Chapter1

TheRoleandEnvironment
ofManagerialFinance
.1

Learning Goals

1.

Definefinance,itsmajorareasandopportunitiesavailableinthisfield,andthelegalformsof
businessorganization.

2.

Describethemanagerialfinancefunctionanditsrelationshiptoeconomicsandaccounting.

3.

Identifytheprimaryactivitiesofthefinancialmanager.

4.

Explainthegoalofthefirm,corporategovernance,theroleofethics,andtheagencyissue.

5.

Understandfinancialinstitutionsandmarkets,andtheroletheyplayinmanagerialfinance.

6.

Discussbusinesstaxesandtheirimportanceinfinancialdecisions.

.2

True/False

1.

Afinancialanalystisresponsibleformaintainingandcontrollingthefirmsdailycashbalances.
Frequentlymanagesthefirmsshortterminvestmentsandcoordinatesshorttermborrowingand
bankingrelationships.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:1
Topic:CareerOpportunities

2.

Financeisconcernedwiththeprocessinstitutions,markets,andinstrumentsinvolvedinthetransfer
ofmoneyamongandbetweenindividuals,businessesandgovernment.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:1
Topic:FinanceDefined

3.

Financialservicesareconcernedwiththedutiesofthefinancialmanager.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:1
Topic:RoleofFinancialManager

2GitmanPrinciplesofFinance,EleventhEdition

4.

Financialmanagersactivelymanagethefinancialaffairsofmanytypesofbusinessfinancialand
nonfinancial,privateandpublic,forprofitandnotforprofit.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:1
Topic:RoleofFinancialManager

5.

Inpartnerships,ownershaveunlimitedliabilityandmayhavetocoverdebtsofotherlessfinancially
soundpartners.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:1
Topic:LegalFormofOrganization

6.

Inpartnerships,apartnercanreadilytransferhis/herwealthtootherpartners.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:1
Topic:LegalFormofOrganization

7.

Theboardofdirectorsisresponsibleformanagingdaytodayoperationsandcarryingoutthe
policiesestablishedbythechiefexecutiveofficer.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:1
Topic:CorporateGovernance

8.

Thesoleproprietorhasunlimitedliability;hisorhertotalinvestmentinthebusinesscanbetakento
satisfycreditors.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:1
Topic:LegalFormofOrganization

9.

Inlimitedpartnerships,onlyonepartnermayassumelimitedliability.Allotherpartnershaveto
haveunlimitedliability.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:1
Topic:LegalFormofOrganization

10.

Thepresidentorchiefexecutiveofficeriselectedbythefirmsstockholdersandhasultimate
authoritytoguidecorporateaffairsandmakegeneralpolicy.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:1
Topic:CorporateGovernance

Chapter1TheRoleandEnvironmentofManagerialFinance3

11.

Inlimitedpartnerships,partnersliabilitiesarelimitedtotheirinvestmentinthepartnership.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:1
Topic:LegalFormofOrganization

12.

Inlimitedliabilitypartnerships,theliabilityprotectiondoesnotprotectpartnersfromtheir
individualactsofmalpractice.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:1
Topic:LegalFormofOrganization

13.

Thecapitalexpendituresanalyst/managerisresponsiblefortheevaluationandrecommendationof
proposedassetinvestmentsandmaybeinvolvedinthefinancialaspectsofimplementationof
approvedinvestments.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:1
Topic:ManagerialFinanceFunctions

14.

Thefinancialanalystadministersthefirmscreditpolicybyanalyzingormanagingtheevaluationof
creditapplications,extendingcredit,andmonitoringandcollectingaccountsreceivable.
Answer: FALSE
LevelofDifficulty:3
LearningGoal:1
Topic:ManagerialFinanceFunctions

15.

Inlargecompanies,theprojectfinancemanagerisresponsibleforcoordinatingtheassetsand
liabilitiesoftheemployeespensionfund.
Answer: FALSE
LevelofDifficulty:4
LearningGoal:1
Topic:ManagerialFinanceFunctions

16.

InScorporations,stockholdersreceivealloftheorganizationalbenefitsofacorporationandthetax
advantagesofapartnership,butlosecertaintaxadvantagesrelatedtopensionplansthatare
availabletotraditionalcorporations.
Answer: TRUE
LevelofDifficulty:4
LearningGoal:1
Topic:LegalFormofOrganization

17.

UnlikeanScorporation,thelimitedliabilitycorporation(LLC)canownmorethan80percentof
anothercorporation,andcorporations,partnerships,ornonU.S.residentscanownlimitedliability
corporationshares.
Answer: TRUE
LevelofDifficulty:4
LearningGoal:1
Topic:LegalFormofOrganization

4GitmanPrinciplesofFinance,EleventhEdition

18.

Inlimitedliabilitypartnership,allpartnershavelimitedliabilitywithregardtothebusinessthey
arenotpersonallyliableforotherpartnersmalpracticeandthelimitedliabilitypartnershipis
taxedaspartnership.
Answer: TRUE
LevelofDifficulty:4
LearningGoal:1
Topic:LegalFormofOrganization

19.

Marginalanalysisstatesthatfinancialdecisionsshouldbemadeandactionstakenonlywhenadded
benefitsexceedsaddedcosts.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:2
Topic:FundamentalConcepts

20.

Thecorporatecontrollertypicallyhandlestheaccountingactivities,suchastaxmanagement,data
processing,andcostandfinancialaccounting.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:2
Topic:ManagerialFinanceFunctions

21.

Thefinancialmanagerplacesprimaryemphasisoncashflows,theinflowandoutflowofcash.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:2
Topic:FundamentalConcepts

22.

Managerialfinanceisconcernedwithdesignanddeliveryofadviceandfinancialproductsto
individuals,business,andgovernment.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:2
Topic:ManagerialFinanceFunctions

23.

Thecorporatetreasurertypicallyhandlesthebothcostaccountingandfinancialaccounting.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:2
Topic:ManagerialFinanceFunctions

24.

Theaccrualmethodrecognizesrevenueatthepointofsaleandrecognizesexpenseswhenincurred.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:2
Topic:AccountingConcepts

Chapter1TheRoleandEnvironmentofManagerialFinance5

25.

Theaccountantevaluatesfinancialstatements,developsadditionaldata,andmakesdecisionsbased
onhisorherassessmentoftheassociatedreturnsandrisks.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:2
Topic:AccountingConcepts

26.

Thecorporatetreasureristheofficerresponsibleforthefirmsaccountingactivities,suchas
corporateaccounting,taxmanagement,financialaccounting,andcostaccounting.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:2
Topic:ManagerialFinanceFunctions

27.

Thecorporatecontrolleristheofficerresponsibleforthefirmsfinancialactivitiessuchasfinancial
planningandfundraising,makingcapitalexpendituredecisions,andmanagingcash,credit,the
pensionfund,andforeignexchange.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:2
Topic:ManagerialFinanceFunctions

28.

Highcashflowisgenerallyassociatedwithahighersharepricewhereashigherrisktendstoresult
inalowershareprice.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:2
Topic:FundamentalConcepts

29.

Thecorporatetreasurersfocustendstobemoreexternal,whilethecontrollersfocusismore
internal.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:2
Topic:ManagerialFinanceFunctions

30.

Thefinancialmanagerpreparesfinancialstatementsthatrecognizerevenueatthepointofsaleand
expenseswhenincurred.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:2
Topic:RoleofFinancialManager

31.

Usingcertainstandardizedandgenerallyacceptedprinciples,theaccountantpreparesfinancial
statementsthatrecognizerevenueatthepointofsaleandexpenseswhenincurred.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:2
Topic:AccountingConcepts

6GitmanPrinciplesofFinance,EleventhEdition

32.

Thefinancialmanagermustlookbeyondfinancialstatementstoobtaininsightintodevelopingor
existingproblemssincetheaccrualaccountingdatadonotfullydescribethecircumstancesofa
firm.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:2
Topic:RoleofFinancialManager

33.

Whenconsideringeachfinancialdecisionalternativeorpossibleactionintermsofitsimpactonthe
sharepriceofthefirmsstock,financialmanagersshouldacceptonlythoseactionsthatareexpected
toincreasethefirmsprofitability.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:3
Topic:GoaloftheFirm

34.

Financialanalysisandplanningisconcernedwithanalyzingthemixofassetsandliabilities.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:3
Topic:ManagerialFinanceFunctions

35.

Financingdecisionsdealwiththelefthandsideofthefirmsbalancesheetandinvolvethemost
appropriatemixofcurrentandfixedassets.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:3
Topic:ManagerialFinanceFunctions

36.

Thegoalofethicsistomotivatebusinessandmarketparticipantstoadheretoboththeletterandthe
spiritoflawsandregulationsinallaspectsofbusinessandprofessionalpractice.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:4
Topic:TheRoleofEthics

37.

Toachievethegoalofprofitmaximization,foreachalternativebeingconsidered,thefinancial
managerwouldselecttheonethatisexpectedtoresultinthehighestmonetaryreturn.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:4
Topic:FundamentalConcepts

38.

Dividendpaymentschangedirectlywithchangesinearningspershare.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:4
Topic:FundamentalConcepts

Chapter1TheRoleandEnvironmentofManagerialFinance7

39.

Thewealthofcorporateownersismeasuredbythesharepriceofthestock.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:4
Topic:GoaloftheFirm

40.

Economicvalueadded(EVA)isthedifferencebetweenthecostoffundsusedtofinancean
investmentanditsaftertaxoperatingprofits.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:4
Topic:FundamentalConcepts

41.

Economicvalueadded(EVA)iscalculatedbysubtractingthecostoffundsusedtofinancean
investmentfromitsaftertaxoperatingprofits.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:4
Topic:FundamentalConcepts

42.

Returnandriskarethekeydeterminantsofshareprice,whichrepresentsthewealthoftheownersin
thefirm.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:4
Topic:FundamentalConcepts

43.

Ahighearningspershare(EPS)doesnotnecessarilytranslateintoahighstockprice.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:4
Topic:FundamentalConcepts

44.

Theprofitmaximizationgoalignoresthetimingofreturns,doesnotdirectlyconsidercashflows,
andignoresrisk.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:4
Topic:GoaloftheFirm

45.

Whenconsideringeachfinancialdecisionalternativeorpossibleactionintermsofitsimpactonthe
sharepriceofthefirmsstock,financialmanagersshouldacceptonlythoseactionsthatareexpected
toincreaseshareprice.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:4
Topic:GoaloftheFirm

8GitmanPrinciplesofFinance,EleventhEdition

46.

Higherrisktendstoresultinahighersharepricesincethestockholdermustbecompensatedforthe
greaterrisk.
Answer: FALSE
LevelofDifficulty:3
LearningGoal:4
Topic:GoaloftheFirm

47.

Whereriskisinvolved,stockholdersexpecttoearnhigherratesofreturnoninvestmentsoflower
riskandviceversa.
Answer: FALSE
LevelofDifficulty:3
LearningGoal:4
Topic:GoaloftheFirm

48.

Thelikelihoodthatmanagersmayplacepersonalgoalsaheadofcorporategoalsiscalledtheagency
problem.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:4
Topic:AgencyIssue

49.

Agentsofcorporateownersarethemselvesownersofthefirmandhavebeenelectedbyallthe
corporateownerstorepresentthemindecisionmakingandmanagementofthefirm.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:4
Topic:AgencyIssue

50.

Theagencyproblemistheacquisitionofafirmbyanotherfirmthatisnotsupportedby
management.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:4
Topic:AgencyIssue

51.

Marketforcesandagencycostshelptopreventorminimizeagencyproblems.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:4
Topic:FinancialInstitutions

52.

Creditunionsarethelargesttypeoffinancialintermediarythathandleindividualsavings.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:5
Topic:FinancialInstitutions

Chapter1TheRoleandEnvironmentofManagerialFinance9

53.

Amutualfundisatypeoffinancialintermediarythatobtainsfundsthroughthesaleofsharesand
usestheproceedstoacquirebondsandstocksissuedbyvariousbusinessandgovernmentalunits.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:5
Topic:FinancialInstitutions

54.

Primaryandsecondarymarketsaremarketsforshorttermandlongtermsecurities,respectively.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:5
Topic:FinancialMarkets

55.

Financialmarketsareintermediariesthatchannelthesavingsofindividuals,businessesand
governmentintoloansorinvestments.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:5
Topic:FinancialMarkets

56.

Moneymarketsinvolvethetradingofsecuritieswithmaturitiesofoneyearorlesswhilecapital
marketinvolvethebuyingandsellingofsecuritieswithmaturitiesofmorethanoneyear.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:5
Topic:FinancialMarkets

57.

Afinancialinstitutionisanintermediarythatchannelsthesavingsofindividuals,businesses,and
governmentsintoloansorinvestments.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:5
Topic:FinancialInstitutions

58.

Apublicofferingisthesaleofanewsecurityissuetypicallydebtorpreferredstockdirectlyto
aninvestororgroupofinvestors.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialMarkets

59.

Eurocurrencydepositsarisewhenacorporationorindividualmakesadepositinabankina
currencyotherthanthelocalcurrencyofthecountrywherethebankislocated.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialInstitutions

10GitmanPrinciplesofFinance,EleventhEdition

60.

TheDepositoryInstitutionsDeregulationandMonetaryControlActof1980(DIDMCA)instituted
interestrateceilingsonallaccountsafinancialinstitutionoffers.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialInstitutions

61.

Afinancialsupermarketisaninstitutionatwhichacustomercanobtainafullarrayoffinancial
services,suchaschecking,savings,brokerage,insurance,retirementandestateplanning.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialInstitutions

62.

Aprimarymarketisafinancialmarketinwhichpreownedsecuritiesaretraded.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialMarkets

63.

Loantransactionsbetweencommercialbanksinwhichthefederalgovernmentbecomesinvolved
arereferredtoasfederalfunds.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialInstitutions

64.

TheeurocurrencymarketisamarketforshorttermbankdepositsdenominatedinU.S.dollarsor
othereasilyconvertiblecurrencies.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialMarkets

65.

TheOvertheCounter(OTC)exchangeisnotanorganizationbutanintangiblemarketfortrading
securitieswhicharenotlistedbytheorganizedexchanges.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialMarkets

66.

Themoneymarketisafinancialrelationshipcreatedbyanumberofinstitutionsandarrangements
thatallowssuppliersanddemandersoflongtermfundstomaketransactions.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialMarkets

Chapter1TheRoleandEnvironmentofManagerialFinance11

67.

Unliketheorganizedexchanges,theOTCmakesamarketinbothoutstandingsecuritiesandnew
publicissues,makingitbothasecondaryandaprimarymarket.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialMarkets

68.

IntheOTCmarket,theaskpriceisthehighestpriceofferedbyadealertopurchaseagivensecurity.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialMarkets

69.

IntheOTCmarket,thepricesatwhichsecuritiesaretradedresultfrombothcompetitivebidsand
negotiation.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialMarkets

70.

Thepricetoearnings(PE)ratiomeasurestheamountcommonstockinvestorsarewillingtopayfor
eachdollarofthefirmsearnings.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:5
Topic:FundamentalConcepts

71.

Anefficientmarketisamarketthatallocatesfundstotheirmostproductiveuseasaresultof
competitionamongwealthmaximizinginvestors.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialMarkets

72.

InvestorsfindEurobondsattractivebecausetheyprovidecurrencydiversificationandbecausethey
provideanonymitytotheinvestorwishingtoavoidpaymentoftaxes.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:5
Topic:FinancialMarkets

73.

Theordinaryincomeofacorporationisincomeearnedthroughthesaleofafirmsgoodsand
servicesandiscurrentlytaxedsubjecttotheindividualincometaxrates.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:6
Topic:BusinessTaxes

12GitmanPrinciplesofFinance,EleventhEdition

74.

Themarginaltaxraterepresentstherateatwhichadditionalincomeistaxed.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:6
Topic:BusinessTaxes

75.

Dividendsreceivedoncommonandpreferredstocksheldinothercorporationsareallsubjectto
exclusionfortaxpurposesinordertoavoidtripletaxation.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:6
Topic:BusinessTaxes

76.

Becauseofthedividendexclusiononly70percentoftheintercorporatedividendsareincludedas
ordinaryincome.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:6
Topic:BusinessTaxes

77.

Taxlawsareusedtoaccomplisheconomicgoalssuchasprovidingincentivesforcorporate
investmentincertaintypesofassets.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:6
Topic:BusinessTaxes

78.

Withprogressivetaxrates,theaveragetaxrateisalwayslessthanorequaltothemarginaltaxrate.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:6
Topic:BusinessTaxes

79.

Dividendsreceivedbycorporationsoncommonandpreferredstockheldinothercorporationsand
representinglessthan20percentownershipinthemissubjectto70percentexclusionfortax
purposes.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:6
Topic:BusinessTaxes

80.

Theboardofdirectorsofmostlargecorporationstodayincludebothinsidedirectorsandoutside
directors.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:4
Topic:CorporateGovernance

Chapter1TheRoleandEnvironmentofManagerialFinance13

81.

ThemajorpurposeoftheSarbanesOxleyActof2002wastoplacecapsonthecompensationthat
couldbepaidtocorporateexecutives.
Answer: FALSE
LevelofDifficulty:3
LearningGoal:4
Topic:CorporateGovernance

82.

Institutionalinvestorsareprofessionalinvestorswhoworkonbehalfofthefederalgovernmentto
ensurefairnessinthefinancialmarkets.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:4
Topic:CorporateGovernance

83.

RecentstudiesonexecutivecompensationhavefailedtofindastrongrelationshipbetweenCEO
compensationandshareprice.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:4
Topic:AgencyIssue

.3

Multiple Choice Questions

1.

Thepartoffinanceconcernedwithdesignanddeliveryofadviceandfinancialproductsto
individuals,business,andgovernmentiscalled
(a) ManagerialFinance.
(b) FinancialManager.
(c) FinancialServices.
(d) Noneoftheabove.
Answer: C
LevelofDifficulty:1
LearningGoal:1
Topic:ManagerialFinanceFunctions

2.

Managerialfinance
(a) involvestaskssuchasbudgeting,financialforecasting,cashmanagement,andfunds
procurement.
(b) involvesthedesignanddeliveryofadviceandfinancialproducts.
(c) recognizesfundsonanaccrualbasis.
(d) devotesthemajorityofitsattentiontothecollectionandpresentationoffinancialdata.
Answer: A
LevelofDifficulty:1
LearningGoal:1
Topic:ManagerialFinanceFunctions

14GitmanPrinciplesofFinance,EleventhEdition

3.

Financecanbedefinedas
(a) thesystemofdebitsandcredits.
(b) thescienceoftheproduction,distribution,andconsumptionofwealth.
(c) theartandscienceofmanagingmoney.
(d) theartofmerchandisingproductsandservices.
Answer: C
LevelofDifficulty:1
LearningGoal:1
Topic:FinanceDefined

4.

Financialservice
(a) isconcernedwiththedutiesofthefinancialmanager.
(b) involvesthedesignanddeliveryofadviceandfinancialproducts.
(c) providesguidelinesfortheefficientoperationofthebusiness.
(d) handlesaccountingactivitiesrelatedtodataprocessing.
Answer: B
LevelofDifficulty:1
LearningGoal:1
Topic:CareerOpportunities

5.

CareeropportunitiesinfinancialservicesincludeallofthefollowingEXCEPT
(a) investments.
(b) realestateandinsurance.
(c) capitalexpendituresmanagement.
(d) personalfinancialplanning.
Answer: C
LevelofDifficulty:1
LearningGoal:1
Topic:CareerOpportunities

6.

Whichofthefollowingisacareeropportunityinmanagerialfinance?
(a) Investment.
(b) RealEstateandInsurance.
(c) CapitalexpendituresManagement.
(d) PersonalFinancialPlanning.
Answer: C
LevelofDifficulty:1
LearningGoal:1
Topic:CareerOpportunities

7.

Whichofthefollowinglegalformsoforganizationismostexpensivetoorganize?
(a) Soleproprietorships.
(b) Partnerships.
(c) Corporations.
(d) Limitedpartnership.
Answer: C
LevelofDifficulty:1
LearningGoal:1

Chapter1TheRoleandEnvironmentofManagerialFinance15

Topic:LegalFormofOrganization

16GitmanPrinciplesofFinance,EleventhEdition

8.

WhichofthefollowinglegalformsoforganizationsincomeisNOTtaxedunderindividualincome
taxrate?
(a) Soleproprietorships.
(b) Partnerships.
(c) Limitedpartnership.
(d) Corporation.
Answer: D
LevelofDifficulty:1
LearningGoal:1
Topic:LegalFormofOrganization

9.

Underwhichofthefollowinglegalformsoforganization,isownershipreadilytransferable?
(a) Soleproprietorships.
(b) Partnerships.
(c) Limitedpartnership.
(d) Corporation.
Answer: D
LevelofDifficulty:1
LearningGoal:1
Topic:LegalFormofOrganization

10.

Thetrueowner(s)ofthecorporationis(are)the_________.
(a) boardofdirectors
(b) chiefexecutiveofficer
(c) stockholders
(d) creditors
Answer: C
LevelofDifficulty:1
LearningGoal:1
Topic:CorporateGovernance

11.

The_________has/havetheultimateresponsibilityinguidingcorporateaffairsandcarryingout
policies.
(a) boardofdirectors
(b) chiefexecutiveofficer
(c) stockholders
(d) creditors
Answer: A
LevelofDifficulty:1
LearningGoal:1
Topic:CorporateGovernance

Chapter1TheRoleandEnvironmentofManagerialFinance17

12.

Theresponsibilityformanagingdaytodayoperationsandcarryingoutcorporatepoliciesbelongs
tothe_________.
(a) boardofdirectors
(b) chiefexecutiveofficer
(c) stockholders
(d) creditors
Answer: B
LevelofDifficulty:1
LearningGoal:1
Topic:CorporateGovernance

13.

Inacorporation,themembersoftheboardofdirectorsareelectedbythe
(a) chiefexecutiveofficer.
(b) creditors.
(c) stockholders.
(d) employees.
Answer: C
LevelofDifficulty:1
LearningGoal:1
Topic:CorporateGovernance

14.

_________isconcernedwiththedutiesofthefinancialmanagerinthebusinessfirm.
(a) FinancialServices
(b) FinancialManager
(c) ManagerialFinance
(d) Noneoftheabove
Answer: C
LevelofDifficulty:2
LearningGoal:1
Topic:RoleoftheFinancialManager

15.

About75percentofallbusinessfirmsare
(a) soleproprietorships.
(b) partnerships.
(c) corporations.
(d) Scorporations.
Answer: A
LevelofDifficulty:2
LearningGoal:1
Topic:LegalFormofOrganization

18GitmanPrinciplesofFinance,EleventhEdition

16.

Amajorweaknessofapartnershipis
(a) limitedliability.
(b) difficultyliquidatingortransferringownership.
(c) accesstocapitalmarkets.
(d) loworganizationalcosts.
Answer: B
LevelofDifficulty:2
LearningGoal:1
Topic:LegalFormofOrganization

17.

AllofthefollowingarekeystrengthsofacorporationEXCEPT
(a) accesstocapitalmarkets.
(b) limitedliability.
(c) loworganizationcosts.
(d) readilytransferableownership.
Answer: C
LevelofDifficulty:2
LearningGoal:1
Topic:LegalFormofOrganization

18.

Whichofthefollowinglegalformsoforganizationischaracterizedbylimitedliability?
(a) Soleproprietorship.
(b) Partnership.
(c) Corporation.
(d) Professionalpartnership.
Answer: C
LevelofDifficulty:2
LearningGoal:1
Topic:LegalFormofOrganization

19.

Thedominantformoforganizationwithrespecttoreceiptsandnetprofitsisthe
(a) soleproprietorship.
(b) partnership.
(c) corporation.
(d) Scorporation.
Answer: C
LevelofDifficulty:2
LearningGoal:1
Topic:LegalFormofOrganization

Chapter1TheRoleandEnvironmentofManagerialFinance19

20.

Alegalentitywhichcansueandbesued,makeandbepartytocontracts,andacquirepropertyin
itsownnameis
(a) asoleproprietorship.
(b) apartnership.
(c) acorporation.
(d) aprofessionalpartnership.
Answer: C
LevelofDifficulty:2
LearningGoal:1
Topic:LegalFormofOrganization

21.

The_________isresponsibleforevaluatingandrecommendingproposedassetinvestments.
(a) FinancialAnalyst
(b) CreditAnalyst
(c) PensionFundManager
(d) CapitalexpendituresAnalyst
Answer: D
LevelofDifficulty:3
LearningGoal:1
Topic:ManagerialFinanceFunctions

22.

Ina(n)_________,ownershavelimitedliabilitywithregardtothebusinesstheyarenot
personallyliableforthemalpracticeofotherowners.
(a) limitedpartnership
(b) Scorporation
(c) partnership
(d) limitedliabilitypartnership
Answer: D
LevelofDifficulty:3
LearningGoal:1
Topic:LegalFormofOrganization

23.

Managerialfinance
(a) involvestaskssuchasbudgeting,financialforecasting,cashmanagement,andfunds
procurement.
(b) involvesthedesignanddeliveryofadviceandfinancialproducts.
(c) recognizesfundsonanaccrualbasis.
(d) devotesthemajorityofitsattentiontothecollectionandpresentationoffinancialdata.
Answer: A
LevelofDifficulty:1
LearningGoal:2
Topic:ManagerialFinanceFunctions

20GitmanPrinciplesofFinance,EleventhEdition

24.

Thetreasureriscommonlyresponsiblefor
(a) taxes.
(b) dataprocessing.
(c) makingcapitalexpenditures.
(d) costaccounting.
Answer: C
LevelofDifficulty:1
LearningGoal:2
Topic:ManagerialFinanceFunctions

25.

Thecontrolleriscommonlyresponsiblefor
(a) managingcash.
(b) financialaccounting.
(c) managingcreditactivities.
(d) financialplanning.
Answer: B
LevelofDifficulty:1
LearningGoal:2
Topic:ManagerialFinanceFunctions

26.

Theaccountantsprimaryfunctionis
(a) evaluatingthefinancialstatements.
(b) makingdecisionsbasedonfinancialdata.
(c) thecollectionandpresentationoffinancialdata.
(d) planningcashflows.
Answer: C
LevelofDifficulty:1
LearningGoal:2
Topic:AccountingConcepts

27.

Theaccountantrecognizesrevenuesandexpenseson
(a) acashbasis.
(b) arevenuebasis.
(c) anaccrualbasis.
(d) anexpensebasis.
Answer: C
LevelofDifficulty:1
LearningGoal:2
Topic:AccountingConcepts

28.

Thefinancialmanagerrecognizesrevenuesandexpensesutilizing
(a) theaccrualmethod.
(b) theactualinflowsandoutflowsofcash.
(c) thestandardized,generallyaccepted,accountingprinciples.
(d) therevenuemethod.
Answer: B
LevelofDifficulty:1
LearningGoal:2

Chapter1TheRoleandEnvironmentofManagerialFinance21

Topic:RoleofFinancialManager

22GitmanPrinciplesofFinance,EleventhEdition

29.

Thefinancialmanagerisinterestedinthecashinflowsandoutflowsofthefirm,ratherthanthe
accountingdata,inordertoensure
(a) profitability.
(b) theabilitytopaydividends.
(c) theabilitytoacquirenewassets.
(d) solvency.
Answer: D
LevelofDifficulty:1
LearningGoal:2
Topic:RoleofFinancialManager

30.

TheaccountantmayberesponsibleforanyofthefollowingEXCEPT
(a) processingpurchaseordersandinvoices.
(b) ensuringaccountspayablearepaidontime.
(c) preparingthemonthlyincomestatement.
(d) analyzingthemixofcurrenttofixedassets.
Answer: D
LevelofDifficulty:1
LearningGoal:2
Topic:AccountingConcepts

31.

Economictheoriesthatthefinancialmanagermustbeabletoutilizeforefficientbusiness
operations,include
(a) supplyanddemandanalysis.
(b) marginalanalysis.
(c) profitmaximizingstrategies.
(d) pricetheory.
(e) alloftheabove.
Answer: E
LevelofDifficulty:1
LearningGoal:2
Topic:FundamentalConcepts

32.

Theprimaryeconomicprincipleusedinmanagerialfinanceis
(a) supplyanddemand.
(b) theliquiditytrap.
(c) thecrowdingouteffect.
(d) marginalanalysis.
Answer: D
LevelofDifficulty:2
LearningGoal:2
Topic:FundamentalConcepts

Chapter1TheRoleandEnvironmentofManagerialFinance23

33.

Johnson,Inc.hasjustendedthecalendaryearmakingasaleintheamountof$10,000of
merchandisepurchasedduringtheyearatatotalcostof$7,000.Althoughthefirmpaidinfullfor
themerchandiseduringtheyear,ithasyettocollectatyearendfromthecustomer.Thenetprofit
andcashflowfromthissalefortheyearare
(a) $3,000and$10,000,respectively.
(b) $3,000and$7,000,respectively.
(c) $7,000and$3,000,respectively.
(d) $3,000and$7,000,respectively.
Answer: B
LevelofDifficulty:2
LearningGoal:2
Topic:FundamentalConcepts

34.

Afirmhasjustendeditscalendaryearmakingasaleintheamountof$150,000ofmerchandise
purchasedduringtheyearatatotalcostof$112,500.Althoughthefirmpaidinfullforthe
merchandiseduringtheyear,ithasyettocollectatyearendfromthecustomer.Thenetprofitand
cashflowfromthissalefortheyearare
(a) $0and$150,000,respectively.
(b) $37,500and$150,000,respectively.
(c) $37,500and$112,500,respectively.
(d) $150,000and$112,500,respectively.
Answer: C
LevelofDifficulty:2
LearningGoal:2
Topic:FundamentalConcepts

35.

Theprimaryemphasisofthefinancialmanageristheuseof
(a) accruedearnings.
(b) cashflow.
(c) organizationcharts.
(d) profitincentives.
Answer: B
LevelofDifficulty:2
LearningGoal:2
Topic:RoleoftheFinancialManager

36.

Byconcentratingoncashflowswithinthefirmthefinancialmanagershouldbeableto
(a) preparetaxreturns.
(b) speakauthoritativelytostockholders.
(c) avoidinsolvency.
(d) controlexpenses.
Answer: C
LevelofDifficulty:2
LearningGoal:2
Topic:RoleoftheFinancialManager

24GitmanPrinciplesofFinance,EleventhEdition

37.

Theofficerresponsibleforthefirmsfinancialactivitiessuchasfinancialplanningandfundraising,
makingcapitalexpendituredecisions,andmanagingcash,credit,thepensionfund,andforeign
exchangeis
(a) treasurer.
(b) controller.
(c) foreignexchangemanager.
(d) Noneoftheabove.
Answer: A
LevelofDifficulty:3
LearningGoal:2
Topic:ManagerialFinanceFunctions

38.

Marginalanalysisstatesthatfinancialdecisionsshouldbemadeandactionstakenonlywhen
(a) demandequalssupply.
(b) benefitsequalcosts.
(c) addedbenefitsexceedaddedcosts.
(d) addedbenefitsaregreaterthanzero.
Answer: C
LevelofDifficulty:3
LearningGoal:2
Topic:FundamentalConcepts

39.

Theofficerresponsibleforthefirmsaccountingactivities,suchascorporateaccounting,tax
management,financialaccounting,andcostaccountingisthe
(a) treasurer.
(b) controller.
(c) foreignexchangemanager.
(d) Noneoftheabove.
Answer: B
LevelofDifficulty:3
LearningGoal:2
Topic:ManagerialFinanceFunctions

40.

Afirmhasjustendeditscalendaryearmakingasaleintheamountof$200,000ofmerchandise
purchasedduringtheyearatatotalcostof$150,500.Althoughthefirmpaidinfullforthe
merchandiseduringtheyear,ithasyettocollectatyearendfromthecustomer.Thepossible
problemthisfirmmayfaceis
(a) lowprofitability.
(b) lackofcashflow.
(c) inabilitytoreceivecredit.
(d) highleverage.
Answer: B
LevelofDifficulty:3
LearningGoal:2
Topic:FundamentalConcepts

Chapter1TheRoleandEnvironmentofManagerialFinance25

41.

Thekeyroleofthefinancialmanageris
(a) decisionmaking.
(b) thepresentationoffinancialstatements.
(c) thepreparationofdataforfutureevaluation.
(d) thecollectionoffinancialdata.
Answer: A
LevelofDifficulty:1
LearningGoal:3
Topic:RoleoftheFinancialManager

42.

ThekeyactivitiesofthefinancialmanagerincludeallofthefollowingEXCEPT
(a) makingfinancingdecisions.
(b) financialanalysisandplanning.
(c) managingfinancialaccounting.
(d) makinginvestmentdecisions.
Answer: C
LevelofDifficulty:1
LearningGoal:3
Topic:RoleoftheFinancialManager

43.

Includedintheprimaryactivitiesofthefinancialmanagerare
(a) financialanalysisandplanning.
(b) makinginvestmentdecisions.
(c) makingfinancingdecisions.
(d) analyzingandplanningcashflows.
(e) alloftheabove.
Answer: E
LevelofDifficulty:1
LearningGoal:3
Topic:RoleoftheFinancialManager

44.

ThefinancialmanagermayberesponsibleforanyofthefollowingEXCEPT
(a) monitoringofquarterlytaxpayments.
(b) analyzingbudgetandperformancereports.
(c) determiningwhethertoacceptorrejectacapitalassetacquisition.
(d) analyzingtheeffectsofmoredebtonthefirmscapitalstructure.
Answer: A
LevelofDifficulty:1
LearningGoal:3
Topic:RoleoftheFinancialManager

26GitmanPrinciplesofFinance,EleventhEdition

45.

MakinginvestmentdecisionsincludesallofthefollowingEXCEPT
(a) inventory.
(b) fixedassets.
(c) accountsreceivable.
(d) notespayable.
Answer: D
LevelofDifficulty:1
LearningGoal:3
Topic:ManagerialFinanceFunctions

46.

MakingfinancingdecisionsincludesallofthefollowingEXCEPT
(a) determiningtheappropriatemixofshorttermandlongtermfinancing.
(b) decidingwhichindividualshorttermsourcesarebestatagivenpointintime.
(c) analyzingquarterlybudgetandperformancereports.
(d) decidingwhichindividuallongtermsourcesarebestatagivenpointintime.
Answer: C
LevelofDifficulty:1
LearningGoal:3
Topic:ManagerialFinanceFunctions

47.

ManagingthefirmsassetsincludesallofthefollowingEXCEPT
(a) inventory.
(b) fixedassets.
(c) accountsreceivable.
(d) notespayable.
Answer: D
LevelofDifficulty:1
LearningGoal:3
Topic:ManagerialFinanceFunctions

48.

ManagingthefirmsliabilitiesincludesallofthefollowingEXCEPT
(a) accruals.
(b) notespayable.
(c) cash.
(d) accountspayable.
Answer: C
LevelofDifficulty:1
LearningGoal:3
Topic:ManagerialFinanceFunctions

49.

ThefinancialmanagermayberesponsibleforanyofthefollowingEXCEPT
(a) keepingtrackofquarterlytaxpayments.
(b) analyzingquarterlybudgetandperformancereports.
(c) determiningwhethertoacceptorrejectacapitalassetacquisition.
(d) analyzingtheeffectsofmoredebtonthefirmscapitalstructure.
Answer: A
LevelofDifficulty:1
LearningGoal:3

Chapter1TheRoleandEnvironmentofManagerialFinance27

Topic:RoleoftheFinancialManager

28GitmanPrinciplesofFinance,EleventhEdition

50.

FinancialanalysisandplanninginvolveallofthefollowingEXCEPT
(a) transformingdataintoaformthatcanbeusedtomonitorthefirmsfinancialposition.
(b) evaluatingtheneedforincreasedorreducedproductivecapacity.
(c) controllingthedataprocessingactivities.
(d) determiningtheadditionalfinancingneeds.
Answer: C
LevelofDifficulty:2
LearningGoal:3
Topic:ManagerialFinanceFunctions

51.

Thefinancialmanagersinvestmentdecisionsdetermine
(a) boththemixandthetypeofassetsfoundonthefirmsbalancesheet.
(b) boththemixandthetypeofliabilitiesfoundonthefirmsbalancesheet.
(c) boththemixandthetypeofassetsandliabilitiesfoundonthefirmsbalancesheet.
(d) boththemixandthetypeofshorttermandlongtermfinancing.
Answer: A
LevelofDifficulty:2
LearningGoal:3
Topic:ManagerialFinanceFunctions

52.

Inplanningandmanagingtherequirementsofthefirm,thefinancialmanagerisconcernedwith
(a) themixandtypeofassets,butnotthetypeoffinancingutilized.
(b) thetypeoffinancingutilized,butnotthemixandtypeofassets.
(c) theacquisitionoffixedassets,allowingsomeoneelsetoplanthelevelofcurrentassetsrequired.
(d) themixandtypeofassets,thetypeoffinancingutilized,andanalysisinordertomonitorthe
financialcondition.
Answer: D
LevelofDifficulty:2
LearningGoal:3
Topic:ManagerialFinanceFunctions

53.

Thefinancialmanagersfinancingdecisionsdetermine
(a) boththemixandthetypeofassetsfoundonthefirmsbalancesheet.
(b) themostappropriatemixofshorttermandlongtermfinancing.
(c) boththemixandthetypeofassetsandliabilitiesfoundonthefirmsbalancesheet.
(d) theproportionofthefirmsearningstobepaidasdividend.
Answer: B
LevelofDifficulty:3
LearningGoal:3
Topic:ManagerialFinanceFunctions

Chapter1TheRoleandEnvironmentofManagerialFinance29

54.

Theprimarygoalofthefinancialmanageris
(a) minimizingrisk.
(b) maximizingprofit.
(c) maximizingwealth.
(d) minimizingreturn.
Answer: C
LevelofDifficulty:1
LearningGoal:4
Topic:GoaloftheFirm

55.

Corporateownersreceiverealizablereturnthrough
(a) earningspershareandcashdividends.
(b) increaseinsharepriceandcashdividends.
(c) increaseinsharepriceandearningspershare.
(d) profitandearningspershare.
Answer: B
LevelofDifficulty:1
LearningGoal:4
Topic:GoaloftheFirm

56.

Thewealthoftheownersofacorporationisrepresentedby
(a) profits.
(b) earningspershare.
(c) shareprice.
(d) cashflow.
Answer: C
LevelofDifficulty:1
LearningGoal:4
Topic:GoaloftheFirm

57.

Wealthmaximizationasthegoalofthefirmimpliesenhancingthewealthof
(a) theBoardofDirectors.
(b) thefirmsemployees.
(c) thefederalgovernment.
(d) thefirmsstockholders.
Answer: D
LevelofDifficulty:1
LearningGoal:4
Topic:GoaloftheFirm

58.

IfacompanysmanagersareNOTownersofthecompany,theyare
(a) dealers.
(b) agents.
(c) outsiders.
(d) brokers.
Answer: B
LevelofDifficulty:1
LearningGoal:4

30GitmanPrinciplesofFinance,EleventhEdition

Topic:AgencyIssue

Chapter1TheRoleandEnvironmentofManagerialFinance31

59.

Theconflictbetweenthegoalsofafirmsownersandthegoalsofitsnonownermanagersis
(a) theagencyproblem.
(b) incompatibility.
(c) seriousonlywhenprofitsdecline.
(d) oflittleimportanceinmostlargeU.S.firms.
Answer: A
LevelofDifficulty:1
LearningGoal:4
Topic:AgencyIssue

60.

TheagencyproblemmayresultfromamanagersconcernsaboutanyofthefollowingEXCEPT
(a) jobsecurity.
(b) personalwealth.
(c) corporategoals.
(d) companyprovidedperquisites.
Answer: C
LevelofDifficulty:1
LearningGoal:4
Topic:AgencyIssue

61.

AgencycostsincludeallofthefollowingEXCEPT
(a) bondingandstructuringexpenses.
(b) costofgoodssold.
(c) monitoringexpenditures.
(d) opportunitycosts.
Answer: B
LevelofDifficulty:1
LearningGoal:4
Topic:AgencyIssue

62.

AgencycostsincludeallofthefollowingEXCEPT
(a) managementreportstostockholders.
(b) performanceincentivespaidtomanagers.
(c) thecostofmonitoringmanagementbehavior.
(d) purchasinginsuranceagainstmanagementmisconduct.
Answer: A
LevelofDifficulty:2
LearningGoal:4
Topic:AgencyIssue

32GitmanPrinciplesofFinance,EleventhEdition

63.

Onewayoftenusedtoinsurethatmanagementdecisionsareinthebestinterestofthestockholders
isto
(a) threatentofiremanagerswhoareseenasnotperformingadequately.
(b) removemanagementsperquisites.
(c) tiemanagementcompensationtotheperformanceofthecompanyscommonstockprice.
(d) tiemanagementcompensationtothelevelofearningspershare.
Answer: C
LevelofDifficulty:2
LearningGoal:4
Topic:AgencyIssue

64.

Theamountearnedduringtheaccountingperiodoneachoutstandingshareofcommonstockis
called
(a) commonstockdividend.
(b) earningspershare.
(c) netprofitsaftertaxes.
(d) netincome.
Answer: B
LevelofDifficulty:2
LearningGoal:4
Topic:AccountingConcepts

65.

Thegoalofprofitmaximizationwouldresultinpriorityfor
(a) cashflowsavailabletostockholders.
(b) riskoftheinvestment.
(c) earningspershare.
(d) timingofthereturns.
Answer: C
LevelofDifficulty:2
LearningGoal:4
Topic:GoaloftheFirm

66.

ProfitmaximizationdoesNOTtakeintoconsideration
(a) riskandcashflow.
(b) cashflowandstockprice.
(c) riskandEPS.
(d) EPSandstockprice.
Answer: A
LevelofDifficulty:2
LearningGoal:4
Topic:AgencyIssue

Chapter1TheRoleandEnvironmentofManagerialFinance33

67.

ProfitmaximizationasthegoalofthefirmisNOTidealbecause
(a) profitsareonlyaccountingmeasures.
(b) cashflowsaremorerepresentativeoffinancialstrength.
(c) profitmaximizationdoesnotconsiderrisk.
(d) profitstodayarelessdesirablethanprofitsearnedinfutureyears.
Answer: C
LevelofDifficulty:2
LearningGoal:4
Topic:AgencyIssue

68.

ProfitmaximizationfailsbecauseitignoresallEXCEPT
(a) thetimingofreturns.
(b) earningspershare.
(c) cashflowsavailabletostockholders.
(d) risk.
Answer: B
LevelofDifficulty:2
LearningGoal:4
Topic:GoaloftheFirm

69.

Thekeyvariablesintheownerwealthmaximizationprocessare
(a) earningspershareandrisk.
(b) cashflowsandrisk.
(c) earningspershareandshareprice.
(d) profitsandrisk.
Answer: B
LevelofDifficulty:2
LearningGoal:4
Topic:GoaloftheFirm

70.

Returnandriskarethekeydeterminantsinshareprice.Increasedreturnresultsin_________,other
thingsremainingthesame.
(a) alowershareprice.
(b) ahighershareprice.
(c) anunchangedshareprice.
(d) anundeterminedshareprice.
Answer: B
LevelofDifficulty:2
LearningGoal:4
Topic:GoaloftheFirm

34GitmanPrinciplesofFinance,EleventhEdition

71.

Returnandriskarethekeydeterminantsinshareprice.Increasedrisk,otherthingsremainingthe
same,resultsin
(a) alowershareprice.
(b) ahighershareprice.
(c) anunchangedshareprice.
(d) anundeterminedshareprice.
Answer: A
LevelofDifficulty:2
LearningGoal:4
Topic:GoaloftheFirm

72.

Financialmanagersevaluatingdecisionalternativesorpotentialactionsmustconsider
(a) onlyrisk.
(b) onlyreturn.
(c) bothriskandreturn.
(d) risk,return,andtheimpactonshareprice.
Answer: D
LevelofDifficulty:2
LearningGoal:4
Topic:GoaloftheFirm

73.

Anethicsprogramisexpectedtohavea_________impactonthefirmsshareprice.
(a) positive
(b) negative
(c) noimpact
(d) undetermined
Answer: A
LevelofDifficulty:2
LearningGoal:4
Topic:RoleofEthics

74.

Thedifferencebetweenthecostoffundsusedtofinanceaninvestmentanditsaftertaxoperating
profitsiscalled
(a) earningspershare.
(b) dividend.
(c) economicvalueadded.
(d) retainedearnings.
Answer: C
LevelofDifficulty:3
LearningGoal:4
Topic:FundamentalConcepts

Chapter1TheRoleandEnvironmentofManagerialFinance35

75.

Returnandrisk
(a) havenoeffectonshareprice.
(b) haveaninverseeffectonshareprice.
(c) adverselyaffectshareprice.
(d) havethesameeffectonshareprice.
Answer: B
LevelofDifficulty:3
LearningGoal:4
Topic:GoaloftheFirm

76.

Astheriskofastockinvestmentincreases
(a) returnwillincrease.
(b) returnwilldecrease.
(c) requiredrateofreturnwilldecrease.
(d) requiredrateofreturnwillincrease.
Answer: D
LevelofDifficulty:3
LearningGoal:4
Topic:GoaloftheFirm

77.

Amorerecentissuethatiscausingmajorproblemsinthebusinesscommunityis
(a) theprivatizationofownership.
(b) shorttermversuslongtermfinancialgoalsofmanagement.
(c) ethicalproblems.
(d) environmentalconcerns.
Answer: C
LevelofDifficulty:3
LearningGoal:4
Topic:RoleofEthics

78.

Allofthefollowingaremeasuresthatcanbeusedasaguideforestablishingacorporateethics
policy,EXCEPT
(a) aneffectiveinternalcontrolsystem.
(b) aneffectiveinternalauditsystem.
(c) makingreferencechecksbeforehiringnewemployees.
(d) makingsureviolationsarepenalized,whileatthesametimenotsubjectingtheemployeeto
publicity.
Answer: D
LevelofDifficulty:3
LearningGoal:4
Topic:RoleofEthics

36GitmanPrinciplesofFinance,EleventhEdition

79.

Corporateethicspoliciestypicallyapplyto_________indealingwith_________.
(a) employeeactions;customersandcreditors
(b) employeeactions;customers,vendors,andregulators
(c) managementactions;allcorporateconstituents
(d) employeeactions;allcorporateconstituents
Answer: D
LevelofDifficulty:3
LearningGoal:4
Topic:RoleofEthics

80.

Afinancialmanagermustchoosebetweenfouralternativeinvestments,1,2,3,and4.Eachasset
costs$35,000andisexpectedtoprovideearningsoverathreeyearperiodasdescribedbelow.
Asset
1
2
3
4

Year1
$21,000
9,000
3,000
6,000

Year2
$15,000
15,000
20,000
12,000

Year3
$6,000
21,000
19,000
12,000

Basedontheprofitmaximizationgoal,thefinancialmanagerwouldchoose
(a) Asset1.
(b) Asset2.
(c) Asset3.
(d) Asset4.
Answer: B
LevelofDifficulty:4
LearningGoal:4
Topic:GoaloftheFirm
81.

Afinancialmanagermustchoosebetweenfouralternativeinvestments,1,2,3,and4.Eachassetis
expectedtoprovideearningsoverathreeyearperiodasdescribedbelow.
Asset
1
2
3
4

Year1
$21,000
9,000
3,000
6,000

Year2
$15,000
15,000
18,000
12,000

Year3
$9,000
21,000
19,000
12,000

Basedontheprofitmaximizationgoal,thefinancialmanagerwouldchoose
(a) Asset1.
(b) Asset2.
(c) Asset3.
(d) Asset4.
Answer: A
LevelofDifficulty:4
LearningGoal:4
Topic:GoaloftheFirm

Chapter1TheRoleandEnvironmentofManagerialFinance37

82.

Afinancialmanagermustchoosebetweenthreealternativeinvestments.Eachassetisexpectedto
provideearningsoverathreeyearperiodasdescribedbelow.Basedonthewealthmaximization
goal,thefinancialmanagerwould
Year
1
2
3
(a)
(b)
(c)
(d)

Asset1
$21,000
15,000
9,000
$46,000

Asset2
$9,000
15,000
18,000
$41,000

Asset3
$8,000
21,000
19,000
$48,000

chooseAsset1.
chooseAsset2.
chooseAsset3.
beindifferentbetweenAsset1andAsset2.

Answer: A
LevelofDifficulty:4
LearningGoal:4
Topic:GoaloftheFirm
83.

Arecentethicssurveyindicatedtheopinionthatmaintaininghighethicalstandards
(a) weakenedafirmscompetitiveposition,particularlyinforeignmarkets.
(b) hadnoeffectonafirmscompetitiveposition.
(c) strengthenedafirmscompetitiveposition.
(d) wasdifficulttoenforce.
Answer: C
LevelofDifficulty:4
LearningGoal:4
Topic:RoleofEthics

84.

Theimplementationofaproactiveethicsprogramisexpectedtoresultin
(a) apositivecorporateimageandincreasedrespect,butisnotexpectedtoaffectcashflows.
(b) anincreasedsharepriceresultingfromadecreaseinrisk,butisnotexpectedtoaffectcash
flows.
(c) apositivecorporateimageandincreasedrespect,butisnotexpectedtoaffectshareprice.
(d) apositivecorporateimageandincreasedrespect,areductioninrisk,andenhancedcashflow
resultinginanincreaseinshareprice.
Answer: D
LevelofDifficulty:4
LearningGoal:4
Topic:RoleofEthics

38GitmanPrinciplesofFinance,EleventhEdition

85.

Amongsolutionstotheagencyprobleminpubliclyheldcorporationsareallofthefollowing
EXCEPT
(a) stockoptions.
(b) performanceshares.
(c) cashbonusestiedtogoalachievement.
(d) bonusesbasedonshorttermresults.
Answer: D
LevelofDifficulty:4
LearningGoal:4
Topic:AgencyIssue

86.

EmergingtrendsresultingfromtheagencyproblemareallofthefollowingEXCEPT
(a) largeprivatecorporations.
(b) restructuringthroughleveragedbuyouts.
(c) managementbyactiveinvestors.
(d) prohibitingmanagersfrommaintaininganownershipinterest.
Answer: D
LevelofDifficulty:4
LearningGoal:4
Topic:AgencyIssue

87.

WhichofthefollowingisNOTafinancialinstitution?
(a) Acommercialbank.
(b) Aninsurancecompany.
(c) Apensionfund.
(d) Anewspaperpublisher.
Answer: D
LevelofDifficulty:1
LearningGoal:5
Topic:FinancialInstitutions

88.

Thekeyparticipantsinfinancialtransactionsareindividuals,businesses,andgovernments.
Individualsarenet_________offunds,andbusinessesarenet_________offunds.
(a) demanders;suppliers
(b) users;providers
(c) suppliers;demanders
(d) purchasers;sellers
Answer: C
LevelofDifficulty:1
LearningGoal:5
Topic:FinancialMarkets

Chapter1TheRoleandEnvironmentofManagerialFinance39

89.

A_________issimilartoacommercialbankexceptthatitmaynotholddemanddeposits.
(a) savingsbank
(b) creditunion
(c) mutualfund
(d) insurancecompany
Answer: A
LevelofDifficulty:1
LearningGoal:5
Topic:FinancialInstitutions

90.

A_________isafinancialintermediarythatdealsprimarilyinthetransferoffundsbetween
consumers.Membershipisgenerallybasedonsomecommonbond.
(a) savingsbank
(b) creditunion
(c) lifeinsurancecompany
(d) commercialbank
Answer: B
LevelofDifficulty:1
LearningGoal:5
Topic:FinancialInstitutions

91.

A_________isthelargestfinancialintermediaryhandlingindividualsavings.Itreceivespremium
paymentsthatareplacedinloansorinvestmentstoaccumulatefundstocoverfuturebenefits.
(a) savingsbank
(b) creditunion
(c) lifeinsurancecompany
(d) commercialbank
Answer: C
LevelofDifficulty:1
LearningGoal:5
Topic:FinancialInstitutions

92.

A_________issetupsothatemployeesofcorporationsorgovernmentscanreceiveincomeafter
retirement.
(a) savingsbank
(b) creditunion
(c) lifeinsurancecompany
(d) pensionfund
Answer: D
LevelofDifficulty:1
LearningGoal:5
Topic:FinancialInstitutions

40GitmanPrinciplesofFinance,EleventhEdition

93.

A_________isatypeoffinancialintermediarythatpoolssavingsofindividualsandmakesthem
availabletobusinessandgovernmentdemanders.Fundsareobtainedthroughthesaleofshares.
(a) savingsbank
(b) creditunion
(c) mutualfund
(d) savingsandloans
Answer: C
LevelofDifficulty:1
LearningGoal:5
Topic:FinancialInstitutions

94.

PassageoftheDepositoryInstitutionsDeregulationandMonetaryControlAct(DIDMCA)of1980
signaledthebeginningof
(a) lowerinterestratesontimedeposits.
(b) thefinancialservicesrevolution.
(c) automatedtellermachines.
(d) prohibitiononinterstatebanking.
Answer: B
LevelofDifficulty:1
LearningGoal:5
Topic:FinancialInstitutions

95.

Mostbusinessesraisemoneybysellingtheirsecuritiesina
(a) publicoffering.
(b) privateplacement.
(c) directplacement.
(d) stockexchange.
Answer: A
LevelofDifficulty:1
LearningGoal:5
Topic:FinancialMarkets

96.

AllofthefollowingareservicesprovidedbyfinancialinstitutionsEXCEPT
(a) paysaversinterestondepositedfunds.
(b) lendmoneytocustomers.
(c) buythebusinessesofcustomers.
(d) investcustomerssavingsinstocksandbonds.
Answer: C
LevelofDifficulty:1
LearningGoal:5
Topic:FinancialInstitutions

Chapter1TheRoleandEnvironmentofManagerialFinance41

97.

The_________iscreatedbyafinancialrelationshipbetweensuppliersanddemandersofshortterm
funds.
(a) stockmarket
(b) capitalmarket
(c) financialmarket
(d) moneymarket
Answer: D
LevelofDifficulty:1
LearningGoal:5
Topic:FinancialMarkets

98.

Governmentusually
(a) isanetsupplieroffunds.
(b) isanetdemanderoffunds.
(c) borrowsfundsdirectlyfromfinancialinstitutions.
(d) maintainspermanentdepositswithfinancialinstitutions.
Answer: B
LevelofDifficulty:1
LearningGoal:5
Topic:FinancialMarkets

99.

Bydefinition,themoneymarketinvolvesthebuyingandsellingof
(a) stocksandbonds.
(b) shorttermfunds.
(c) fundsthatmatureinmorethanoneyear.
(d) flowsoffunds.
Answer: B
LevelofDifficulty:1
LearningGoal:5
Topic:FinancialMarkets

100. Acompetitivemarketthatallocatesfundstotheirmostproductiveuseiscalleda(n)
(a) liquidmarket.
(b) middlemansmarket.
(c) efficientmarket.
(d) investorsmarket.
Answer: C
LevelofDifficulty:1
LearningGoal:5
Topic:FinancialMarkets

42GitmanPrinciplesofFinance,EleventhEdition

101. Theoverthecounter(OTC)marketis
(a) theNewYorkStockExchange.
(b) anorganizedstockexchange.
(c) aplacewheresecuritiesareboughtandsold.
(d) anintangiblemarketforunlistedsecurities.
Answer: D
LevelofDifficulty:1
LearningGoal:5
Topic:FinancialMarkets
102. Mostmoneymarkettransactionsaremadein
(a) commonstock.
(b) marketablesecurities.
(c) stocksandbonds.
(d) preferredstock.
Answer: B
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialMarkets
103. Firmsthatrequirefundsfromexternalsourcescanobtaintheminoneofthefollowingways
EXCEPT
(a) financialinstitution.
(b) financialmarkets.
(c) government.
(d) privateplacement.
Answer: C
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialInstitutionsandMarkets
104. A_________acceptsbothdemandandtimedepositsandprimarilymakesloansdirectlytoboth
individualandbusinessborrowersorthroughthefinancialmarkets.
(a) savingsbank
(b) creditunion
(c) mutualfund
(d) commercialbank
Answer: D
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialInstitutions

Chapter1TheRoleandEnvironmentofManagerialFinance43

105. The_________iscreatedbyanumberofinstitutionsandarrangementsthatallowthesuppliersand
demandersoflongtermfundstomaketransactions.
(a) financialmarket
(b) capitalmarket
(c) moneymarket
(d) creditmarket
Answer: B
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialMarkets
106. Firmsthatrequirefundsfromexternalsourcescanobtainthemfrom
(a) privateplacement.
(b) financialinstitutions.
(c) financialmarkets.
(d) Alloftheabove.
Answer: D
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialInstitutionsandMarkets
107. Thenonexclusivesaleofeitherbondsorstockstothegeneralpubliciscalled
(a) privateplacement.
(b) publicoffering.
(c) organizedselling.
(d) Noneoftheabove.
Answer: B
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialMarkets
108. TradingiscarriedoutontheflooroftheNewYorkStockExchangeby
(a) thenegotiationprocess.
(b) theauctionprocess.
(c) atelecommunicationsnetwork.
(d) investmentbankers.
Answer: B
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialMarkets

44GitmanPrinciplesofFinance,EleventhEdition

109. AllofthefollowingarefunctionsofsecurityexchangesEXCEPT
(a) allocatingscarcecapital.
(b) aidinginnewfinancing.
(c) creatingcontinuousmarkets.
(d) holdingdemanddeposits.
Answer: D
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialMarkets
110. TradingiscarriedoutontheflooroftheNewYorkStockExchangeby
(a) thenegotiationprocess.
(b) theauctionprocess.
(c) atelecommunicationsnetwork.
(d) investmentbankers.
Answer: B
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialMarkets
111. AllofthefollowingareexamplesoforganizedstockexchangesEXCEPT
(a) theNewYorkStockExchange.
(b) theAmericanStockExchange.
(c) thePacificStockExchange.
(d) theoverthecounterexchange.
Answer: D
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialMarkets
112. Themajorsecuritiestradedinthecapitalmarketsare
(a) commercialpaperandTreasurybills.
(b) Treasurybillsandcertificatesofdeposit.
(c) stocksandbonds.
(d) bondsandcommercialpaper.
Answer: C
LevelofDifficulty:2
LearningGoal:5
Topic:FinancialMarkets
113. Longtermdebtinstrumentsusedbybothgovernmentandbusinessareknownas
(a) stocks.
(b) bills.
(c) bonds.
(d) equities.
Answer: C
LevelofDifficulty:2
LearningGoal:5

Chapter1TheRoleandEnvironmentofManagerialFinance45

Topic:FinancialMarkets

46GitmanPrinciplesofFinance,EleventhEdition

114. Thetwokeyfinancialmarketsare
(a) primarymarketandsecondarymarket.
(b) primarymarketandmoneymarket.
(c) moneymarketandcapitalmarket.
(d) capitalmarketandsecondarymarket.
Answer: C
LevelofDifficulty:3
LearningGoal:5
Topic:FinancialMarkets
115. The_________stockexchangeisaprimarymarketwherenewpublicissuesaresold.
(a) regional
(b) American
(c) NewYork
(d) overthecounter
Answer: D
LevelofDifficulty:3
LearningGoal:5
Topic:FinancialMarkets
116. TradingiscarriedoutintheOvertheCounter(OTC)Exchangeby
(a) thecompetitivebidprocess.
(b) thecompetitivebidprocessandthenegotiationprocess.
(c) theauctionprocess.
(d) aninvestmentbanker.
Answer: B
LevelofDifficulty:3
LearningGoal:5
Topic:FinancialMarkets
117. SecuritiesexchangescreateefficientmarketsthatdoallofthefollowingEXCEPT
(a) ensureamarketinwhichthepricereflectsthetruevalueofthesecurity.
(b) allocatefundstothemostproductiveuses.
(c) controlthesupplyanddemandforsecuritiesthroughprice.
(d) allowthepricetobedeterminedbysupplyanddemandofsecurities.
Answer: C
LevelofDifficulty:3
LearningGoal:5
Topic:FinancialMarkets
118. Thetaxdeductibilityofexpenses_________theiraftertaxcost.
(a) increases
(b) reduces
(c) hasnoeffecton
(d) hasanundeterminedeffecton
Answer: B
LevelofDifficulty:1
LearningGoal:6

Chapter1TheRoleandEnvironmentofManagerialFinance47

Topic:BusinessTaxes

48GitmanPrinciplesofFinance,EleventhEdition

119. Acapitalgainoccurswhenanassethasbeenheldfor
(a) morethansixmonths.
(b) lessthansixmonths.
(c) morethanoneyear.
(d) anylengthoftime.
Answer: D
LevelofDifficulty:1
LearningGoal:6
Topic:BusinessTaxes
120. Thetaxliabilityofacorporationwithordinaryincomeof$105,000is_________.
(a) $42,000
(b) $35,700
(c) $23,950
(d) $24,200
Answer: D
LevelofDifficulty:2
LearningGoal:6
Topic:BusinessTaxes
121. Thetaxliabilityofacorporationwithordinaryincomeof$1,500,000is_________.
(a) $498,250
(b) $510,000
(c) $585,000
(d) $690,000
Answer: B
LevelofDifficulty:2
LearningGoal:6
Topic:BusinessTaxes
122. Thetaxliabilityofacorporationwithordinaryincomeof$1,100,000is_________.
(a) $362,250
(b) $340,000
(c) $374,000
(d) $390,000
Answer: C
LevelofDifficulty:2
LearningGoal:6
Topic:BusinessTaxes

Chapter1TheRoleandEnvironmentofManagerialFinance49

123. Jennings,Inc.hasataxliabilityof$170,000onpretaxincomeof$500,000.Whatistheaveragetax
rateforJennings,Inc.?
(a) 34percent
(b) 46percent
(c) 25percent
(d) 40percent
Answer: A
LevelofDifficulty:2
LearningGoal:6
Topic:BusinessTaxes
124. Theaveragetaxrateofacorporationwithordinaryincomeof$105,000andataxliabilityof
$24,200is
(a) 46percent.
(b) 23percent.
(c) 34percent.
(d) 15percent.
Answer: B
LevelofDifficulty:2
LearningGoal:6
Topic:BusinessTaxes
125. Ifacorporationsellscertainassetsformorethantheirinitialpurchaseprice,thedifferencebetween
thesalepriceandthepurchasepriceiscalleda(n)
(a) ordinarygain.
(b) capitalloss.
(c) capitalgain.
(d) ordinaryloss.
Answer: C
LevelofDifficulty:2
LearningGoal:6
Topic:BusinessTaxes
126. Ingeneral,mostcorporatecapitalgainsaretaxedat_________taxrate.
(a) a46percent
(b) theordinary
(c) a28percent
(d) a30percent
Answer: B
LevelofDifficulty:2
LearningGoal:6
Topic:BusinessTaxes

50GitmanPrinciplesofFinance,EleventhEdition

127. Congressallowscorporationstoexcludefromtaxes70to100percentofdividendsreceivedfrom
othercorporations.Congressdidthisto
(a) encouragecorporationstoinvestineachother.
(b) avoiddoubletaxationondividends.
(c) avoidtripletaxationondividends.
(d) lowerthecostofequityfinancingforcorporations.
Answer: C
LevelofDifficulty:2
LearningGoal:6
Topic:BusinessTaxes
128. CorporationXneeds$1,000,000andcanraisethisthroughdebtatanannualrateof10percent,or
preferredstockatanannualcostof7percent.Ifthecorporationhasa40percenttaxrate,the
aftertaxcostofeachis
(a) debt:$100,000;preferredstock:$70,000.
(b) debt:$60,000;preferredstock:$42,000.
(c) debt:$60,000;preferredstock:$70,000.
(d) debt:$100,000;preferredstock:$42,000.
Answer: C
LevelofDifficulty:3
LearningGoal:6
Topic:BusinessTaxes
129. CorporationAowns15percentofthestockofcorporationB.CorporationBpayscorporationA
$100,000individendsin2002.CorporationAmustpaytaxon
(a) $100,000ofordinaryincome.
(b) $30,000ofordinaryincome.
(c) $70,000ofordinaryincome.
(d) $70,000ofcapitalgain.
Answer: B
LevelofDifficulty:3
LearningGoal:6
Topic:BusinessTaxes
130. Thedividendexclusionforcorporationsreceivingdividendsfromanothercorporationhasresulted
in
(a) alowercostofequityforthecorporationpayingthedividend.
(b) ahigherrelativecostofbondfinancingforthecorporationpayingthedividend.
(c) stockinvestmentsbeingrelativelylessattractive,relativetobondinvestmentsmadebyone
corporationinanothercorporation.
(d) stockinvestmentsbeingrelativelymoreattractiverelativetobondinvestmentsmadebyone
corporationinanothercorporation.
Answer: D
LevelofDifficulty:3
LearningGoal:6
Topic:BusinessTaxes

Chapter1TheRoleandEnvironmentofManagerialFinance51

131. AllofthefollowingaretrueEXCEPT
(a) Interestincomereceivedbyacorporationistaxedasordinaryincome.
(b) Corporationspaytaxesonalldividendsreceivedfromothercorporations,nomattertheirshare
ofownership.
(c) Corporationsmaypaytaxesononly30percentofthedividendsreceivedfromother
corporations,dependingontheirpercentageofownership.
(d) Capitalgainsistaxedasordinaryincome.
Answer: B
LevelofDifficulty:4
LearningGoal:6
Topic:BusinessTaxes
132. Theboardofdirectorsistypicallyresponsiblefor
(a) developingstrategicgoalsandplans
(b) hiringandfiring
(c) both(a)and(b)
(d) neither(a)nor(b)
Answer: C
LevelofDifficulty:2
LearningGoal:4
Topic:CorporateGovernance
133. TheSarbanesOxleyActof2002waspassedinresponseto
(a) insidertradingactivities
(b) falsedisclosuresinfinancialreporting
(c) thedeclineintechnologystocks
(d) alloftheabove
Answer: B
LevelofDifficulty:4
LearningGoal:4
Topic:CorporateGovernance
134. TheSarbanesOxleyActof2002didallofthefollowingEXCEPT
(a) tightenauditregulationsandcontrols.
(b) toughenpenaltiesagainstovercompensatedexecutives.
(c) toughenpenaltiesagainstexecutiveswhocommitcorporatefraud.
(d) alloftheabovearetrue.
Answer: B
LevelofDifficulty:4
LearningGoal:4
Topic:CorporateGovernance

52GitmanPrinciplesofFinance,EleventhEdition

.4

Essay Questions

1.

MeesePaperDistributors,Inc.hasbeforetaxearningsof$1,900,000.Calculatetheamountofthe
totaltaxliability.
Answer:
MeesePaperDistributors
0.15$50,000
0.25$25,000
0.34$25,000
0.39($335,000$100,000)
0.34(1,900,000$335,000)
Totaltaxliability

TaxLiability
$7,500
6,250
8,500
91,650
$532,100
$646,000

LevelofDifficulty:3
LearningGoal:6
Topic:BusinessTaxes
2.

During2002,afirmhassold5assetsdescribedbelow.Calculatethetaxliabilityontheassets.The
firmpaysa40percenttaxrateonordinaryincome.
Asset
1
2
3
4
5

Purchase
Price
$10,000
$50,000
$37,500
$3,000
$15,000

Sale
Price
$12,000
$40,000
$50,000
$3,500
$12,000

Answer:
Asset
1
2
3
4
5

TaxLiability
$2,000(0.40)

$12,500(0.40)
$500(0.40)

LevelofDifficulty:3
LearningGoal:6
Topic:BusinessTaxes

$800

$5,000
$200

Chapter1TheRoleandEnvironmentofManagerialFinance53

3.

Considertwofirms,GoDebtcorporationandNoDebtcorporation.Bothfirmsareexpectedtohave
earningsbeforeinterestandtaxesof$100,000duringthecomingyear.Inaddition,GoDebtis
expectedtoincur$40,000ininterestexpensesasaresultofitsborrowingswhereasNoDebtwill
incurnointerestexpensebecauseitdoesnotusedebtfinancing.However,NoDebtwillhavetopay
stockholders$40,000individendincome.Bothfirmsareinthe40percenttaxbracket.Calculatethe
Earningsaftertaxforbothfirms.Whichfirmhasthehigheraftertaxearnings?Whichfirmappears
tohavethehighercashflow?Howdoyouaccountforthedifference?
Answer:

Earningsbeforeinterest
andtaxes
Less:Interestexpense
Earningsbeforetaxes
Less:Taxes(40%)
Earningsaftertaxes
Less:Dividendspaid

Go
Debt
$100,000

No
Debt
$100,000

40,000
$60,000
24,000
$36,000
0

0
$100,000
40,000
$60,000
40,000

GoDebthaslowerearningsaftertaxescomparedtoNoDebt.However,fromacash
outflowperspective,GoDebtpaidoutatotalofonly$64,000($40,000ininterest
expensesplus$24,000intaxes)whileNodebtpaidoutatotalof$80.000($40,000in
taxesand$40,000individends).Thedifferencebetweenthetwois$16,000whichis
exactlythedifferenceintaxespaidbetweenthetwofirms($24,000comparedto$40,000).
Thisdifferenceresultsfromthefactthatinterestexpenseisataxdeductibleexpense.
LevelofDifficulty:4
LearningGoal:6
Topic:BusinessTaxes