Test Bank for Fundamentals of Corporate Finance, 4th Edition

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1
Fundamentals of Corporate Finance, 4e (Berk/DeMarzo/Harford)
Chapter 1 Corporate Finance and the Financial Manager
1.1 Why Study Finance?
1) The Valuation Principle shows how to make the costs and benefits of a decision comparable so that we
can evaluate them properly.
Answer: TRUE
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
2) Financial decisions require that you weigh alternatives in strictly monetary terms.
Answer: FALSE
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
3) Which of the following best describes why the Valuation Principle is a key concept in making financial
decisions?
A) It shows how to assign monetary value to intangibles such as good health and well-being.
B) It allows fixed assets and liquid assets to be valued correctly.
C) It gives a good indication of the net worth of a person, item, or company and can be used to estimate
any changes in that net worth.
D) It shows how to make the costs and benefits of a decision comparable so that we can weigh them
properly.
Answer: D
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
1.2 The Four Types of Firms
1) Partnerships are the most common type of business firm in the world.
Answer: FALSE
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised

2
2) Corporations have come to dominate the business world through their ability to raise large amounts of
capital by sale of ownership shares to anonymous outside investors.
Answer: TRUE
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
3) Which of the following types of firms does NOT have limited liability?
A) sole proprietorships
B) limited partnerships
C) corporations
D) none of the above
Answer: A
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
4) Over four-fifths of all U.S. business revenue is generated by which type of firm?
A) sole proprietorships
B) partnerships
C) limited partnerships
D) corporations
Answer: D
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
5) What is the most common type of firm in the United States and the world?
A) sole proprietorships
B) partnerships
C) limited partnerships
D) corporations
Answer: A
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition

3
6) Which of the following is typically the major factor in limiting the growth of sole proprietorships?
A) The organizational structure of such firms tends to become extremely complicated over time.
B) It is extremely difficult to transfer control of such firms to a new owner if the present owner dies or
wishes to sell the firm.
C) The amount of money that can be raised by such firms is limited by the fact that the single owner must
make good on all debts.
D) Investors have a great deal of control over the day-to-day running of such firms, leading to confusion
when conflicts in direction arise.
Answer: C
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
7) Joe is a general partner in a limited partnership firm, while Jane is a limited partner in the same firm.
Which of the following statements regarding their respective relationships to the firm is correct?
A) Joe has no management authority within the partnership.
B) Jane is legally involved in the managerial decision making of the firm.
C) Jane's liability for the firm's debts consists solely of her investment in the firm.
D) Withdrawal of Jane from the partnership will dissolve the partnership.
Answer: C
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Reflective Thinking Skills
Author: DS
Question Status: Revised
8) What is the major way in which the roles and obligations of the owners of a limited liability company
differ from the roles and obligations of limited partners in a limited partnership?
A) The owners of a limited liability company have personal obligation for debts incurred by the
company.
B) There is no separation between the company and its owners in a limited liability company.
C) The owners of a limited liability company can withdraw from the company without the company
being dissolved.
D) The owners of a limited liability company can take an active role in running the company.
Answer: D
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition

4
9) In which of the following ways is a limited liability company like a corporation?
A) It was created and developed first in the United States.
B) It can choose to be considered a partnership for tax purposes.
C) Its owners' liability is restricted to their investment.
D) It is directly managed by the owners.
Answer: C
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
10) Why is it possible for a corporation to enter into contracts, acquire assets, incur obligations, and enjoy
protection against the seizure of its property?
A) The number of owners, and hence the spread of risk among these owners, is not limited.
B) Its owners are liable for any obligations it enters into.
C) The state in which a corporation is incorporated provides safeguards against any wrongdoing by the
corporation.
D) It is a legally defined, artificial entity that is separate from its owners.
Answer: D
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
11) Which of the following features of a corporation is LEAST accurate?
A) The owners' identities are separate from a corporation.
B) The owners of a corporation are not liable for any obligations the corporation enters into.
C) Changes in ownership do not result in the dissolution of the corporation.
D) Earnings from a corporation are taxed only once.
Answer: D
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
12) What is the major advantage corporations have over other business entities?
A) It is easier for a corporation to raise capital than other forms of businesses.
B) A corporation is treated as a separate legal entity for tax and legal purposes.
C) A corporation's shares can be freely traded among its shareholders.
D) All of the above are advantages that a corporation has over other business forms.
Answer: D
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition

5
13) Helen owns 10.2% of the stock of the Median Corporation. If Median makes a dividend payment of
$25,000,000 paid proportionally to its shareholders, how much of this amount would Helen receive,
disregarding tax?
A) $3,060,000
B) $2,550,000
C) $3,570,000
D) $2,040,000
Answer: B
Explanation: B) Helen will receive ownership dividend payment proportional to her ownership of 10.2%:
Diff: 2 Var: 50+
Skill: Analytical
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
14) Valiant Corp. is a C corporation that earned $3.4 per share before it paid any taxes. Valiant Corp.
retained $1 of after-tax earnings for reinvestment and distributed what remained in dividend payments.
If the corporate tax rate was 35% and dividend earnings were taxed at 12.5%, what was the value of the
dividend earnings received after-tax by a holder of 100,000 shares of Valiant Corp.?
A) $105,875
B) $127,050
C) $148,225
D) $84,700
Answer: A
Explanation: A) Corporate tax paid on $3.4 earnings = $3.4 × 0.35 = 1.190; earnings after-
earnings distributed as taxes paid on

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announces a profit of $6 per share, of which it retains $1 for reinvestment and distributes the rest as
dividend payments. Given that the personal tax rate is 35%, how much tax must you pay per share?
A) $0
B) $2.10
C) $1.75
D) $2.52
Answer: C
Explanation: C) Tax paid by shareholder of S
Diff: 2 Var: 8
Skill: Analytical
AACSB Objective: Reflective Thinking Skills
Author: DS
Question Status: Revised
17) A C corporation earns $8.30 per share before taxes. The corporate tax rate is 39%, the personal tax rate
on dividends is 15%, and the personal tax rate on non-dividend income is 36%. What is the total amount
of taxes paid if the company pays a $6.00 dividend?
A) $3.31
B) $4.96
C) $4.14
D) $5.79
Answer: C
Explanation: C) Corporate tax = $8.30 × 39% = $3.24,
Diff: 2

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19) A C corporation earns $8.30 per share before taxes and the company pays a dividend of $4.00 per
share. The corporate tax rate is 39%, the personal tax rate on dividends is 15%, and the personal tax rate
on non-dividend income is 36%. What is the after-tax amount an individual would receive from the
dividend?
A) $2.72
B) $4.08
C) $4.76
D) $3.40
Answer: D
Explanation: D) Personal tax = $4 × 15% = $0.60.
Diff: 2 Var: 50+
Skill: Analytical
AACSB Objective: Reflective Thinking Skills
Author: WC
Question Status: Revised
20) A C corporation earns $4.30 per share before taxes. The corporate tax rate is 35%, the personal tax rate
on dividends is 20%, and the personal tax rate on non-dividend income is 39%. What is the total amount
of taxes paid if the company pays a $3.00 dividend?
A) $1.68
B) $2.53
C) $2.11
D) $2.95
Answer: C
Explanation: C) Corporate tax = $4.30 × 35% = $1.51,
Diff: 2

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26) Which of the following is NOT an advantage of a sole proprietorship?
A) single taxation
B) ease of setup
C) unlimited liability
D) no separation of ownership and control
Answer: C
Diff: 2 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: JN
Question Status: Revised
27) A limited liability company is essentially ________.
A) a limited partnership without limited partners
B) a limited partnership without a general partner
C) just another name for a limited partnership
D) just another name for a corporation
Answer: B
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: JN
Question Status: Revised

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30) How is a corporation different from most of the other forms of business organizations?
Answer: A corporation has a separate legal identity from those of its owners. This separation gives the
owners limited liability for the actions of the corporation. The down side is that each dollar earned by the
corporation is taxed twice, once when it is earned by the corporation and subsequently when it is passed
on to the owners.
Diff: 2 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: SS
Question Status: Revised
1.3 The Financial Manager
1) The principal goal of a financial manager is to maximize the wealth of the stockholders.
Answer: TRUE
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
2) It is generally not the duty of financial managers to ensure that a firm has the cash it needs for day-to-
day transactions.
Answer: FALSE
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills

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4) Why in general do financial managers make financial decisions in a corporation, rather than the
owners making these decisions themselves?
A) It is best for the control of the finances of a corporation to be in the hands of a disinterested third
party.
B) The interests of the various owners may conflict with each other.
C) The owners may not be U.S. citizens or residents.
D) There are often many owners, and they can often change as they buy and sell stock.
Answer: D
Diff: 2 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
5) What is the most important duty of a firm's financial officer?
A) to ensure that the firm has enough cash on hand to meet its commitments at any given time
B) to decide how to pay for investments
C) to manage working capital
D) to make investment decisions
Answer: D
Diff: 2 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised

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7) Which of the following is NOT a reason why a firm's financial managers must take great care when
making investment decisions?
A) These investment decisions determine whether the firm will add value for its owners.
B) These investments determine the long-term directions in which the company may move.
C) These investment decisions determine the corporation's mix of debt and equity.
D) These investment decisions typically involve substantial costs which must be carefully weighed
against their potential benefits.
Answer: C
Diff: 2 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
8) A company that produces racing motorbikes has several models that sell well within the motorcycle
racing community and which are very profitable for the company. Despite having a profitable product,
why must this company take care to ensure that it has sufficient cash on hand to meet its obligations?
A) Profits from the sales of popular models will be lost when returned to the shareholders in the form of
dividends.
B) New models will require a lot of money to develop and bring to market before they generate any
revenue.
C) The company will have built up debts which must be repaid in order to bring the current models to
market.
D) Equity must be raised to finance the development of new models to replace the existing models.
Answer: B
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Reflective Thinking Skills
Author: DS

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4) Which of the following is NOT a function of the board of directors?
A) determining how top executives should be compensated
B) monitoring the performance of the company
C) answering to shareholders of the company
D) day-to-day running of the company
Answer: D
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
5) In most corporations, to whom does the chief financial officer report?
A) shareholders
B) the board of directors
C) the chief executive officer
D) the controller
Answer: C
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised

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7) Which of the following would be best considered to be an agency conflict problem in the behavior of
the following financial managers?
A) Bill chooses to pursue a risky investment for the company's funds because his compensation will
substantially rise if it succeeds.
B) Sue instructs her staff to skip safety inspections in one of the company's factories, knowing that it will
likely fail the inspection and incur significant costs to fix.
C) James ignores an opportunity for his company to invest in a new drug to fight Alzheimer's disease,
judging the drug's chances of succeeding as low.
D) Michael chooses to enhance his firm's reputation at some cost to its shareholders by sponsoring a team
of athletes for the Olympics.
Answer: A
Diff: 3 Var: 1
Skill: Conceptual
AACSB Objective: Ethical Understanding and Reasoning Abilities
Author: DS
Question Status: Revised
8) A factory owner wants his workers to produce as many widgets as they can so he pays his workers
based on how many widgets they produce. However, in order to make sure that the workers do not rush
and produce a large number of poorly made widgets, he checks the widgets at random during various
stages of their manufacture. If a defect is found in a widget, the pay of the entire section of the factory
responsible for that defect is docked. How is this factory owner seeking to solve the agency conflict
problem in this case?
A) by supplying incentives so the agents act in the way principal desires
B) by ensuring that all workers co-operate to maximize the gains of their section
C) by making the agents into principals themselves
D) by maximizing the information that the principal obtains about the behavior of the agents
Answer: A
Diff: 1 Var: 1
Skill: Conceptual
AACSB Objective: Ethical Understanding and Reasoning Abilities
Author: DS

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