TESTBANK FOR Corporate Finance, 3rd Edition by Jonathan Berk and Peter DeMarzo

TESTBANK FOR Corporate Finance, 3rd Edition by Jonathan Berk and Peter DeMarzo Corporate Finance, 3e (Berk/DeMarzo) Chapter 1 The Corporation 1.1 The Four Types of Firms 1) A sole proprietorship is owned by: A) one person. B) two of more persons. C) shareholders. D) bankers. Answer: A Diff: 1 Section: 1.1 The Four Types of Firms Skill: Definition 2) Which of the following organization forms for a business does NOT avoid double taxation? A) Limited partnership B) "C" corporation C) "S" corporation D) Limited liability company Answer: B Diff: 1 Section: 1.1 The Four Types of Firms Skill: Conceptual 3) Which of the following organization forms accounts for the most revenue? A) "S" corporation B) Limited partnership C) "C" corporation D) Limited liability company Answer: C Diff: 1 Section: 1.1 The Four Types of Firms Skill: Conceptual 4) Which of the following organization forms accounts for the greatest number of firms? A) "S" corporation B) Limited partnership C) Sole proprietorship D) "C" corporation Answer: C Diff: 1 Section: 1.1 The Four Types of Firms Skill: Conceptual 5) Which of the following is NOT an advantage of a sole proprietorship? A) Single taxation B) Ease of setup C) Limited liability D) No separation of ownership and control Answer: C Diff: 2 Section: 1.1 The Four Types of Firms Skill: Conceptual 6) Which of the following statements regarding limited partnerships is TRUE? A) There is no limit on a limited partner's liability. B) A limited partner's liability is limited by the amount of their investment. C) A limited partner is not liable until all the assets of the general partners have been exhausted. D) A general partner's liability is limited by the amount of their investment. Answer: B Diff: 2 Section: 1.1 The Four Types of Firms Skill: Conceptual 7) Which of the following is/are an advantage of incorporation? A) Access to capital markets B) Limited liability C) Unlimited life D) All of the above Answer: D Diff: 2 Section: 1.1 The Four Types of Firms Skill: Conceptual 8) Which of the following statements is most correct? A) An advantage to incorporation is that it allows for less regulation of the business. B) An advantage of a corporation is that it is subject to double taxation. C) Unlike a partnership, a disadvantage of a corporation is that has limited liability. D) Corporations face more regulations when compared to partnerships. Answer: D Diff: 2 Section: 1.1 The Four Types of Firms Skill: Conceptual 9) A limited liability company is essentially: A) a limited partnership without limited partners. B) a limited partnership without a general partner. C) just another name for a limited partnership. D) just another name for a corporation. Answer: B Diff: 1 Section: 1.1 The Four Types of Firms Skill: Conceptual 10) The distinguishing feature of a corporation is that: A) their is no legal difference between the corporation and its owners. B) it is a legally defined, artificial being, separate from its owners. C) it spreads liability for its corporate obligations to all shareholders. D) provides limited liability only to small shareholders. Answer: B Diff: 2 Section: 1.1 The Four Types of Firms Skill: Conceptual 11) Which of the following are subject to double taxation? A) Corporation B) Partnership C) Sole proprietorship D) A and B Answer: A Diff: 1 Section: 1.1 The Four Types of Firms Skill: Conceptual 12) You own 100 shares of a "C" corporation. The corporation earns $5.00 per share before taxes. Once the corporation has paid any corporate taxes that are due, it will distribute the rest of its earnings to its shareholders in the form of a dividend. If the corporate tax rate is 40% and your personal tax rate on (both dividend and non-dividend) income is 30%, then how much money is left for you after all taxes have been paid? A) $210 B) $300 C) $350 D) $500 Answer: A Explanation: A) EPS × number of shares × (1 - Corporate Tax Rate) × (1 - Individual Tax Rate) $5.00 per share × 100 shares × (1 - .40) × (1 - .30) = $210 Diff: 2 Section: 1.1 The Four Types of Firms Skill: Analytical 13) You own 100 shares of a Sub Chapter "S" corporation. The corporation earns $5.00 per share before taxes. Once the corporation has paid any corporate taxes that are due, it will distribute the rest of its earnings to its shareholders in the form of a dividend. If the corporate tax rate is 40% and your personal tax rate on (both dividend and non-dividend) income is 30%, then how much money is left for you after all taxes have been paid? A) $210 B) $300 C) $350 D) $500 Answer: C Explanation: C) EPS × number of shares × (1 - Individual Tax Rate) $5.00 per share × 100 shares × (1 - .30) = $350 Diff: 2 Section: 1.1 The Four Types of Firms Skill: Analytical 14) You are a shareholder in a "C" corporation. This corporation earns $4 per share before taxes. After it has paid taxes, it will distribute the remainder of its earnings to you as a dividend. The dividend is income to you, so you will then pay taxes on these earnings. The corporate tax rate is 35% and your tax rate on dividend income is 15%. The effective tax rate on your share of the corporations earnings is closest to: A) 15% B) 35% C) 45% D) 50% Answer: C Explanation: C) First the corporation pays taxes. It earned $4 per share, but must pay $4 × .35 = $1.40 to the government in corporate taxes. That leaves $4.00 - $1.40 = $2.60 to distribute to the shareholders. However, the shareholder must pay $2.60 × .15 = $0.39 in income taxes on this amount, leaving only $2.21 to the shareholder after all taxes are paid. The total amount paid in taxes is $1.40 + 0.39 = $1.79. The effective tax rate is then $1.79 ÷ $4 = .4475 or 44.75% which is closest to 45%. Diff: 3 Section: 1.1 The Four Types of Firms Skill: Analytical 15) Explain the benefits of incorporation. Answer: 1. Limited liability 2. Unlimited life 3. Access to capital markets/availability of outside funding Diff: 2 Section: 1.1 The Four Types of Firms Skill: Conceptual 16) Explain the difference between a sub-chapter "S" corporation and a sub-chapter "C" corporation. Answer: "C" Corporation "S" Corporation Publicly traded stock Privately traded stock Unlimited shareholders No more than 75 shareholders Double taxation Taxed like a partnership Diff: 2 Section: 1.1 The Four Types of Firms Skill: Conceptual 1.2 Ownership Versus Control of Corporations 1) In a corporation, the ultimate decisions regarding business matters are made by: A) the Board of Directors. B) debt holders. C) shareholders. D) investors. Answer: A Diff: 1 Section: 1.2 Ownership Versus Control of Corporations Skill: Conceptual 2) The person charged with running the corporation by instituting the rules and policies set by the board of directors is called: A) the chief operating officer. B) the company president. C) the chief executive officer. D) the chief financial officer. Answer: C Diff: 1 Section: 1.2 Ownership Versus Control of Corporations Skill: Definition 3) The Principal-Agent Problem arises: A) because managers have little incentive to work in the interest of shareholders when this means working against their own self-interest. B) because of the separation of ownership and control in a corporation. C) Both A and B D) None of the above Answer: C Diff: 1 Section: 1.2 Ownership Versus Control of Corporations Skill: Conceptual 4) If shareholders are unhappy with a CEO's performance, they are most likely to: A) buy more shares in an effort to gain control of the firm. B) file a shareholder resolution. C) replace the CEO through a grassroots shareholder uprising. D) sell their shares. Answer: D Diff: 2 Section: 1.2 Ownership Versus Control of Corporations Skill: Conceptual 5) A ________ is when a rich individual or organization purchases a large fraction of the stock of a poorly performing firm and in doing so gets enough votes to replace the board of directors and the CEO. A) shareholder proposal B) leveraged buyout C) shareholder action D) hostile takeover Answer: D Diff: 2 Section: 1.2 Ownership Versus Control of Corporations Skill: Definition 6) Which of the following statements is FALSE? A) In bankruptcy, management is given the opportunity to reorganize the firm and renegotiate with debt holders. B) Because a corporation is a separate legal entity, when it fails to repay its debts, the people who lent to the firm, the debt holders are entitled to seize the assets of the corporation in compensation for the default. C) As long as the corporation can satisfy the claims of the debt holders, ownership remains in the hands of the equity holders. D) If the corporation fails to satisfy debt holders' claims, debt holders may lose control of the firm. Answer: D Explanation: D) If the corporation fails to satisfy debt holders' claims, debt holders may take control of the firm. Diff: 2 Section: 1.2 Ownership Versus Control of Corporations Skill: Conceptual 7) The most senior financial manager in a corporation is usually called: A) the chief executive officer. B) the chief financial officer. C) the chief operating officer. D) the chairman of the board. Answer: B Diff: 1 Section: 1.2 Ownership Versus Control of Corporations Skill: Definition 8) You overhear your manager saying that she plans to book an Ocean-view room on her upcoming trip to Miami for a meeting. You know that the interior rooms are much less expensive, but that your manager is traveling at the Company's expense. This use of additional funds comes about as a result of: A) an agency problem. B) an adverse selection problem. C) a moral hazard. D) a publicity problem. Answer: A Diff: 1 Section: 1.2 Ownership Versus Control of Corporations Skill: Definition 9) An agency problem can be alleviated by: A) requiring all firms to be sole proprietorships. B) compensating managers in such a way that acting in the best interest of shareholders is also in the best interest of managers. C) asking managers to take on more risk than they are comfortable taking. D) A and B. Answer: D Diff: 1 Section: 1.2 Ownership Versus Control of Corporations Skill: Definition 10) Do corporate decisions that increase the value of the firm's equity benefit society as a whole? A) Yes, as long as the value of the firm's equity increases, society is better off. B) Yes, as long as the increase in the value of the firm's equity does not come at the expense of others. C) No, any gain in the value of the firm's equity is always less than the cost to society. D) No, any gains in the value of the firm's equity are perfectly offset by societal costs. Answer: B Diff: 1 Section: 1.2 Ownership Versus Control of Corporations Skill: Conceptual 11) What strategies are available to shareholders to help ensure that managers are motivated to act in the interest of the shareholders rather than their own interest? Answer: 1. The threat of a hostile takeover 2. Shareholder initiatives 3. Performance based compensation Diff: 3 Section: 1.2 Ownership Versus Control of Corporations Skill: Conceptual 1.3 The Stock Market Use the table for the question(s) below. Consider the following two quotes for XYZ stock: November 11th November 18th Ask: 25.25 Ask: 26.00 Bid: 25.20 Bid: 25.93 1) How much would you have to pay to purchase 100 shares of XYZ stock on November 18th? A) $2520 B) $2525 C) $2593 D) $2600 Answer: D Explanation: D) 100 shares × $26.00 (ask price) = $2600 Diff: 1 Section: 1.3 The Stock Market Skill: Analytical 2) How much would you receive if you sold 200 shares of XYZ stock on November 11th? A) $5050 B) $5040 C) $5186 D) $5200 Answer: B Explanation: B) 200 shares × $25.20 (bid price) = $5040 Diff: 1 Section: 1.3 The Stock Market Skill: Analytical 3) The largest stock market in the world is: A) the London Stock Exchange. B) NASDAQ. C) the American Stock Exchange. D) the New York Stock Exchange. Answer: D Diff: 1 Section: 1.3 The Stock Market Skill: Definition 4) An investment is said to be liquid if the investment: A) has large day to day fluctuations in price. B) has a large bid-ask spread. C) can easily be converted into cash. D) is traded on a stock exchange. Answer: C Diff: 2 Section: 1.3 The Stock Market Skill: Definition 5) What type of company trades on an organized stock exchange? A) A limited liability company B) A private company C) An "S" corporation D) A public company Answer: D Diff: 1 Section: 1.3 The Stock Market Skill: Definition 6) Which of the following statements is FALSE? A) On Nasdaq, stocks can and do have multiple market makers who compete with each other. Each market maker must post bid and ask prices in the Nasdaq network where they can be viewed by all participants. B) Bid prices exceed ask prices. C) Because customers always buy at the ask and sell at the bid, the bid-ask spread is a transaction cost investors have to pay in order to trade. D) On the floor of the NYSE, market makers (known on the NYSE as specialists) match buyers and sellers. Answer: B Explanation: B) Ask prices exceed bid prices. Diff: 2 Section: 1.3 The Stock Market Skill: Conceptual 7) If you buy shares of Coca-Cola on the primary market: A) Coca-Cola receives the money because the company has issued new shares. B) you buy the shares from another investor who decided to sell the shares. C) you buy the shares from the New York Stock Exchange. D) you buy the shares from the Federal Reserve. Answer: A Diff: 1 Section: 1.3 The Stock Market Skill: Definition 8) If you buy shares of Coca-Cola on the secondary market: A) Coca-Cola receives the money because the company has issued new shares. B) you buy the shares from another investor who decided to sell the shares. C) you buy the shares from the New York Stock Exchange. D) you buy the shares from the Federal Reserve. Answer: B Diff: 1 Section: 1.3 The Stock Market Skill: Definition Use the table for the question(s) below. Consider the following two quotes for XYZ stock: November 11th November 18th Ask: 25.25 Ask: 26.00 Bid: 25.20 Bid: 25.93 9) What are your net proceeds if you purchased 2500 shares of XYZ stock on November 11th and then sold them a week later on November 18th? Answer: buy at ask price 11/11 = 2500 × $25.25 = $63,125 sell at bid price 11/18 = 2500 × $25.93 = $64,825 now subtract the price paid for the shares so net proceeds = 64,825 - 63,125 = $1700 Diff: 2 Section: 1.3 The Stock Market Skill: Analytical 10) Explain the main differences between the NYSE and NASDAQ stock markets. Answer: Key points: NYSE has physical location—NASDAQ is an electronic market. NYSE has one specialist in each stock and his role is to match buyers and sellers. NASDAQ has multiple market makers (dealers) in each stock who stand ready to trade on their own accounts. Diff: 2 Section: 1.3 The Stock Market Skill: Conceptual Corporate Finance, 3e (Berk/DeMarzo) Chapter 2 Introduction to Financial Statement Analysis 2.1 Firms' Disclosure of Financial Information 1) U.S. public companies are required to file their annual financial statements with the U.S. Securities and Exchange Commission on which form? A) 10-A B) 10-K C) 10-Q D) 10-SEC Answer: B Diff: 1 Section: 2.1 Firms' Disclosure of Financial Information Skill: Definition 2) Which of the following is NOT a financial statement that every public company is required to produce? A) Income Statement B) Statement of Sources and Uses of Cash C) Balance Sheet D) Statement of Stockholders' Equity Answer: B Diff: 2 Section: 2.1 Firms' Disclosure of Financial Information Skill: Conceptual 3) The third party who checks annual financial statements to ensure that they are prepared according to GAAP and verifies that the information reported is reliable is the: A) NYSE Enforcement Board. B) Accounting Standards Board. C) Securities and Exchange Commission (SEC). D) auditor. Answer: D Diff: 1 Section: 2.1 Firms' Disclosure of Financial Information Skill: Definition 4) What is the role of an auditor in financial statement analysis? Answer: Key points: 1. To ensure that the annual financial statements are prepared accurately. 2. To ensure that the annual financial statements are prepared according to GAAP. 3. To verify that the information used in preparing the annual financial statements is reliable. Diff: 2 Section: 2.1 Firms' Disclosure of Financial Information Skill: Conceptual 5) What are the four financial statements that all public companies must produce? Answer: 1. Balance Sheet 2. Income Statement 3. Statement of Cash Flows 4. Statement of Stockholder's Equity Diff: 2 Section: 2.1 Firms' Disclosure of Financial Information Skill: Conceptual 2.2 The Balance Sheet 1) Which of the following balance sheet equations is INCORRECT? A) Assets - Liabilities = Shareholders' Equity B) Assets = Liabilities + Shareholders' Equity C) Assets - Current Liabilities = Long Term Liabilities D) Assets - Current Liabilities = Long Term Liabilities + Shareholders' Equity Answer: C Diff: 2 Section: 2.2 The Balance Sheet Skill: Conceptual 2) Cash is a: A) long-term asset. B) current asset. C) current liability. D) long-term liability. Answer: B Diff: 1 Section: 2.2 The Balance Sheet Skill: Definition 3) Accounts payable is a: A) long-term liability. B) current asset. C) long-term asset. D) current liability. Answer: D Diff: 1 Section: 2.2 The Balance Sheet Skill: Definition 4) A 30 year mortgage loan is a: A) long-term liability. B) current liability. C) current asset. D) long-term asset. Answer: A Diff: 1 Section: 2.2 The Balance Sheet Skill: Definition 5) Which of the following statements regarding the balance sheet is INCORRECT? A) The balance sheet provides a snapshots of the firm's financial position at a given point in time. B) The balance sheet lists the firm's assets and liabilities. C) The balance sheet reports stockholders' equity on the right hand side. D) The balance sheet reports liabilities on the left hand side. Answer: D Diff: 2 Section: 2.2 The Balance Sheet Skill: Conceptual 6) Dustin's Donuts experienced a decrease in the value of the trademark of a company it acquired two years ago. This reduction in value results in: A) an impairment charge. B) depreciation expense. C) an operating expense. D) goodwill. Answer: A Diff: 1 Section: 2.2 The Balance Sheet Skill: Definition 7) Which of the following is an example of an intangible asset? A) Brand names and trademarks B) Patents C) Customer relationships D) All of the above are intangible assets. Answer: D Diff: 1 Section: 2.2 The Balance Sheet Skill: Definition 8) On the balance sheet, short-term debt appears: A) in the Stockholders' Equity section. B) in the Operating Expenses section. C) in the Current Assets section. D) in the Current Liabilities section. Answer: D Diff: 1 Section: 2.2 The Balance Sheet Skill: Definition 9) On the balance sheet, current maturities of long-term debt appears: A) in the Stockholders' Equity section. B) in the Operating Expenses section. C) in the Current Assets section. D) in the Current Liabilities section. Answer: D Diff: 1 Section: 2.2 The Balance Sheet Skill: Definition 10) The firm's assets and liabilities at a given point in time are reported on the firm's: A) income statement or statement of financial performance. B) income statement or statement of financial position. C) balance sheet or statement of financial performance. D) balance sheet or statement of financial position. Answer: D Diff: 1 Section: 2.2 The Balance Sheet Skill: Definition 11) The statement of financial position is also known as the: A) balance sheet. B) income statement. C) statement of cash flows. D) statement of stockholder's equity. Answer: A Diff: 1 Section: 2.2 The Balance Sheet Skill: Definition Use the following information for ECE incorporated: Assets $200 million Shareholder Equity $100 million Sales $300 million Net Income $15 million Interest Expense $2 million 12) If ECE's stock is currently trading at $24.00 and ECE has 25 million shares outstanding, then ECE's market-to-book ratio is closest to: A) 0.24 B) 4 C) 6 D) 30 Answer: C Explanation: C) Market to Book = (MV Equity)/(BV Equity) = ($24 × 25 million)/100 million = 6.0 Diff: 2 Section: 2.2 The Balance Sheet Skill: Analytical Use the information for the question(s) below. In November 2009, Perrigo Co. (PRGO) had a share price of $39.20. They had 91.33 million shares outstanding, a market-to-book ratio of 3.76. In addition, PRGO had $845.01 million in outstanding debt, $163.82 million in net income, and cash of $257.09 million. 13) Perrigo's market capitalization is closest to: A) $952.16 million B) $3,580.14 million C) $4,168.06 million D) $4,425.15 million Answer: B Explanation: B) Market cap = price × shares outstanding = $39.2 × 91.33 million = $3,580.14 million Diff: 1 Section: 2.2 The Balance Sheet Skill: Analytical 14) Perrigo's book value of equity is closest to: A) $952.16 million B) $3,580.14 million C) $4,168.06 million D) $4,425.15 million Answer: A Explanation: A) Market to Book = (MV Equity)/(BV Equity) = ($39.2 × 91.33 million)/(BV Equity) = 3.76; BV Equity = $952.16 million. Diff: 2 Section: 2.2 The Balance Sheet Skill: Analytical 15) Perrigo's enterprise value is closest to: A) $952.16 million B) $3,580.14 million C) $4,168.06 million D) $4,425.15 million Answer: C Explanation: C) Enterprise Value = MV Equity + Debt - Cash = $39.2 × 91.33 +$845.01 - $257.09 = $4168.06 Diff: 2 Section: 2.2 The Balance Sheet Skill: Analytical