of the Firm, Maximize Shareholder Wealth
Learning Obj.: L.O. 1.1
AACSB: Reflective Thinking
Page 3
Copyright © 2020 Pearson Education Ltd.
, 17) The goal of the firm should be
A) maximization of profits (net income per share).
B) maximization of shareholder wealth.
C) maximization of market share.
D) maximization of sales.
Answer: B
Diff: 1 Page Ref: 31
Keywords: Goal of the Firm, Maximize Shareholder Wealth
Learning Obj.: L.O. 1.1
AACSB: Reflective Thinking
18) Which of the following goals of the firm are synonymous (equivalent) to the maximization of shareholder
wealth?
A) profit maximization
B) risk minimization
C) maximization of the total market value of the firm's common stock
D) none of the above
Answer: C
Diff: 1 Page Ref: 32
Keywords: Goal of the Firm, Maximize Shareholder Wealth
Learning Obj.: L.O. 1.1
AACSB: Reflective Thinking
19) Which of the following is the most important goal that a corporation should strive for?
A) maximize current profits
B) maximize market share
C) maximize revenue
D) maximize shareholder wealth
Answer: D
Diff: 1 Page Ref: 31
Keywords: Goal of the Firm, Maximize Shareholder Wealth
Learning Obj.: L.O. 1.1
AACSB: Reflective Thinking
20) One of the causes of the recent financial crisis in the United States has been excessive risk taking due to
underestimation of risk. How does this relate to shareholder wealth maximization and financial leverage?
Can overestimation of risk also be detrimental?
Answer: Underestimation of risk can lead managers to borrow excessively to fund more and more projects.
High levels of debt require interest and principal payments which may become impossible to make if
the company's cash flows are reduced, even for short periods of time. Overestimation of risk can also
be problematic. Managers who take on too little risk may be passing up desirable projects that could
increase shareholder wealth. The principle that risk requires a reward does not mean that all risk is
bad, but rather that additional risk is ok if additional expected returns are high enough. If all risk was
bad, companies would go out of business and all investors would buy U.S. Treasury bills.
Diff: 2 Page Ref: 32, 37
Keywords: Risk Requires a Reward, Goal of the Firm
Learning Obj.: L.O. 1.1
AACSB: Reflective Thinking
Page 4
Copyright © 2020 Pearson Education Ltd.
Learning Objective 1.1
1) Financial management deals with the maintenance and creation of economic value or wealth.
Answer: TRUE
Diff: 1 Page Ref: 31
Keywords: Financial Management
Learning Obj.: L.O. 1.1
AACSB: Reflective Thinking
2) Each financial decision made by a corporate manager can be evaluated by its direct impact on the
corporation's stock price.
Answer: FALSE
Diff: 1 Page Ref: 32
Keywords: Goal of the Firm
Learning Obj.: L.O. 1.1
AACSB: Reflective Thinking
3) The fundamental goal of a business is to maximize the retained earnings available to the corporation's
shareholders.
Answer: FALSE
Diff: 1 Page Ref: 31
Keywords: Goal of the Firm
Learning Obj.: L.O. 1.1
AACSB: Reflective Thinking
4) Shareholder wealth maximization means maximizing the price of the existing common stock.
Answer: TRUE
Diff: 1 Page Ref: 31
Keywords: Shareholder Wealth, Goal of the Firm
Learning Obj.: L.O. 1.1
AACSB: Reflective Thinking
5) It is important to evaluate a corporate manager's financial decision by measuring the effect the decision
should have on the corporation's stock price if everything else were held constant.
Answer: TRUE
Diff: 2 Page Ref: 32
Keywords: Goal of the Firm, Maximize Shareholder Wealth
Learning Obj.: L.O. 1.1
AACSB: Reflective Thinking
6) Corporate managers should accept investment projects that maximize profits in the short run because of the
time value of money.
Answer: FALSE
Diff: 2 Page Ref: 32
Keywords: Goal of the Firm, Profits, Time Value of Money
Learning Obj.: L.O. 1.1
AACSB: Reflective Thinking
Page 1
Copyright © 2020 Pearson Education Ltd.
, 7) The goal of the firm's financial managers should be the maximization of the total value of the firm's stock.
Answer: TRUE
Diff: 1 Page Ref: 31
Keywords: Goal of the Firm
Learning Obj.: L.O. 1.1
AACSB: Reflective Thinking
8) The payment of a dividend to current shareholders will have no impact on a corporation's share price
because the cash paid is not available to future potential shareholders who may want to buy the
corporation's stock.
Answer: FALSE
Diff: 1 Page Ref: 32
Keywords: Goal of the Firm
Learning Obj.: L.O. 1.1
AACSB: Reflective Thinking
9) One problem with maximization of shareholder wealth as a goal is that it ignores risk taken by the firm's
financial decisions.
Answer: FALSE
Diff: 1 Page Ref: 32
Keywords: Goal of the Firm
Learning Obj.: L.O. 1.1
AACSB: Reflective Thinking
10) The goal of profit maximization ignores the risk of financial decisions.
Answer: FALSE
Diff: 1 Page Ref: 32
Keywords: Goal of the Firm
Learning Obj.: L.O. 1.1
AACSB: Reflective Thinking
11) Only a firm's financial decisions affect its stock prices.
Answer: FALSE
Diff: 1 Page Ref: 32
Keywords: Determinants of Stock Price
Learning Obj.: L.O. 1.1
AACSB: Reflective Thinking
12) Shareholders react to poor investment or dividend decisions by causing the total value of the firm's stock to
fall, and they react to good decisions by bidding the price of the stock up.
Answer: TRUE
Diff: 2 Page Ref: 32
Keywords: Determinants of Stock Price
Learning Obj.: L.O. 1.1
AACSB: Reflective Thinking
Page 2
Copyright © 2020 Pearson Education Ltd.
,13) The primary goal of a publicly owned corporation is to
A) maximize dividends per share
B) maximize shareholder wealth
C) maximize earnings per share after taxes
D) minimize shareholder risk
Answer: B
Diff: 1 Page Ref: 31
Keywords: Goal of the Firm, Corporation
Learning Obj.: L.O. 1.1
AACSB: Reflective Thinking
14) Maximization of shareholder wealth
A) represents a zero sum game in which one corporation gains at the expense of others.
B) provides benefits to society as scarce resources are directed to their most productive use.
C) is not a practical goal since it cannot be measured effectively.
D) is achieved only if cash flows exceed accounting profits.
Answer: B
Diff: 1 Page Ref: 31
Keywords: Goal of the Firm, Maximize Shareholder Wealth
Learning Obj.: L.O. 1.1
AACSB: Reflective Thinking
15) A financial manager is considering two projects, A and B. A is expected to add $2 million to profits this year
while B is expected to add $1 million to profits this year. Which of the following statements is MOST correct?
A) The manager should select project A because it maximizes profits.
B) The manager should select the project that maximizes long-term profits, not just one year of profits.
C) The manager should select project A or he is irrational.
D) The manager should select the project that causes the stock price to increase the most, which could be
A or B.
Answer: D
Diff: 2 Page Ref: 32
Keywords: Goal of the Firm
Learning Obj.: L.O. 1.1
AACSB: Analytical Thinking
16) Shareholder wealth maximization means
A) maximizing earnings per share.
B) maximizing dividends per share.
C) maximizing the price of existing common stock.
D) maximizing stockholders equity.
Answer: C
Diff: 1 Page Ref: 32
Keywords: Goal of the Firm, Maximize Shareholder Wealth
Learning Obj.: L.O. 1.1
AACSB: Reflective Thinking
Page 3
Copyright © 2020 Pearson Education Ltd.
, 17) The goal of the firm should be
A) maximization of profits (net income per share).
B) maximization of shareholder wealth.
C) maximization of market share.
D) maximization of sales.
Answer: B
Diff: 1 Page Ref: 31
Keywords: Goal of the Firm, Maximize Shareholder Wealth
Learning Obj.: L.O. 1.1
AACSB: Reflective Thinking
18) Which of the following goals of the firm are synonymous (equivalent) to the maximization of shareholder
wealth?
A) profit maximization
B) risk minimization
C) maximization of the total market value of the firm's common stock
D) none of the above
Answer: C
Diff: 1 Page Ref: 32
Keywords: Goal of the Firm, Maximize Shareholder Wealth
Learning Obj.: L.O. 1.1
AACSB: Reflective Thinking
19) Which of the following is the most important goal that a corporation should strive for?
A) maximize current profits
B) maximize market share
C) maximize revenue
D) maximize shareholder wealth
Answer: D
Diff: 1 Page Ref: 31
Keywords: Goal of the Firm, Maximize Shareholder Wealth
Learning Obj.: L.O. 1.1
AACSB: Reflective Thinking
20) One of the causes of the recent financial crisis in the United States has been excessive risk taking due to
underestimation of risk. How does this relate to shareholder wealth maximization and financial leverage?
Can overestimation of risk also be detrimental?
Answer: Underestimation of risk can lead managers to borrow excessively to fund more and more projects.
High levels of debt require interest and principal payments which may become impossible to make if
the company's cash flows are reduced, even for short periods of time. Overestimation of risk can also
be problematic. Managers who take on too little risk may be passing up desirable projects that could
increase shareholder wealth. The principle that risk requires a reward does not mean that all risk is
bad, but rather that additional risk is ok if additional expected returns are high enough. If all risk was
bad, companies would go out of business and all investors would buy U.S. Treasury bills.
Diff: 2 Page Ref: 32, 37
Keywords: Risk Requires a Reward, Goal of the Firm
Learning Obj.: L.O. 1.1
AACSB: Reflective Thinking
Page 4
Copyright © 2020 Pearson Education Ltd.
