Chapter 1-3_Review Materials.pdf

Corporate Finance_Chapter 1 Review Materials Finance and the firm 1) A firm is a business organization that sells goods and services. Answer: TRUE 2) In finance we say that the goal of the firm ought to be to maximize profits. Answer: FALSE 3) Other things being equal, it is better to receive money sooner rather than later. Answer: TRUE 4) Financial managers evaluating decision alternatives or potential actions must consider ________. A) only risk B) only return C) either risk or return D) risk, return, and the impact on share price Answer: D 5) If a firm earns a profit, it will necessarily also generate a positive cash flow. Answer: FALSE 6) If a firm's stockholders are risk averse, the firm will make its stockholders better off by earning the highest possible returns on its investments. Answer: FALSE 7) Which of the following is an example of a firm's stakeholder? A) suppliers B) Federal Reserve C) media D) competitors Answer: A 8) A financial manager must choose between four alternative Assets: 1, 2, 3, and 4. Each asset costs $35,000 and is expected to provide earnings over a three-year period as described below. Based on the wealth maximization goal, the financial manager would choose ________. A) Asset 1 B) Asset 2 C) Asset 3 D) Asset 4 Answer: A 9) In the most recent year, two different companies generated the same earnings per share. The stocks of these two companies should trade at the same price. Answer: FALSE 10) One reason that firms exist is that most investors are risk averse, so they are not willing to make the kinds of risky investments that firms typically undertake. Answer: FALSE 11) Which of the following is true of stakeholders? A) They are the owners of a firm. B) They are groups to whom a firm has financial obligations. C) They are groups having a direct economic link to a firm. D) They include only the bondholders, common stockholders, and preferred stockholders. Answer: C 12) Which of the following is true regarding cash flow? A) Profits do not necessarily result in cash flows available to the stockholders. B) It is guaranteed that the board of directors will increase dividends when net cash flows increase. C) A firm's income statement will never show a positive profit when its cash outflows exceed its cash inflows. D) An increase in revenue will always result in an increase in cash flow. Answer: A 13) Investors who are risk averse will make risky investments as long as they expect sufficient compensation for doing so. Answer: TRUE 14) Which of the following is true of cash flows and risk? A) Lower cash flow and lower risk result in an increase in share price. B) Higher cash flow and lower risk result in an increase in share price. C) Higher cash flow and higher risk result in an increase in share price. D) Lower cash flow and higher risk result in an increase in share price. Answer: B 15) The goal of business ethics is to motivate business and market participants to adhere to both the letter and the spirit of laws and regulations in all aspects of business and professional practice. Answer: TRUE 16) The primary goal of a financial manager is ________. A) minimizing risk B) maximizing profit C) maximizing wealth D) minimizing return Answer: C 17) Corporate owners earn a return ________. A) by realizing gains through increases in share price and interest earnings B) by realizing gains through increases in share price and cash dividends C) through capital appreciation and retained earnings D) through interest earnings and earnings per share Answer: B 18) The wealth of the owners of a corporation is represented by ________. A) profits B) earnings per share C) share value D) cash flow Answer: C 19) Wealth maximization as the goal of a firm implies enhancing the wealth of ________. A) the auditors B) the creditors C) the federal reserve D) the firm's stockholders Answer: D 20) The amount earned during the accounting period on each outstanding share of common stock is called ________. A) dividend per share B) earnings per share C) net profits after taxes D) book value per share Answer: B 21) Firm A generates more cash flow while taking less risk than Firm B. The stock price of Firm A should be higher than the stock price of Firm B. Answer: TRUE 22) Which of the following is NOT a reason that a firm that maximizes profits may fail to maximize shareholder wealth. A) The timing of profits matters. Shareholders might prefer lower profits that arrive sooner. B) Risk matters. Shareholders are risk averse, so they prefer less risky investments that generate lower profits. C) Shareholder wealth depends on cash flow which is not the same as profit. D) If a firm maximizes profits by engaging in unethical business practices, it's stock price may be adversely affected. Answer: B 23) ________ pool investment capital, make risky investment decisions, and manage risky investments on behalf of investors who would otherwise not be able to do so own their own. A) Firms B) Stockholders C) Stakeholders D) Regulators Answer: A 24) Finance is ________. A) the system of verifying, analyzing, and recording business transactions B) the science of the production, distribution, and consumption of goods and services C) the science and art of how individuals and businesses raise, allocate, and invest money D) the art of merchandising products and services Answer: C 25) In a recent quarter, Amazon and Clorox reported nearly identical earnings per share, but the stock price of Amazon was more than six times higher than the Clorox stock price. The most likely explanation for that difference is that ________. A) Clorox is bad for the environment B) Amazon is a riskier company C) investors see better long-term prospects for Amazon D) Amazon has more shares of stock outstanding Answer: C 26) The wealth of corporate owners is measured by the share price of the stock. Answer: TRUE 27) Risk, along with the magnitude and timing of cash flows are the key determinants of share price, which represent the wealth of the owners in the firm. Answer: TRUE 28) A higher earnings per share (EPS) does not necessarily translate into a higher stock price. Answer: TRUE 29) The profit maximization goal ignores the timing of returns, does not directly consider cash flows, and ignores risk. Answer: TRUE 30) When considering a firm's financial decision alternatives, financial managers should accept only those actions that are expected to maximize shareholder value. Answer: TRUE 31) An increase in a firm's risk will always result in a higher share price since the stockholder must be compensated for the greater risk. Answer: FALSE 32) An objection to managing a firm on behalf of stakeholders rather than shareholders is that ________. A) stakeholders have no economic interest in the firm B) stakeholders have an interest only in short-term outcomes C) there is no clear way to satisfy all stakeholders whose economic interests may be at odds with each other D) the goal of managing on behalf of stakeholders is too narrow Answer: C 33) An effective ethics program ________. A) can weaken corporate value B) has no effect on a corporation's value C) can enhance a corporation's value D) will result in high employee attrition rate Answer: C 34) When considering a firm's financial decision alternatives, financial managers should accept only those actions that are expected to increase the firm's profitability. Answer: FALSE 35) ________ are the standards of conduct or moral judgment that apply to persons engaged in commerce. A) Government regulations B) The Uniform Commercial Codes C) The rules of fair play D) Business ethics Answer: D 36) Cash flows and risk are the key determinants in share price. Increased risk, other things remaining the same, results in ________. A) a lower share price B) a higher share price C) an unchanged share price D) an undetermined share price Answer: A 37) Cash flows and risk are the key determinants in share price. Increased cash flow results in ________, other things remaining the same. A) a lower share price B) a higher share price C) an unchanged share price D) an undetermined share price Answer: B Managing the Firm 1) A treasurer is responsible for the firm's accounting activities, such as corporate accounting, tax management, financial accounting, and cost accounting. Answer: FALSE 2) ________ decisions focus on how a company will spend its financial resources on long- term projects that ultimately determine whether the firm successfully creates value for its owners. A) Investment B) Financing C) Working capital D) Risk management Answer: A 3) The principle of the time value of money basically says that ________. A) because firms pay managers a great deal, managers need to use their time very effectively B) money received today is more valuable than money received in the future because money in the future is more risky C) money received today is more valuable than money received in the future because firms and individuals can invest money they have today and earn a return on that money D) because of the principal-agent problem, investors cannot trust that money firms promise to pay in the future will ever arrive Answer: C 4) The primary principle that finance borrows from economics is ________. A) generally accepted accounting principles B) cash is king C) marginal cost-benefit analysis D) shareholder value maximization Answer: C 5) Financing decisions deal with the left-hand side of the firm's balance sheet. Answer: FALSE 6) Which of the following activities of a finance manager determines the types of assets the firm holds? A) budget allocation B) investment decisions C) financing decisions D) analyzing and planning cash flows Answer: B 7) You own a building supply store. Today you sold construction materials to a contractor for $10,000 that you acquired a week ago for $8,000. You paid for the materials in cash, but you sold them to the contractor on credit, and you expect him to pay his bill in a few months. Based on this information during the week you earned a positive profit but experienced a negative cash flow. Answer: TRUE 8) There is a tendency for CEOs of larger companies to earn more money than CEOs of smaller companies. Suppose a CEO decides to acquire another company, thus increasing the size of the CEO's firm. Suppose also that the price of the stock of the acquiring firm falls when investors learns of the upcoming acquisition. This appears to be an example of ________. A) a CEO pursuing profit maximization rather than wealth maximization B) the principal-agent problem C) a CEO behaving unethically D) the general principal that acquisitions are generally not good investments Answer: B 9) A corporation's stockholders elect its CEO. Answer: FALSE 10) The money that firms raise to finance their activities is called ________. A) the capital budget B) working capital C) capital D) accruals Answer: C 11) Marginal cost-benefit analysis states that financial decisions should be made and actions should be taken only when the added benefits exceed the added costs. Answer: TRUE 12) The treasurer typically manages a firm's cash, investing surplus funds when available and securing outside financing when needed. Answer: TRUE 13) A corporate treasurer's focus tends to be more external, while the controller's focus is more internal. Answer: TRUE 14) The accrual method recognizes revenue at the point of sale and recognizes expenses when incurred. Answer: TRUE 15) A treasurer is commonly responsible for handling ________. A) tax management B) corporate accounting C) investing surplus funds D) cost accounting Answer: C 16) Which of the following is true of accrual basis accounting? A) Expenses are recognized either when they are incurred or cash is paid. B) Revenue is recognized when a customer pays cash. C) Expenses are recognized when they are incurred. D) Revenue is recognized when a customer pays cash or shows interest to purchase the product or service. Answer: C 17) Johnson, Inc. has just ended the calendar year making a sale in the amount of $10,000 of merchandise purchased during the year at a total cost of $7,000. Although the firm paid in full for the merchandise during the year, it is yet to collect at year end from the customer. The net profit and cash flow from this sale for the year are ________. A) $3,000 and $10,000, respectively B) $3,000 and -$7,000, respectively C) $7,000 and -$3,000, respectively D) $3,000 and $7,000, respectively Answer: B 18) A firm has just ended its calendar year making a sale in the amount of $150,000 of merchandise purchased during the year at a total cost of $112,500. Although the firm paid in full for the merchandise during the year, it is yet to collect at year end from the customer. The net profit and cash flow from this sale for the year are ________. A) $0 and $150,000, respectively B) $37,500 and -$150,000, respectively C) $37,500 and -$112,500, respectively D) $150,000 and $112,500, respectively Answer: C 19) Stockholders expect to earn higher rates of return on investments with lower risk and lower rates of return on investments with higher risk. Answer: FALSE 20) As the risk of a stock investment increases, investors' ________. A) return will increase B) return will decrease C) required rate of return will decrease D) required rate of return will increase Answer: D 21) The principal-agent problem arises when ________. A) the owners of the firm are not the people managing the firm B) the owners of the firm also manage the firm C) managers serve on a firm's board of directors D) a firm is organized as a sole proprietorship Answer: A 22) Which of the following works as a conduit of information between the firm and its investors? A) the treasurer B) the controller C) the director of internal audit D) the director of investor relations Answer: D 23) ________ decisions refer to how a firm manages its short-term resources on a day-to-day basis. A) Financing B) Investment C) Working capital D) Managerial finance Answer: C 24) There is a tradeoff between risk and return (i.e., to earn higher returns you generally have to take more risk) because ________. A) investors like risk and return and want more of both B) investors are risk averse, so they will not accept riskier investments unless they offer higher returns C) to earn higher returns you have to make bigger investments and bigger investments are always riskier than smaller ones D) investors care about returns but not about risks Answer: B 25) The time value of money principle implies that all other things being equal, investments that produce profits faster are preferred over those that produce more distant profits. Answer: TRUE 26) The ________ has a role that focuses on budgeting, accounting, and tracking the performance of a single business unit. A) controller B) treasurer C) chief financial officer D) director of risk management Answer: A 27) When managers are trying to create value for shareholders, their primary focus should be on earnings rather than cash flow. Answer: FALSE Organizational forms, taxation, and the principal-agent relationship 1) Which of the following legal forms of organization is most expensive to organize? A) sole proprietorships B) partnerships C) corporations D) limited partnership Answer: C 2) Which of the following legal forms of organization is the easiest to dissolve? A) sole proprietorships B) partnerships C) limited partnerships D) corporations Answer: A 3) Under which of the following legal forms of organization is ownership readily transferable? A) sole proprietorships B) partnerships C) limited partnerships D) corporations Answer: D 4) Which of the following forms of organizations is the easiest to form? A) sole proprietorships B) limited liability corporation C) limited partnership D) S-corporations Answer: A 5) A major weakness of a partnership is ________. A) the difficulty in maintaining owners' control B) the difficulty in liquidating or transferring ownership C) the double taxation of income D) its high organizational costs Answer: B 6) Which of the following is a strength of a corporation? A) low taxes B) limited liability C) low organization costs D) less government regulation Answer: B 7) Which of the following legal forms of organizations is characterized by unlimited liability? A) sole proprietorship B) limited partnership C) corporation D) C-corporation Answer: A 8) Which of the following is true of a partnership and a corporation? A) In a corporation, income is taxed at the corporate level; whereas, in a partnership, income is taxed twice. B) In a partnership, income is taxed once at the individual level; whereas, in a corporation, income is taxed twice. C) Income from both forms of organizations are double-taxed. D) In a partnership, income is exempted from tax up to $10 million; whereas, in a corporation, income is taxed twice. Answer: B 9) Which of the following is true of sole proprietorships and corporations? A) It is difficult to transfer ownership of corporations compared to that of sole proprietorships. B) Income from both forms of organizations are taxed only at the corporate level. C) Both sole proprietorships and corporations are equally scrutinized and regulated by government bodies. D) In sole proprietorships, owners have unlimited liability; whereas, in corporations, owners have limited liability. Answer: D 10) In partnerships, partners can readily transfer their wealth to other partners. Answer: FALSE 11) A sole proprietor has unlimited liability; his or her total investment in the business, but not his or her personal assets, can be taken to satisfy creditors. Answer: FALSE 12) In a limited partnership, all partners' liabilities are limited to their investment in the partnership. Answer: TRUE 13) Under a progressive tax structure in which tax rates rise with income levels ________. A) the marginal tax rate and the average tax rate are the same B) the average tax rate is what really matters when an individual or business is making a financial decision C) the marginal tax rate is usually less than the average tax rate D) the marginal tax rate is usually greater than the average tax rate Answer: D 14) The term "double taxation" means that ________. A) partnerships and sole proprietorships pay tax on the income that they earn, and then income distributed from the business to the owner is taxed again at the individual level B) the highest federal income tax rate faced by corporations is twice the highest tax rate faced by individuals C) corporations pay tax on the income they earn and then shareholders pay tax on income that the corporation distributes to them D) a corporation pays tax on the interest it pays to bondholders and then bondholders pay tax again on the interest payments they receive from firms Answer: C 15) Suppose a certain business pays 10.0% tax on its first $10,000 in come, 12.0% tax on income above $10,000 but below $40,000, and 22.0% tax on income above $40,000. Suppose the business earns $50,000 in income this year. It's marginal tax rate is ________. A) 12.0% B) 13.6% C) 22.0% D) greater than 22.0% Answer: C 16) Corporate governance refers to ________. A) the rules, processes, and laws by which companies are operated, controlled, and regulated B) the fact that corporations heavily influence the actions of governments through their lobbying efforts C) the notion that corporations act like a democracy in the sense that every shareholder has an equal vote on corporate decisions D) the idea that a corporate CEO is really accountable to no one and must be constrained by government action Answer: A 17) Agency costs are ________. A) costs that managers bear when they do not act in the interests of shareholders B) costs that firms must pay to comply with the regulations imposed by federal government agencies C) costs that are exempt from taxation D) costs that shareholders bear because managers pursue their own interests rather than acting in the interests of shareholders Answer: D 18) Firms are legally required to pay dividends to stockholders just as they must make interest payments to lenders. Answer: FALSE 19) Suppose a certain business pays 10% tax on its first $10,000 in come, 12% tax on income above $10,000 but below $40,000, and 22% tax on income above $40,000. Suppose the business earns $50,000 in income this year. Its average tax rate is closest to ________. A) 22% B) 14% C) 10% D) 17% Answer: B 20) Dividends are periodic distributions of cash to the stockholders of a firm. Answer: TRUE 21) Suppose a certain business pays 10% tax on its first $10,000 in come, 12% tax on income above $10,000 but below $40,000, and 22% tax on income above $40,000. Suppose the business earns $50,000 in income this year. It tax liability is ________. A) $6,800 B) $11,000 C) $9,800 D) $5,800 22) Under a flat tax structure, where the same tax rate applies to all income levels ________. A) the marginal tax rate is greater than the average tax rate B) the marginal tax rate is less than the average tax rate C) the marginal tax rate is equal to the average tax rate D) the marginal tax rate is irrelevant Answer: C 23) In partnerships, owners have unlimited liability and may have to cover debts of other less financially sound partners. Answer: TRUE 24) The board of directors is responsible for managing day-to-day operations and carrying out the policies established by the chief executive officer. Answer: FALSE 25) Institutional investors are professional investors who work on behalf of individuals, business, and government. Answer: TRUE 26) The major purpose of the Sarbanes-Oxley Act of 2002 was to place caps on the compensation that could be paid to corporate executives. Answer: FALSE 27) The board of directors is typically responsible for ________. A) approving strategic goals and plans B) managing day-to-day operations C) arranging finance for approved long-term investments D) maintaining and controlling the firm's daily cash balances Answer: A 28) The responsibility for managing day-to-day operations and carrying out corporate policies belongs to the ________. A) board of directors B) chief executive officer C) stockholders D) creditors Answer: B 29) Which of the following is an example of agency cost? A) costs incurred for setting up an agency B) failure to make an investment that would make shareholders wealthier C) payment of income tax D) payment of interest Answer: B 30) Which of the following is a routine way that boards try to align the interests of managers and stockholders? A) fire managers who are inefficient B) remove management's perquisites C) tie management compensation to the performance of the company's common stock price D) tie management compensation to the level of dividend per share Answer: C 31) The marginal tax rate paid on a firm's ordinary income can be calculated by dividing its taxes by its net income. Answer: FALSE 32) The average tax rate paid on the firm's ordinary income can be calculated by dividing its taxes by its taxable income. Answer: TRUE 33) The tax deductibility of various expenses such as general and administrative expenses ________. A) increases their pretax cost B) reduces their after-tax cost C) has no effect on their after-tax cost D) has an unpredictable effect on their after-tax cost Answer: B 34) Jennings, Inc. has a tax liability of $170,000 on pretax income of $500,000. What is the average tax rate for Jennings, Inc.? A) 34 percent B) 46 percent C) 25 percent D) 40 percent Answer: A 35) The average tax rate of a corporation with ordinary income of $105,000 and a tax liability of $24,200 is ________. A) 46 percent B) 23 percent C) 34 percent D) 15 percent Answer: B 36) If a corporation sells certain capital equipment for more than its initial purchase price, the difference between the sale price and the purchase price is called a(n) ________. A) ordinary gain B) revenue gain C) capital gain D) abnormal gain Answer: C 37) In general, most corporate capital gains are taxed at ________ tax rate. A) the average B) the regular corporate C) the historic D) a 30 percent Answer: B 38) Corporation X needs $1,000,000 and can raise this through debt at an annual rate of 6 percent, or preferred stock at an annual cost of 8 percent. If the corporation has a 21 percent tax rate, the after-tax cost of each is ________. A) debt: $60,000; preferred stock: $80,000 B) debt: $47,400; preferred stock: $63,200 C) debt: $47,400; preferred stock: $80,000 D) debt: $60,000; preferred stock: $63,200 Answer: C 39) The marginal tax rate represents the rate at which the next dollar of income is taxed. Answer: TRUE 40) All dividend income received by a corporation is exempted from taxation. Answer: FALSE 41) The tax liability of a sole proprietorship with ordinary income of $105,000 is closest to ________. Range of taxable income Marginal rate $ 0 to $ 9,875 10% 9,875 to 40,125 12 40,125 to 85,525 22 85,525 to 163,300 24 A) $25,200 B) $22,050 C) $32,090 D) $19,280 Answer: D 42) The tax liability of a sole proprietorship with ordinary income of $450,000 is closest to ________. Range of taxable income Marginal rate $ 0 to $ 9,875 10% 9,875 to 40,125 12 40,125 to 85,525 22 85,525 to 163,300 24 163,300 to 207,350 32 207,350 to 518,400 35 A) $157,500 B) $132,295 C) $94,500 D) $114,700 Answer: B 43) Prior to the Tax Cuts and Jobs Act, corporations faced a progressive tax rate schedule with rates ranging from 15% to 39%. Under that old tax law, a firm with taxable income of $100 million would have owed taxes of $35 million. Under the Tax Cuts and Jobs Act, the corporate tax rate is a flat 21%. For a firm that makes $100 million in taxable income, the size of the tax reduction that the firm enjoys because of the new tax law is closest to ________. A) $18 million B) $21 million C) $14 million D) $35 million Answer: C 44) Corporation A owns a small percentage of the stock of corporation B. Corporation B pays corporation A $100,000 in dividends. Corporation A pays tax at a 21% rate and is allowed to exclude from taxable income 50% of dividends received from other firms. The incremental taxes that Corporation A must pay on the dividends received are ________. A) $21,000 B) $10,500 C) $0 D) $1,050 Answer: B 45) Consider two firms, Go Debt corporation and No Debt corporation. Both firms are expected to have earnings before interest and taxes of $100,000 during the coming year. In addition, Go Debt is expected to incur $40,000 in interest expenses as a result of its borrowings whereas No Debt will incur no interest expense because it does not use debt financing. Both firms are in the 21 percent tax bracket. Calculate the earnings after tax for both firms. Compare the difference in after-tax earnings to the difference in interest expense. Can you reconcile that difference? Answer: Go Debt has lower earnings after taxes compared to No Debt, and the difference is $31,600 ($79,000 - $47,400). The difference in interest expense is $40,000. The reason the difference in earnings is less than the difference in interest expense is that the interest expense that Go Debt pays saves the company $8,400 in taxes (a number which you can calculate by multiplying 21% times the $40,000 interest expense). 46) Restricted stock is stock that ________. A) is not publicly traded due to on-going investigations by the Securities and Exchange Commission B) allow managers to buy new shares of stock at a fixed price C) firms pay out to managers as part of a compensation package that do not fully transfer from the company to the managers until specific conditions are met D) firms issue for the sold purpose of raising funds to invest in environmentally friendly projects Answer: A 47) An activist investor is an investor who ________. A) lobbies the government to force companies to manage for stakeholders rather than for shareholders only B) specializes in influencing management C) organizes boycotts and other kinds of protests to draw attention to firms' unethical treatment of labor D) served in government before moving into the investment industry Answer: A Developing skills for your career 1) Communication skills are very important to financial and nonfinancial managers because ________. A) they will be communicating with the investment community regularly B) they work together in cross-functional teams and need to understand how members of their teams think C) they will write reports that are disclosed in the firm's financial reports D) they are all responsible for selling the firms goods and services to customers Answer: B 2) Developing financial computing skills, such as expertise with software like Excel, is important because ________. A) everyone in the firm must be an Excel expert to have success B) everyone in the firm needs to understand financial reports and models at some level, and those are usually constructed and presented in Excel C) there are no good alternatives to Excel D) mistakes are more likely to occur when people do financial work by hand rather than using a product like Excel Answer: B REVIEW QUESTIONS What is the goal of the firm and, therefore, of managers and employees? Discuss how one measures achievement of this goal. The goal of a firm, and therefore of all financial managers, is maximizing shareholder wealth. The proper metric for this goal is the price of the firm’s stock. Other things equal, an increasing price per share of common stock relative to the stock market as a whole indicates achievement of this goal. For what three main reasons is profit maximization potentially inconsistent with wealth maximization? Actions that maximize the firm’s current profit may not produce the highest stock price because (1) some firm activities that result in slightly lower profit today generate much larger profits in the future periods (i.e., focusing on current profit overlooks the time value of money); (2) activities that generate higher accounting profits today may not result in higher cash flows to stockholders; and (3) activities that lead to high profits today may involve higher risk, which could result in significant future losses. What is risk? Why must financial managers consider risk as well as return when they evaluate a decision alternative or action? Risk is the chance actual outcomes may differ from expected outcomes. Financial managers must consider risk and return because the two factors tend to have an opposite effect on share price. That is, other things equal, an increase in the risk of cash flows to shareholders will depress firm stock price while higher average cash flows to shareholders will increase stock price Is maximizing shareholder wealth inconsistent with having concern for the welfare of a firm’s other stakeholders? Maximizing shareholder wealth does not mean overlooking or minimizing the welfare of other firm stakeholders. Firms with satisfied employees, customers, and suppliers tend to produce higher (or less risky) cash flows for their shareholders compared with companies that neglect non- owner stakeholders. That said, customers prefer lower prices for firm output, firm employees prefer higher wages, and firm suppliers prefer higher prices for the input goods and services they provide. So actions that produce the highest price of the firm’s stock cannot simultaneously maximize customer, employee, and supplier satisfaction. What are the main types of decisions that financial managers make? Broadly speaking, the decisions made by financial managers fall under three headings: (i) investment, (ii) capital budgeting, and (iii) working capital. Investment decisions involve the firm’s long-term projects while financing decisions concern the funding of those projects. Working-capital decisions, in contrast are related to the firm’s management of short-term financial resources. Why is it important that managers recognize that a tradeoff exists between risk and return? Why does that tradeoff exist? Financial managers must recognize the tradeoff between risk and return because shareholders prefer higher cash flows but dislike large swings in cash flows. And, as a general rule, actions that boost the firm’s average cash flows also result in greater cash-flow greater volatility. Viewed another way, firm actions to reduce the chance cash flows will be low or negative also tend to reduce average cash flows over time. Understanding this tradeoff is important because shareholders are risk averse. That is, they will only accept larger swings in a firm’s cash flows only if compensated over time with higher average cash flows. What is the primary economic principle used in managerial finance? Finance is often considered applied economics. One reason is firms operate within the larger economy. More importantly, the bedrock concept in economics—marginal benefit-marginal cost analysis—is also central to managerial finance. Marginal benefit-marginal cost analysis is the notion a firm (or any other economic actor) should take only those actions for which the extra benefits exceed the extra costs. Nearly, all financial decisions ultimately turn on an assessment of their marginal benefits and marginal costs. What are the major differences between accounting and finance with respect to emphasis on cash flows and decision making? Accountants and financial managers perform separate but equally important functions for the firm. Accountants primarily collect and present financial data according to generally accepted financial principles while financial managers make investment, capital-budgeting, and working-capital decisions with financial data. In part because of their different functions, accountants and financial managers log firm revenues and expenses using different conventions. Accountants operate on an accrual basis, recognizing revenues as firm output is sold (whether or not payment is actually received) and firm expenses as incurred. Financial managers, in contrast, focus on actual inflows and outflows of cash, recognizing revenues when physically received and expenses when actually paid. If managers do not act in the best interests of shareholders, what role might incentives play in explaining that behavior? Like any economic actor, managers respond to incentives. Managers have a fiduciary duty to maximize shareholder wealth, but as humans, they also have personal goals—such as maximizing their own income, wealth, reputation, and quality of life. If the personal benefits of delivering for shareholders (or the costs of slighting them) are small, a financial manager might opt to further his own interest at the expense of shareholders. For example, CEOs of large firms—those with more sales, assets, employees, etc.—tend to receive more compensation than CEOs of smaller firms. If a CEO has to choose between two operating strategies—one that produces modest growth for his firm but a large jump in current stock price and another that generates rapid growth but a more modest rise in share price—and the firm’s board is not closely monitoring the CEO, she might pursue the high-growth strategy to boost her future compensation. A partial solution to such a problem is a compensation closely linking CEO compensation to firm stock price. Which legal form of business organization is most common? Which form do the largest businesses typically take and why? Sole proprietorships are the most common form of business organization, while corporations tend to be the largest. Large firms tend to organize as corporations to insulate owners from losses (limit liability) and facilitate acquisition of financial capital to fund growth. Describe the roles of, and the relationships among, the major parties in a corporation: stockholders, board of directors, and managers. How are corporate owners rewarded for the risks they take? Stockholders are the owners of a corporation. Their ownership (equity) takes the form of common stock or, less frequently, preferred stock. Stockholders elect the board of directors, which has ultimate responsibility for guiding corporate affairs and setting general policy. The board usually comprises key corporate personnel and outside directors. The corporation’s president or chief executive officer (CEO) reports to the board. He or she oversees day-to-day operations subject to the general policies established by the board. The corporation’s owners (shareholders) do not have a direct relationship with management; they provide input by electing board members and voting on major charter issues. Shareholders receive compensation in two forms: (i) dividends paid on their stock (from corporate earnings) and (ii) capital gains from increases in the price of their shares (which reflect market expectations about future dividends). Explain why corporations face a double taxation problem? For corporations, how are the marginal and average tax rates related? Generally speaking, income from sole proprietorships and partnerships is taxed only once at the individual level; the owner or owners pay personal income tax on their share of firm’s profits. In contrast, corporate income is taxed first at the firm level (via the corporate income tax paid on firm profits) and then again at the personal level (via personal income tax paid on dividends or capital gains enjoyed by shareholders). Under the tax law prevailing in 2020, corporations paid tax at a flat rate of 21%, which means that the average tax rate and the marginal tax rate are the same (21%). Under a progressive tax structure, the tax rates rises with income, so the marginal tax rate generally exceeds the average tax rate Define agency problems and describe how they give rise to agency costs. Explain how a firm’s corporate governance structure can help avoid agency problems. Agency problems arise when managers place personal goals ahead of their duty to shareholders to maximize stock price. The attendant costs are called agency costs. Agency costs can be implicit or explicit; either way they reduce shareholder wealth. An example of an “implicit” agency cost is the dividends or capital gains shareholders miss out on because the firm’s management team pursued a personal interest (like maximizing sales to boost future compensation) rather than maximizing shareholder wealth. Of course, if shareholders sense stock price is not what it should be, they will start monitoring management more closely (as in the chapter opener with Brookdale Senior Living). The expenses associated with greater monitoring are an example of an “explicit” agency cost. Agency problems in a firm can be reduced with a properly constructed and followed corporate-governance structure. Such a structure will feature checks and balances that reduce management’s interest in and ability to deviate from shareholder-wealth maximization. Like all corporate decisions, reducing agency costs is subject to marginal benefit–marginal cost analysis. In other words, the firm should invest in policies to align the incentives of management and shareholders as long as the marginal benefits exceed the marginal costs How can the firm structure management compensation to minimize agency problems? Firms most commonly try to mitigate agency problems by linking pay to metrics connected with shareholder wealth. Incentive plans tie compensation to share price. For example, the CEO might receive options offering the right to purchase stock at a set price (say current price) any time in the next few years. If the CEO takes actions that subsequently boost share price, she can profit personally by exercising the option—purchasing stock at the set price—and reselling at the higher market price. The higher the firm’s stock price, the more money the CEO can make, so options create a powerful incentive to focus laser-like on shareholder wealth. There is a downside, however. Sometimes general market trends swamp all the good done by management, so even though the CEO obsessed over shareholder wealth, her options proved worthless because a bear market hammered the firm’s stock price. This problem has made performance plans more popular. These plans link compensation with performance measures related to stock price that management can more closely control—such as earnings per share (EPS) and EPS growth. When targets for the performance metrics are attained, managers receive rewards like performance shares and/or cash bonuses. How do market forces—both shareholder activism and the threat of takeover—prevent or minimize the agency problem? What role do institutional investors play in shareholder activism? If the board of directors fails to keep management focused on shareholder wealth, market forces can apply the necessary pressure. Two such forces are activism by institutional investors (such as Land and Buildings in the chapter opener) and the threat of hostile takeovers. Institutions typically hold large quantities of shares in many corporations. Because of their large stakes, these investors actively monitor management and vote their shares for the benefit of all shareholders. Large institutional investors reduce agency problems by using their voting clout to elect new directors that will make the changes in policies and personnel necessary to get underperforming stock to its highest possible price. The threat of hostile takeover can also keep management focused on shareholders. Say a firm has a stock price of $15, but that price could be $20 with bold action management is reluctant to take. The lure of a $5 capital gain per share could tempt an outside individual, group of investors or firm not supported by existing management to purchase controlling interest and force the necessary changes. Incumbent management knows “necessary changes” means unemployment, so the threat of takeover could be enough to align their interests with those of the owners. Corporate Finance_Chapter 2 Review Materials Financial institutions 1) A financial institution is an intermediary that channels the savings of individuals, businesses, and governments into loans or investments. Answer: TRUE 2) Commercial banks advise firms on major transactions such as mergers or financial restructurings. Answer: FALSE 3) As a key participant in financial transactions, individuals are ________. A) net demanders of funds because they save more money than they borrow B) net users of funds because they save less money than they borrow C) net suppliers of funds because they save more money than they borrow D) net purchasers of funds because they save more money than they borrow Answer: C 4) Government is typically a ________. A) net provider of funds because it borrows more than it saves B) net demander of funds because it borrows more than it saves C) net provider of funds because it can print money at will D) net demander of funds because it saves more than it borrows Answer: B 5) Government can obtain funds ________. A) by trading in the equity market B) by issuing financial instruments such as futures and options C) through the foreign exchange market D) by selling debt securities Answer: D 6) Firms that require funds from external sources can obtain them ________. A) through financial institutions B) from central bank directly C) through the foreign exchange market D) by issuing T-bills Answer: A 7) Investment banks are institutions that ________. A) perform all activities of commercial banks and retail banks B) are exempted from Securities and Exchange Commission regulations C) engage in trading and market making activities D) are only limited to capital market activities Answer: C 8) Which of the following serves as an intermediary channeling the savings of individuals, businesses, and governments into loans and investments? A) financial institutions B) financial markets C) Securities and Exchange Commission D) OTC market Answer: A 9) The shadow banking system describes a group of institutions that engage in lending activities, much like traditional banks. Answer: TRUE 10) Which of the following provides savers with a secure place to invest funds and offer both individuals and companies loans to finance investments? A) investment banks B) securities exchanges C) mutual funds D) commercial banks Answer: D 11) Which of the following assists companies in raising capital, advise firms on major transactions such as mergers or financial restructuring, and engage in trading and market making activities? A) investment banks B) securities exchanges C) mutual funds D) commercial banks Answer: A Financial Markets 1) Primary and secondary markets are markets for short-term and long-term securities, respectively. Answer: FALSE 2) The over-the-counter (OTC) market is a market for trading smaller and unlisted securities. Answer: TRUE 3) NASDAQ is considered an OTC market since it is not recognized by the SEC as a "listed exchange." Answer: FALSE 4) The ask price is the highest price offered by a dealer to purchase a given security. Answer: FALSE 5) In the Eurobond market, corporations and governments typically issue bonds denominated in dollars and sell them to investors located outside the United States. Answer: TRUE 6) Capital markets are for investors who want a safe temporary place to deposit funds where they can earn interest and for borrowers who have a short-term need for funds. Answer: FALSE 7) Money markets are markets for long-term funds such as bonds and equity. Answer: FALSE 8) An efficient market is a market that establishes unbiased prices by rapidly incorporating all available information. Answer: TRUE 9) Money markets involve the trading of securities with maturities of one year or less. Answer: TRUE 10) Eurocurrency deposits arise when a corporation or individual makes a deposit in a bank in a currency other than the local currency of the country where the bank is located. Answer: TRUE 11) The Eurocurrency market is a market for short-term bank deposits denominated in U.S. dollars or other easily convertible currencies. Answer: TRUE 12) The money market is a financial relationship created by a number of institutions and arrangements that allows suppliers and demanders of long-term funds to make transactions. Answer: FALSE 13) The over-the-counter (OTC) market is ________. A) a highly liquid market as compared to NASDAQ B) a market in which low risk-high return securities are traded C) an organized market in which all financial derivatives are traded D) a market where smaller, unlisted securities are traded Answer: D 14) Which of the following is true of a primary market? A) It is an organized market in which all financial derivatives are traded. B) It is regulated by The Sarbanes-Oxley Act. C) It is a market where smaller, unlisted securities are traded. D) It is the only market in which the issuer is directly involved in the transaction. Answer: D 15) Which of the following is true of a secondary market? A) It is a market for an unlisted company to raise equity capital. B) It is a market where securities are issued through private placement. C) It is a market in which short-term money market instruments such as Treasury bills are traded. D) It is a market in which investors trade securities with each other. Answer: D 16) Which of the following is true of preferred stock? A) It has features of bonds and a common stock. B) It has a claim on assets prior to creditors in the event of liquidation. C) Its dividends can be paid only after paying dividends to the common stockholders. D) It usually has a maturity of thirty years. Answer: A 17) The key securities traded in the capital markets are ________. A) commercial papers and Treasury bills B) Treasury bills and certificates of deposit C) stocks and bonds D) bills of exchange and commercial papers Answer: C 18) Which of the following is true of international equity markets? A) In the international equity market, corporations cannot raise capital through IPOs, instead they can raise capital by trading in the secondary market. B) In the international equity market, corporations can easily manipulate the price of the shares since it is not regulated by any regulatory bodies. C) In the international equity market, corporations can only sell blocks of shares to institutional investors from European Union. D) In the international equity market, corporations can sell blocks of shares to investors in a number of different countries simultaneously. Answer: D 19) Which of the following is true of a dealer market? A) Buyers and sellers are never brought together directly. B) Brokers execute the buy or sell orders in a dealer market. C) It has centralized trading floors. D) It is a part of the broker market. Answer: A 20) Which of the following is true of a securities exchange? A) It serves as an intermediary by channeling the savings of individuals, businesses, and governments into loans or investments. B) It borrows funds directly from the financial institutions. C) It is an association of banks who meet to buy and sell stocks and bonds. D) It provides a marketplace in which firms can raise funds through the sale of new securities and purchasers can resell securities. Answer: D 21) A market that establishes correct prices for the securities that firms sell and allocates funds to their most productive uses is called a(n) ________. A) future market B) forex market C) efficient market D) weak-form market Answer: C 22) The ________ is created by a financial relationship between suppliers and demanders of short-term funds. A) stock market B) capital market C) forex market D) money market Answer: D 23) By definition, the money market involves the buying and selling of ________. A) stocks and bonds B) short-term securities C) all financial instruments except derivatives D) secured premium notes Answer: B 24) Most money market transactions are made in ________. A) common stock B) marketable securities C) commodities market D) preferred stock Answer: B 25) The ________ is created by a number of institutions and arrangements that allow the suppliers and demanders of long-term funds to make transactions. A) forex market B) capital market C) money market D) commodities market Answer: B 26) Long-term debt instruments used by both government and business are known as ________. A) preferred stocks B) T-bills C) bonds D) equities Answer: C 27) Which of the following is an example of marketable securities? A) U.S. Treasury bills B) treasury stock C) mortgage backed securities D) loans Answer: A 28) In a ________ market, the buyer and seller are brought together to trade securities in an organization called a ________. A) dealer; securities market B) broker; over-the -counter market C) broker; securities market D) dealer; over-the-counter market Answer: C 29) Financial markets are intermediaries that channel the savings of individuals, businesses, and government into loans or investments. Answer: FALSE 30) A public offering is the sale of a new security issue—typically debt or preferred stock— directly to an investor or group of investors. Answer: FALSE 31) A primary market is a financial market in which investors trade securities with each other. Answer: FALSE 32) Most businesses raise money by selling their securities in a ________. A) public offering B) forex market C) futures market D) commodities market Answer: A 33) Which of the following is a means of selling bonds or stocks to the public? A) private placement B) public offering C) organized selling D) direct placement Answer: B 34) Which of the following is a forum in which suppliers and demanders of funds can transact business directly? A) shadow banking system B) financial markets C) commercial banks D) financial institutions Answer: B 35) The sale of a new security directly to an investor or a group of investors is called ________. A) arbitraging B) short selling C) a capital market transaction D) a private placement Answer: D 36) The money market is a market where investors trade highly liquid securities with maturities of 1 year or less. Answer: TRUE 37) The market for short-term bank deposits denominated in dollars and other currencies is the ________. A) money market B) Eurocurrency market C) primary market D) broker market Answer: B 38) The Eurocurrency market is a market where investors can exchange currencies, for example by trading dollars for euros. Answer: FALSE 39) The ________ market is where firms initially issue securities, and the ________ market is where investors trade securities with each other. A) primary; secondary B) money; capital C) secondary; primary D) primary; money Answer: A 40) An efficient market is one where ________. A) prices of stocks move up and down widely without apparent reason B) prices of stocks remain low for long periods of time C) prices of stocks are unaffected by market news D) the price of a security is an unbiased estimate of its true value Answer: D 41) The ________ represents income to a market maker who helps facilitate securities trading. A) commission B) IPO underpricing C) bid/ask spread D) cost of doing business Answer: C 42) You submit an order to buy 100 shares of stock. The price that you pay for the stock is more likely to be the ask price rather than the bid price. Answer: TRUE 43) The money market is a market ________. A) that enables suppliers and demanders of long-term funds to make transactions B) which brings together suppliers and demanders of short-term funds C) where smaller, unlisted securities are traded D) where all derivatives are traded Answer: B 44) In a securities market, the bid price is typically higher than the ask price. Answer: FALSE 45) A ________ is someone who helps facilitate securities trading by offering to buy or sell them at stated bid/ask prices. A) market maker B) stockbroker C) day trader D) middle man Answer: A 46) Apex Inc. issues a bond of $1,000 which pays interest semiannually at a coupon interest rate of 8%. The maturity of the bond is 15 years. Where should this bond be traded? A) forex market B) money market C) capital market D) commodities market Answer: C 47) One piece of evidence suggesting that the stock market is efficient is that most individual investors cannot earn returns that beat the overall market average return, but professional investors such as mutual fund and pension fund managers generally do earn higher-than- average returns. Answer: FALSE 48) One sign that the stock market is efficient is that prices in the market move seemingly at random, display almost no predictable, repeating patterns. Answer: TRUE 49) A market make is willing to buy a certain stock for $21.35 per share and sell it for $21.37 per share. Here, $21.37 is the ________. A) ask price B) bid price C) bid/ask spread D) midpoint of the bid/ask spread Answer: A 50) A certain financial services firm advertises that they charge only $9.95 to customers who want to trade stock. In reality, if you trade stock using this firm's services you may well pay more than $9.95 to buy or sell stock because ________. A) the firm will usually have other fees that they charge but do not advertise B) buying a stock triggers tax payments that you must make to the government C) the price of the stock you want to trade will move before your trade is executed D) you may have to pay a portion of the bid/ask spread when you trade Answer: D 51) In the United States, most retail companies earn more money in the last few months of the year than in any other quarter due to the Christmas season. Thus, in an efficient market, we would expect retail stocks to perform better in the latter part of the year than at any other time of year. Answer: FALSE Regulation of financial markets and institutions 1) The Glass-Steagall Act was imposed to allow commercial and investment banks to combine and work together. Answer: FALSE 2) The Glass-Steagall Act ________. A) was intended to regulate the activities in the secondary market B) created the Securities Exchange Commission C) separated the activities of commercial and investment banks D) was intended to regulate the activities in the primary market Answer: C 3) The Securities Act of 1933 focuses on regulating the sale of securities in the primary market, whereas the 1934 Act deals with the regulations governing the transactions in the secondary market. Answer: TRUE 4) The Federal Deposit Insurance Corporation (FDIC) ________. A) is an agency, created by the Glass-Steagall Act ,that monitors banks on a regular basis to ensure that they were safe and sound B) is an agency that monitors business combinations between commercial banks, investment banks, and insurance companies C) guarantees individuals will not lose any money held at any type of financial institution that fails D) guarantees individuals will not lose any money, up to a specified amount, held at any type of financial institution that fails Answer: A 5) The Gramm-Leach-Bliley Act ________. A) is created to monitor banks on a regular basis to ensure that they were safe and sound B) allows business combinations between commercial banks and investment banks, but not insurance companies C) allows business combinations between commercial banks, investment banks, and insurance companies D) was signed during the Great Depression because of the financial crisis Answer: C 6) Which of the following acts regulates the secondary market? A) The Securities Act of 1933 B) The Gramm-Leach-Bliley Act C) The Securities Exchange Act of 1934 D) The Glass-Steagall Act Answer: C 7) The ________ created new agencies including the Financial Stability Oversight Council and the Bureau of Consumer Financial Protection. A) Securities Exchange Act of 1934 B) Dodd-Frank Wall Street Reform and Consumer Protection Act C) Securities Act of 1933 D) Gramm-Leach-Bliley Act Answer: B 8) Which of the following acts regulates the primary market in which securities are originally issued to the public? A) The Securities Act of 1933 B) The Gramm-Leach-Bliley Act C) The Securities Exchange Act of 1934 D) The Glass-Steagall Act Answer: A 9) The ________ prohibits lawmakers from profiting by making trades based on information that they receive as part of their official duties. A) Securities Exchange Act of 1934 B) Stop Trading on Congressional Knowledge Act of 2012 C) Securities Act of 1933 D) Gramm-Leach Bliley Act Answer: B The securities issuing process 1) A firm conducting an IPO of common stock sold 1 million new shares in the offering at an offer price of $10 per share. After the offering, the firm had 5 million shares outstanding, and the price of those shares in the secondary market was $12. The firm's market capitalization is ________. A) $60 million B) $50 million C) $12 million D) $10 million Answer: A 2) A firm conducting an IPO of common stock sold 1 million new shares in the offering at an offer price of $10 per share. After the offering, the firm had 5 million shares outstanding, and the price of those shares in the secondary market was $12. The firm's IPO was underpriced by ________. A) 0% B) 100% C) 20% D) 16.7% Answer: C 3) A firm conducting an IPO of common stock sold 1 million new shares in the offering at an offer price of $10 per share. After the offering, the firm had 5 million shares outstanding, and the price of those shares in the secondary market was $12. The total proceeds from the firm's IPO were ________. A) $60 million B) $50 million C) $10 million D) $12 million Answer: C 4) Small business investment companies (SBICs) are corporations chartered by the federal government that can borrow at attractive rates from the U.S. Treasury and use the funds to make venture capital investments in private companies. Answer: TRUE 5) Angel capitalists or angels are wealthy individual investors who do not operate as a business but invest in early-stage companies in exchange for a portion of equity. Answer: TRUE 6) A prospectus is another term for a firm's annual report showing the firm's prospects for the coming year. Answer: FALSE 7) Which of the following is an attribute of investment bankers? A) They make long-term investments for banking institutions. B) They bear the risk of selling a security issue. C) They act as middlemen between the issuer and the banker. D) They provide the issuer with advice relating to the amounts of dividend to be paid. Answer: B 8) A prospectus is a portion of the security registration statement that describes the key aspects of the issue, the issuer, and its management and financial position. Answer: TRUE 9) An underwritten issue of common stock is one in which a firm purchases insurance to cover unexpected losses suffered by shareholders. Answer: FALSE 10) A(n)________ is hired by a firm to find prospective buyers for its new stock or bond issue. A) securities analyst B) trust officer C) commercial loan officer D) investment banker Answer: D 11) When an investment bank buys new securities from a firm and takes on the responsibility of reselling those securities to the public it is engaged in ________. A) market manipulation B) underwriting C) the road show D) underpricing the security offering Answer: B 12) ________ is a financial intermediary that specializes in selling new security issues. A) An investment bank B) A commercial bank C) A securities dealer D) A stock exchange Answer: A 13) The term red herring refers to ________. A) the fact that most firms conducting an IPO are losing money, also known as running red ink B) a firm that is conducting an IPO without fully complying with all government regulations C) the fact that IPOs are typically underpriced D) an early version of the prospectus with red printing to indicate that the information the document contains is not final Answer: D 14) The IPO offer price is the price at which a newly public firm's shares begin trading in the secondary market. Answer: FALSE 15) Which ordering below best describe the level of responsibility for helping a firm conduct an IPO offering (ordering goes from most responsible to least responsible)? A) originating investment bank > underwriting syndicate > selling group B) originating investment bank > selling group > underwriting syndicate C) underwriting syndicate > originating investment bank > selling group D) selling group > underwriting syndicate > originating investment bank Answer: A 16) A group formed by an investment banker to share the financial risk associated with underwriting new securities is called a(n) ________. A) underwriting syndicate B) selling group C) investment banking consortium D) broker pool Answer: A 17) The term initial public offering describes a transaction in which a firm sells securities directly to an investor or to a small group of investors. Answer: FALSE 18) The document that a company conducting an initial public offering produces to describe the key aspects of the securities offered for sale is called the ________. A) annual report to stockholders B) term sheet C) prospectus D) tombstone Answer: C 19) When a firm sells stock to the public for the first time the transaction is called ________. A) an initial public offering B) a seasoned equity offering C) a private placement D) a secondary market offering Answer: A 20) A venture capitalist is considering investing in a very risky, early stage startup. Compared to investments that the VC might make in less risky companies ________. A) the VC will pay more for the equity it receives and it will demand a greater share of the startup's equity B) the VC will pay less for the equity it receives and it will demand a greater share of the startup's equity C) the VC will pay more for the equity it receives and it will be willing to take a smaller share of the startup's equity D) the VC will pay less for the equity it receives and it will be willing to take a larger share of the startup's equity Answer: B 21) Based on the risks of the investments that they make, venture capital firms generally look for rates of return in the 5% to 15% range. Answer: FALSE 22) Venture capital firms are usually organized as corporations, and the public shareholders of the VC firm have a stake in the investments that the firm makes. Answer: FALSE 23) One difference between angel investors and venture capitalists is ________. A) venture capitalists are typically businesses, whereas angel investors are usually individuals B) venture capitalists invest in risky startups, whereas angel investors put their money into more mature businesses C) venture capitalists make private equity investments whereas angel investors buy shares in companies in the same way that the rest of the investing public does D) angel investors are active and typically take a seat of the board of directors of any firm that they provide financing for, whereas venture capital investors are more passive Answer: A 24) When venture capitalists invest money in a firm, they are making a private equity investment. Answer: TRUE Financial markets in crisis 1) When home prices are rising it is easier for homeowners who have fallen behind on their mortgages to get caught up because ________. A) they can sell their house and buy a smaller one B) lenders will allow homeowners to use the built-up equity in their home to refinance their mortgages C) they can rent out an extra room in their homes to earn extra income D) with rising home prices homeowners will pay less in property taxes and use the savings to make mortgage payments Answer: B 2) Subprime mortgages are ________. A) mortgages that charge the borrower an interest rate that is less than the prime rate of interest B) mortgages on pieces of real estate located in less than prime neighborhoods C) loans to borrowers with lower incomes and/or poorer credit histories compared to prime borrowers D) mortgages on which the borrower has already fallen behind on payments or defaulted Answer: C 3) Securitization is the process of pooling mortgages or other types of loans and selling the claims or securities against that pool in the secondary market. Answer: TRUE 4) A crisis in the financial sector often spills over into other industries because when financial institutions ________ borrowing, activity in most other industries ________. A) increase; slows down B) contract; slows down C) increase; increases D) contract; increases Answer: B 5) Securitization made it harder for banks to lend money because they could not pass the risk on to other investors. Answer: FALSE 6) Mortgage-backed securities are securities that represent claims on the cash flows generated by a pool of mortgages. Answer: TRUE 7) Prior to the 2008 financial crisis, most investors viewed mortgage-backed securities as relatively safe investments. Answer: TRUE 8) Subprime mortgages are mortgage loans made to borrowers with high incomes and better than average credit histories. Answer: FALSE 9) Recessions associated with a banking crisis tend to be more severe than other recessions because many businesses rely on credit to operate. Answer: TRUE 10) The process of pooling mortgages or other types of loans and selling the claims or securities against that pool in the secondary market is called ________. A) valuation B) securitization C) private placement D) capital restructuring Answer: B 11) The primary risk of mortgage-backed securities is ________. A) that the prices of have high volatility B) that the prices of housing will increase C) that the government will not be able to meet the guarantees on the cash flows D) that homeowners may not be able to, or choose not to, repay their loans Answer: D 12) Which of the following is true of mortgage-backed securities? A) Mortgage-backed securities assure a flat 15% return. B) Mortgage-backed securities are guaranteed by the U.S. government. C) Mortgage-backed securities can only be purchased by investment banks. D) Mortgage-backed securities represent claims on the cash flows generated by a pool of homeloans. Answer: D 13) When home prices are falling, we would expect a(n) ________. A) high mortgage default rates B) low mortgage default rates C) unchanged mortgage default rates D) higher percentage of owner home equity Answer: A You would like to purchase one Class A share of Berkshire Hathaway through your TD Ameritrade brokerage account. TD Ameritrade advertises a $5 commission for trades using their phone-based interactive voice response system. You call and learn that the bid price is $285,705.59 and the ask price is $285,909.62, and you submit your order for one share. What is the current bid/ask spread for Berkshire Hathaway Class A shares? A) The bid/ask spread is $199.03 B) The bid/ask spread is $204.03 C) The bid/ask spread is $209.03 D) The bid/ask spread is equal to the $5 commission Answer: B Your broker calls to offer you the investment opportunity of a lifetime, the chance to invest in mortgage-backed securities. The broker explains that these securities are entitled to the principal and interest payments received from a pool of residential mortgages. Below are potential questions you might ask your broker to assess the risk of this investment opportunity. Which of the following is NOT included? A) "What is the historical performance of the mortgage-backed securities pool in terms of prepayment rates and default rates?" B)"What is the credit quality of the underlying mortgages in the pool?" C)"Can you guarantee that I won't lose money on this investment?" D)"What are the potential risks associated with investing in mortgage-backed securities?" Answer: C REVIEW QUESTIONS What are financial institutions? Describe the role they play within the financial market environment. Financial institutions are intermediaries that facilitate the flow of individual, business, and government savings into loans and investments. Broadly speaking, net savers (primarily individuals) prefer low risk and easy access to their money while net borrowers (businesses and government) would like to take risk with the funds and tie them up for a longer term. Financial institutions transform loans and investments into forms savers prefer to hold (such as deposits) or help net borrowers issue debt and equity instruments tailored to saver preferences. Who are the key customers of financial institutions? Who are net suppliers, and who are net demanders of funds? Overall, the same entities that supply funds—individuals, businesses, and governments—also demand them, so these three groups are all financial-institution customers. That said, the key demanders of funds (net borrowers) are businesses and governments while the key suppliers (net savers) are individuals. Describe the role of commercial banks, investment banks, and the shadow banking system within the financial market environment. Commercial banks, investment banks, and the shadow-banking system are all financial institutions. Broadly speaking, commercial banks transform the deposits of net savers into loans to net borrowers. Investment banks, in contrast, do not “transform” the liquidity and riskiness of financial assets. Instead, they help “match” demanders and issuers of debt and equity instruments. Specifically, investment banks instruct companies on the best vehicles for raising capital, advise them on mergers/restructuring, and engage in trading and market-making to support their consulting function. Finally, the shadow-banking system performs services for net savers and borrowers similar to commercial banks—but without issuing deposits. By not relying on deposit funding, shadow banks can evade prudential regulation designed to constrain risk-taking by ordinary banks. What role do financial markets play in our economy? What are primary and secondary markets? What relationship exists between financial institutions and financial markets? Financial markets facilitate direct interaction of suppliers and demanders of funds. In primary markets, firms sell debt and equity instruments for the first time—a direct exchange between the firm or government issuing securities and the purchasers. An example is Microsoft Corporation selling new shares of common stock to private investors. In secondary markets, investors trade previously issued securities among themselves. An example is an investor buying a share of outstanding Microsoft common stock from another investor through a broker. Put simply, primary markets feature sales of “new” securities while “used” security transactions take place in secondary markets. Primary and secondary markets have a symbiotic relationship—the easier the resale of a financial asset in a secondary market, the easier the initial sale of that asset in a primary market. Similarly, financial institutions and financial markets are far from independent. Commercial banks, for example, hold large inventories of U.S. Treasury securities to improve the liquidity and risk of their asset portfolio, and strong bank demand makes it easier for the Treasury to sell debt in the first place. Because banks have taken deposits and made loans since the days of goldsmiths in Medieval Europe, they enjoy a comparative advantage in originating and monitoring commercial loans. Aware of this advantage, the capital markets watch bank lending for clues about borrower financial strength. When a commercial bank announces a new loan to a publicly traded firm, that firm’s stock price typically rises. What is a private placement versus a public offering? A private placement is the sale of a new security directly to an investor or a small group of sophisticated investors (such as insurance companies and pension funds). A public offering, in contrast, is the sale of newly issued stock or bonds to the public at large. Firms typically rely on public offerings when they need large sums. What is the money market? What is the Eurocurrency market? The money market features trading in short-term, highly marketable debt instruments; “short term” here means an original maturity of one year or less. Money-market instruments typically carry low risk of capital losses. Examples of money-market instruments include U.S. Treasury bills, commercial paper, and negotiable certificates of deposit (issued by large commercial banks). The Eurocurrency market is the international analogue of the U.S. money market. This market features loans of currency held in banks outside the country where it is legal tender. Participants typically use the Eurocurrency market to evade domestic regulations and tax laws. The term stems from the European origin of this market; “Eurocurrency” has nothing to do with the euro per se and is no longer specific to Europe. What is the capital market? What are broker markets? What are dealer markets? How do they differ? The capital market features trading in instruments with original maturities exceeding one year such as bonds and stock (common and preferred). Capital-market instruments are exchanged in broker and dealer markets. In broker markets, a broker coordinates buy and sell orders, executing trades at the midpoint of the bid/ask spread (the highest price a buyer is willing to pay minus the lowest price a seller is willing to accept). The best known broker market is the NYSE. In dealer markets, a market maker executes buy and sell orders using her personal inventory and two distinct trades. For example, an investor might sell the dealer Microsoft stock at the bid price and then, in an independent transaction, another investor would buy Microsoft stock from the dealer at the ask price. “Ask” exceeds “bid,” so the dealer’s reward for maintaining an inventory of Microsoft stock is the opportunity to “buy low, sell high.” The difference, in short, between broker and dealer markets turns on whether traders or dealers provide the liquidity Describe the role of capital markets from the firm’s and investors’ perspectives. What is the efficient markets hypothesis? Firms see the capital market as a source of external finance for long-term projects. Put another way, they sell new bonds and stock to raise funds to build factories, launch marketing campaigns, and expand into new markets. Accordingly, they want a liquid market—one “deep” enough to accept newly issued securities at favorable prices. Investors, in contrast, see the capital market as a savings vehicle for long- term needs like retirement. As citizens of the macroeconomy, investors would also like the capital market to steer scarce funds to the most productive uses. To these ends, investors want an efficient capital market—one where securities prices reflect all available information and react swiftly to new information. Capital-market efficiency means investors need not waste time trying to identify over or undervalued securities or exploitable patterns in securities prices. Instead, they can maximize long- term returns by putting their savings in diversified mutual funds (i.e., avoiding countless hours studying individual stocks and bonds). Investors will also enjoy higher aggregate growth of output and employment from the spotlight securities prices shine on firms most able to profitably use their savings. Why do you think that so many pieces of important legislation related to financial markets and institutions were passed during the Great Depression? The first years of Great Depression featured the worst contraction in American history. Between August 1929 and March 1933, industrial production fell 52%, the Dow Jones Industrial Average tumbled 89%, unemployment soared to nearly 25%, and roughly 9,000 banks failed (37% of those operating in December 1929). Franklin Roosevelt won the 1932 election with a mandate to restore prosperity and prevent future depressions. Much of the U.S. framework for financial and financial-institution regulation stems from the First New Deal (1933–34). This framework addressed specific factors thought to have caused the slump. To protect depositors from losses in bank failures, the Banking Act of 1933 created federal deposit insurance. To prevent failures in the first place, the Act also barred commercial banks from security underwriting, which was thought to pose dangerous additional risks. To head off fraudulent investment schemes like those preceding the stock-market crash of 1929, the Securities Act of 1933 and Securities Exchange Act of 1934 forced companies wishing to issue public securities to disclose information about their financial condition. What different aspects of financial markets do the Securities Act of 1933 and the Securities Exchange Act of 1934 regulate? Both Acts required companies wishing to participate in securities markets to disclose significant information to the public. The Securities Act of 1933 focused on the primary market, compelling sellers of new securities provide reasonably accurate portrayals of their firms to prospective investors. The Securities Exchange Act of 1934, in contrast, regulated trading in secondary markets; forcing publicly traded companies to keep investors informed about firm condition on an ongoing basis. The latter Act also created the Securities Exchange Commission to enforce federal securities laws. What is the difference between an angel investor (angel) and a venture capitalist (VC)? Angel investors and venture capitalists are both sources of private equity. “Angels” are usually wealthy individuals who fund promising start-ups in return for a slice of firm equity. Venture capitalists, in contrast, are businesses that pool contributions from individuals (often institutional investors like university endowments and pension funds) and invest those funds in promising start-ups. In short, angels pick “winners” themselves whereas venture capitalists pick “winners” for their clients. What four ways do VCs use to organize their businesses? How do they structure and price their deals? Venture capitalists (VCs) are organized as (i) limited partnerships (most common), (ii) small business investment companies (SBICs), (iii) financial funds, and (iv) corporate funds. The principal difference is how the VC was created. The federal government charters SBICs. Financial institutions (usually commercial banks), in contrast, create financial funds as subsidiaries while nonfinancial firms launch corporate funds, sometimes as subsidiaries. Unlike other VC types, limited partnerships are launched by private individuals. All VCs use a legal agreement to specify deal structure and pricing. Deal structure allocates responsibilities between the start-up and VC and may include constraints on the firm to enhance its chance of success and mitigate VC risk. Pricing depends on the (i) value of the start-up, (ii) perceived risk of its business operations, and (iii) amount of funding needed. In general, VCs provide less funding and require a greater ownership stake when the firm is the early stages of development. What general procedures must a private firm follow to go public via an initial public offering (IPO)? Firms wishing to go public must (i) secure approval from current shareholders, (ii) obtain certification of the accuracy of their financial documents from company auditors and lawyers, (iii) hire an originating investment bank, (iv) file a registration statement with the Securities and Exchange Commission (SEC), (v) participate in roadshows with the investment bank to spark interest among potential investors and learn about a suitable issuing price, (vi) obtain final SEC approval after the investment bank has finalized issue terms and offer price, and (vii) sell the issue to the investment bank at the guarantee price. The investment bank will then assume the risk of placing the issue with primary-market investors. What role does an investment bank play in a public offering? Describe an underwriting syndicate. Broadly speaking, an investment bank facilitates a firm’s issuance of new securities. In a common-stock issue, the bank helps the issuer file a registration statement with the SEC and market the offering to potential investors in a roadshow. The bank also sets the offering price and other terms of the issue. All along the way, the originating investment bank provides advice to help the issuer maximize the volume of funds raised. Finally, the originating bank buys the new securities from the issuer at the guarantee price and then resells the issue to primary-market investors. Sometimes the bank will form a syndicate of other investment banks to share the financial risk of placing the issue. What is securitization, and how does it facilitate investment in real estate assets? Securitization is the process of creating highly liquid marketable securities out of illiquid assets. The first assets securitized on a large scale were residential mortgages—securitizers “pooled” the mortgages and then issued debt claims backed by cash flows from those pools. In other words, the interest and principal on “mortgage-backed” securities (MBSs) paid to investors came from mortgage payments by residential homeowners. Securitization facilitated investment in mortgages by unbundling risk. Lenders might need their funds before the mortgage is repaid or lose money if the homeowner defaults. Securitization allows mortgage originators to earn fees from making the loans but then reduce liquidity and credit risk by selling the mortgage to a securitizer (who, in turn, creates a security with cash flows tailored to the preferences of market investors). Securitizing mortgages promotes efficient risk sharing, which in turn, makes the real-estate sector a more attractive place to invest. What is a mortgage-backed security? What basic risk is associated with mortgage- backed securities? A mortgage-backed security (MBS) is a debt instrument backed by residential mortgages. “Backed” means principal and interest paid to MBS investors come from payments by residential homeowners with mortgages in the underlying pool. The primary MBS risk is credit risk, the chance homeowners will not make monthly principal and interest payments as stipulated in their mortgage contracts. How do rising home prices contribute to low mortgage delinquencies? When a home buyer takes out a mortgage, initial equity—the difference between purchase price and mortgage-loan balance—is simply the down payment. Over time, equity will rise as the borrower reduces the mortgage balance with monthly principal and interest payments. Should housing prices rise, the gap between house value and mortgage balance will widen further—that is to say, home equity rises even faster. If a borrower needs to skip a mortgage payment, the lender will typically allow her to tap equity. Rising prices also imply a vibrant housing market, so a borrower permanently unable to make the monthly payments can easily sell her home to pay off the mortgage. Why do falling home prices create an incentive for homeowners to default on their mortgages even if they can afford to make the monthly payments? A large decline in housing prices could push the value of a borrower’s home below the mortgage balance. With negative equity, the borrower could hold the loss at the original down payment by allowing the lender to foreclose. The only cost would be the negative impact on the borrower’s credit score. But if the decline in housing prices has led many other homeowners to walk away from their mortgages, this borrower may not be too concerned about the blot on her credit report, thinking future lenders will understand the circumstances. Why does a crisis in the financial sector spill over into other industries? The Great Recession of 2007–09 illustrates how a financial-sector crisis can metastasize. In the years running up to the recession, securitizers increasingly pooled mortgage loans to borrowers with less- than-stellar credit. At the time, “subprime” loans seemed relatively low risk because of rapidly rising housing prices. Then, when home prices began to level off (and even dip in some markets), mortgage delinquencies and defaults started climbing. With payments on underlying mortgages falling, the value of mortgage-back securities (MBSs) began to fall as well. Large investment banks (like Lehmann Brothers) and commercial banks (like Citibank) held considerable inventories of now-problematic MBSs. To offset rising MBS losses, commercial banks sharply curbed lending, which produced an economy-wide decline in consumer and investment spending. Investment banks, meanwhile, were large players in the money market—Lehmann, for example, routinely sold a large amount of commercial paper (short-term unsecured corporate debt). When the firm collapsed almost overnight (rendering its commercial paper worthless), the money market froze as investors became wary of all unsecured debt. Now, nonfinancial companies that regularly tapped the money market for short-term funding found themselves in squeeze. They responded by slashing costs and hoarding cash, which put even more downward pressure on economy-wide consumer and investment spending. Corporate Finance_Chapter 3 Review Materials Mandatory financial reports of public companies 1) The Financial Accounting Standards Board (FASB) is the federal regulatory body that governs the sale and listing of securities. Answer: FALSE 2) GAAP is the accounting profession's rule-setting body. Answer: FALSE 3) Generally accepted accounting principles are authorized by the Financial Accounting Standards Board (FASB). Answer: TRUE 4) The Sarbanes-Oxley Act of 2002 established the Public Company Accounting Oversight Board (PCAOB) which is a not-for-profit corporation that oversees auditors of public corporations. Answer: TRUE 5) The Sarbanes-Oxley Act of 2002 was passed to eliminate many of the disclosure and conflict-of-interest problems of corporations. Answer: TRUE 6) The Sarbanes-Oxley Act of 2002 established the Private Company Accounting Oversight Board (PCAOB) which is a for-profit corporation that oversees CEOs of public corporations. Answer: FALSE 7) Publicly owned corporations with more than $10 million assets and 2,000 or more stockholders are required by the Securities and Exchange Commission (SEC) to a form known as a 10-K annually. Answer: TRUE 8) The letter to stockholders is the primary communication from management in an annual report. Answer: TRUE 9) Common stock dividends paid to stockholders equal the earnings available for common stockholders divided by the number of shares of common stock outstanding. Answer: FALSE 10) The income statement is a financial summary of a firm's operating results during a specified period while the balance sheet is a summary statement of a firm's financial position at a given point in time. Answer: TRUE 11) The common stock entry in balance sheet is the par value of common stock. Answer: TRUE 12) Paid-in capital in excess of par represents the proceeds in excess of par value received from the original sale of common stock. Answer: TRUE 13) Earnings per share represents amount earned during the period on each outstanding share of common stock. Answer: TRUE 14) Net fixed assets represent the difference between gross fixed assets and the amount of depreciation expense from the most recent year. Answer: FALSE 15) Earnings per share results from dividing earnings available for common stockholders by the number of shares of common stock authorized. Answer: FALSE 16) Retained earnings represent the cumulative total of all earnings, net of dividends, that have been retained and reinvested in the firm since its inception. Answer: TRUE 17) The balance sheet is a statement which balances a firm's assets (what it owns) against its debt (what it owes) and its equity (what is provided by owners). Answer: TRUE 18) The amount paid in by the original purchasers of common stock is shown by two entries in the firm's balance sheet—common stock and paid-in capital in excess of par on common stock. Answer: TRUE 19) The original price per share received by the firm on a single issue of common stock is equal to the sum of the common stock and paid-in capital in excess of par accounts divided by the number of shares outstanding. Answer: TRUE 20) The statement of cash flows reconciles the net income earned during a given year, and any cash dividends paid, with the change in retained earnings between the start and end of that year. Answer: FALSE 21) The statement of cash flows provides insight into a firm's operating, investment, and financing cash flows and reconciles them with changes in its cash and marketable securities during the period of concern. Answer: TRUE 22) A U.S. parent company's foreign equity accounts are translated into dollars using the historical rate or average rate based on the company's discretion. Answer: FALSE 23) A U.S. parent company's foreign retained earnings are not adjusted for currency movements to reflect each year's operating profits or losses. Answer: FALSE 24) The Financial Accounting Standards Board (FASB) Standard No. 52 mandates that U.S.- based companies translate their foreign-currency-denominated assets and liabilities into dollars using the current rate (translation) method. Answer: TRUE 25) A firm's annual stockholders' report ________. A) is only accessible to the shareholders of the firm B) summarizes and documents the firm's financial activities during the past year C) documents the list of all investors who bought the firm's shares during the past year D) summarizes and documents the firm's financial plan and budgets during the past year Answer: B 26) The rule-setting body, which authorizes generally accepted accounting principles is the ________. A) IFRS B) FASB C) SEC D) Federal Reserve System Answer: B 27) Accounting practices and procedures used to prepare financial statements are called ________. A) SEC B) IFRS C) GAAP D) IRB Answer: C 28) The federal regulatory body governing the sale and listing of securities is called the ________. A) IRS B) FASB C) GAAP D) SEC Answer: D 29) The stockholders' annual report must include ________. A) common-size financial statements B) an income statement C) an advance tax statement D) the margin of safety report Answer: B 30) The 2002 Sarbanes-Oxley Act was designed to ________. A) limit the compensation that could be paid to corporate CEOs B) eliminate the many disclosure and conflict-of-interest problems of corporations C) provide uniform international accounting standards D) provide the guidelines to minimize the tax Answer: B 31) The 2002 law that established the Public Company Accounting Oversight Board (PCAOB) was called ________. A) the McCain-Feingold Act B) the Harkins-Oxley Act C) the Sarbanes-Harkins Act D) the Sarbanes-Oxley Act Answer: D 32) The Public Company Accounting Oversight Board (PCAOB) ________. A) is a not-for-profit corporation that oversees auditors of public corporations B) is a not-for-profit corporation that oversees managers of public corporations C) is a for-profit corporation that oversees auditors of public corporations D) is a for-profit corporation that oversees managers of public corporations Answer: A 33) The stockholder's report includes ________. A) an estimated interest cost report B) an estimated dividend report C) a break-even sales report D) a statement of retained earnings Answer: D 34) Total assets less net fixed assets equals ________. A) gross assets B) current assets C) depreciation D) liabilities and equity Answer: B 35) A(n) ________ provides a financial summary of a firm's operating results during a specified period. A) income statement B) balance sheet C) statement of cash flows D) statement of retained earnings Answer: A 36) Gross profit is ________. A) operating profits minus depreciation B) operating profits minus cost of goods sold C) sales revenue minus operating expenses D) sales revenue minus cost of goods sold Answer: D 37) Operating profit is ________. A) gross profit minus operating expenses B) sales revenue minus cost of goods sold C) earnings before depreciation and taxes D) sales revenue minus depreciation expense Answer: A 38) Net profit after taxes is ________. A) gross profits minus operating expenses B) sales revenue minus cost of goods sold C) EBITDA minus interest D) EBIT minus interest and taxes Answer: D 39) Operating profit is known as ________. A) earnings after interest and taxes B) earnings before interest and taxes C) earnings before depreciation and taxes D) earnings after tax Answer: B 40) Earnings available for common stockholders is calculated as net profits ________. A) before taxes minus preferred dividends B) after taxes minus preferred dividends C) after taxes minus common dividends D) before taxes minus common dividends Answer: B 41) Which of the following is a current liability? A) accounts receivable B) cash C) notes payable D) inventory Answer: C 42) Which of the following represents a current asset? A) automobiles B) buildings C) marketable securities D) equipment Answer: C 43) Which of the following is a fixed asset? A) land B) accounts payable C) accruals D) notes payable Answer: A 44) The net value of fixed assets is also called its ________. A) market value B) par value C) book value D) intrinsic value Answer: C 45) Retained earnings on the balance sheet represents the ________. A) net profit after taxes B) amount of proceeds in excess of the par value received from the original sale of common stock C) net profit after taxes minus preferred dividends D) cumulative total of all earnings reinvested in the firm Answer: D 46) The ________ represents a summary statement of a firm's financial position at a given point in time. A) income statement B) balance sheet C) statement of cash flows D) statement of retained earnings Answer: B 47) The statement of cash flows ________. A) shows the financial position of a firm at a given point of time B) summarizes all the purchase and sale of fixed assets and raw materials C) provides insight into a firm's operating, investment, and financing cash flows D) classifies a firm's cash flows as operating, investing, financing, and other activities Answer: C 48) When preparing the retained earnings statement, ________ is(are) subtracted in order to derive at the ending balance of retained earnings. A) net profits after taxes B) interest expense C) depreciation D) dividends Answer: D 49) A firm has the following accounts and financial data for the year just ended: The firm's earnings available to common shareholders for the year is ________. A) -$224.25 B) $195.40 C) $302.40 D) $516.60 Answer: C 50) A firm has the following accounts and financial data for the current year: The firm's earnings per share for the year is ________. A) $0.5335 B) $0.5125 C) $0.3204 D) $0.3024 Answer: D 51) A firm had the following accounts and financial data for year just ended: The firm's net profit after taxes for the year is ________. A) -$206.40 B) $213.80 C) $320.40 D) $206.25 Answer: C 52) On the balance sheet, net fixed assets represent ________. A) gross fixed assets at cost minus depreciation expense B) gross fixed assets at market value minus depreciation expense C) gross fixed assets at cost minus accumulated depreciation D) gross fixed assets at market value minus accumulated deprecation Answer: C 53) Paid-in capital in excess of par represents the amount

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