chap 001

Chapter 01 - Goals and Governance of the Firm

1-1

Chapter 01

Goals and Governance of the Firm

Multiple Choice Questions

1. Finance, generally, deals with:

I) Money; II) Markets; III) People

A. I only

B. I and II only

C. I and III only

D. I, II and III

2. This book is mainly about:

A. financial decisions made by households

B. financial decisions made by corporations

C. financial decisions made by governments

D. none of the above

3. The following are examples of the United States-based corporations except:

I) Boeing; II) Microsoft; III) Bank of America; IV) Sony

A. I only

B. I and II only

C. I, II, and III only

D. IV only

4. The following are examples of foreign-based corporations except:

I) British Petroleum; II) General Electric; III) Sony; IV) Volkswagen

A. I only

B. II only

C. II and III only

D. I, II, & IV only


1-2

5. Shareholders of a corporation may be, among others:

I) Individuals; II) Pension Funds; III) Insurance Companies

A. I only

B. I and II only

C. II only

D. I, II and III

6. Generally, a corporation is owned by the:

I) Managers; II) Board of Directors; III) Shareholders

A. I only

B. II and III

C. III only

D. I, II and III

7. Corporations, potentially, have infinite life because:

A. it is a legal entity

B. of separation of ownership and management

C. it has limited liability


8. Limited liability is an important feature of:

A. Sole proprietorships

B. Partnerships

C. Corporations

D. All of the above

9. As a legal entity a corporation can perform the following functions except:

I) borrow money; II) lend money; III) sue and be sued; IV) vote

A. I and II only

B. I, II, and III only

C. IV only

D. I, II, III and IV


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10. The following are examples of intangible assets except:

A. Building

B. Trademarks

C. Patents

D. Technical expertise

11. The following are examples of tangible assets except:

A. Machinery

B. Factories

C. Trademarks

D. Offices

12. A firm's investment decision is also called the:

A. Financing decision

B. Liquidity decision

C. Capital budgeting decision

D. None of the above

13. The following are examples of financial assets except:

A. Common stock

B. Bank loan

C. Preferred stock

D. Buildings

14. The treasurer usually oversees the following functions of a corporation except:

I) Preparation of financial statements; II) Investor relationships; III) Cash management; IV)

raising new capital

A. I only

B. I and II only

C. II, III and IV only

D. III only


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15. The treasurer is usually responsible the following functions of a corporation:

I) Tax obligations; II) Investor relationships; III) Cash management; IV) raising new capital

A. I only

B. I and II only



16. The controller usually oversees the following functions of a corporation:

I) Preparation of financial statements; II) Internal accounting; III) Cash management and IV)

Taxes

A. I, II and IV only

B. III only

C. I and II only

D. II and III

17. The controller is usually responsible for the following functions of a corporation except:

I) Preparation of financial statements; II) Internal accounting; III) Cash management; IV)

Taxes

A. I only

B. III only

C. I and II only

D. IV only

18. The following are important functions of financial markets:

I) Source of financing; II) Provide liquidity; III) Reduce risk; IV) Source of information

A. I only

B. I and II only

C. I, II, III, and IV

D. IV only


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19. The Chief Financial Officer (CFO) of a corporation oversees:

A. Treasurer's functions

B. Controller's functions

C. Both A and B


20. Conflicts of interest between shareholders and managers of a firm result in:

A. Principal-agent problem

B. Increased agency costs

C. Both A and B

D. Managers owning the firm

21. In the principal-agent framework:

A. Shareholders are the principals

B. Managers are the principals

C. Managers are the agents

D. A and D

22. Costs associated with the conflicts of interest between the bondholders and the

shareholders of a corporation are called:

A. Legal costs

B. Bankruptcy costs

C. Administrative costs

D. Agency costs

23. Agency costs are incurred by a corporation because:

A. managers may not attempt to maximize the value of the firm to shareholders

B. shareholders incur monitoring cost

C. separation of ownership and management

D. all of the above


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24. The following groups are some of the claimants to a firm's income stream:

I) Shareholders; II) Bondholders; III) Employees; IV) Management and V) Government

A. I and II only


C. I, II, III and IV only

D. I, II, III, IV and V

25. The financial goal of a corporation is to:

A. Maximize profits

B. Maximize sales

C. Maximize the value of the firm for the shareholders

D. Maximize managers' benefits

26. The purchase of real assets is also referred to as the:

A. Capital decision

B. CFO decision

C. Financing decision

D. Investment decision

27. The sale of financial assets is also referred to as the:

A. Capital decision

B. CFO decision



28. The mixture of debt and equity, used to finance a corporation is also known as:

A. Capital budgeting

B. Capital structure

C. Investing

D. Treasury


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29. Which of the following is not a common function of the firm's chief financial officer?

A. Hiring CEO

B. Hiring controller

C. Investing capital

D. Paying dividends

30. Of the following list, which is a stakeholder?

I) Employee; II) Customer; III) Community; IV) Supplier


B. III only

C. I and II only

D. All

31. The following are examples of real assets:

I) Machinery; II) Office buildings; III) Warehouse; IV) Common stock

A. I, II, and III only

B. I and II only

C. IV only

D. I only


I) Machinery; II) Office buildings; III) Warehouse; IV) Training for employees

A. I only

B. I and II only

C. IV only

D. I, II, and III only


A. Minimize stockholder wealth

B. Maximize profit

C. Maximize value of the corporation to the stockholders

D. Decrease job security


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34. Managers' actions are monitored by:

A. The board of directors

B. Commercial banks that have loaned funds to the firm

C. The Wall Street analysts

D. All of the above

35. The following are some of the actions shareholders can take if the corporation is not

performing well:

A. Replace the board of directors in an election.

B. Force the board of directors to change the management team.

C. Sell their shares of stock in the corporation.

D. Any of the above

36. The idea of "maximizing shareholder value" is widely accepted in:

I) U.S.A.; II) U.K; III) Germany; IV) France; V) Japan

A. I only

B. I and II only

C. III, IV and V only


37. The idea that "firms should be run for stakeholders welfare " is accepted in:


A. I only

B. I and II only



38. The Sarbanes-Oxley Act of 2002 (SOX) was passed largely in response to:

A. the corporate accounting scandals of the previous years

B. the increase in the budget deficits

C. the increase in the trade deficits



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39. A major advantage of the Sarbanes-Oxley Act of 2002 (SOX) is:

A. good investor protection

B. increase in compliance costs

C. that it constrains managers' ability to run the firm

D. that it may discourage development of human capital in the firm

40. Major disadvantages of the Sarbanes-Oxley Act of 2002 (SOX) are the following except:





True / False Questions

41. The board of directors is ultimately responsible for all large investment decisions.

True False

42. A corporation has a legal existence of its own and is based on "articles of incorporation."

True False

43. Real assets of a corporation are claims on their financial assets.

True False

44. Since the investment and financing decisions are analyzed separately, the financial

manager can completely ignore investors and financial markets when analyzing capital

investment projects.

True False


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45. The treasurer's responsibilities include preparation of financial statements.

True False

46. In large firms, there is usually a Chief Financial Officer (CFO) who oversees both the

treasurer and controller's work.

True False

47. The controller's responsibilities include banking relations and cash management.

True False

48. A firm's overall value belongs entirely to the shareholders.

True False

49. Managers, Shareholders, and lenders of firm have identical information about the value

of the firm.

True False

Short Answer Questions

50. Explain the term "corporation."


1-11

51. Briefly explain the term limited liability.

52. Briefly explain the advantages of a corporation as a form of business organization.

53. Briefly explain the sequence flow of cash between financial markets and the firm.

54. Briefly explain the functions of financial markets.


1-12

55. Briefly discuss the role of the financial managers.

56. Briefly explain the term "Agency costs" as related to a corporation.

57. Briefly discuss principal - agent problems as related to a corporation

58. What function does the Securities and Exchange Commission play in protecting

investors?


1-13

59. What items of good corporate governance serve to mitigate the tension between owners

and managers?

60. Explain why "maximization of shareholders' wealth" is the appropriate goal of the firm.

61. Briefly explain some of the institutional arrangements that ensure that managers work

toward increasing the value of a firm.

62. Briefly explain different views taken in different countries about the corporation's goals.


1-14

63. Briefly explain the reasons for enacting the Sarbanes-Oxley Act of 2002.

64. Briefly explain the advantages and disadvantages of Sarbanes-Oxley Act of 2002 (SOX).

65. Briefly explain the major provisions of the Sarbanes-Oxley Act of 2002 (SOX).

66. What are the main purposes of the Sarbanes-Oxley Act of 2002 (SOX).


1-15

67. What is Toyota's business philosophy?


68. Mr. Free has $100 dollars income this year and zero income next year. The market interest

rate is 10% per year. If Mr. Free consumes $30 this year, and invests the rest in the market,

what will be his consumption next year?

A. $50

B. $100

C. $77

D. $55

69. Mr. Bird has $100 income this year and zero income next year. The market interest rate is

10% per year. Mr. Bird also has an investment opportunity in which he can invest $50 today

and receive $80 next year. Suppose Mr. Bird consumes $30 this year and invests in the

project. What will be his consumption next year?

A. $88

B. $102

C. $80

D. $100

70. Ms. Venus has $100 income this year and $110 next year. The market interest rate is 10%

per year. Suppose Ms. Venus consumes $60 this year. What will be her consumption next

year?

A. $154

B. $170

C. $120



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71. Mr. Thomas has $100 income this year and zero income next year. The market interest

rate is 10% per year. Mr. Thomas also has an investment opportunity in which he can invest

$50 this year and receive $80 next year. Suppose Mr. Thomas consumes $50 this year and

invests in the project. What will be his consumption next year?

A. $55

B. $80

C. $50


72. Mr. Dell has $100 income this year and zero income next year. The market interest rate is

10% per year. Mr. Dell also has an investment opportunity in which he can invest $50 this

year and receive $80 next year. Suppose Mr. Dell consumes $50 this year and invests in the

project. What is the NPV of the investment opportunity?

A. $5

B. $22.73

C. $0 (zero)

D. None of the above.

73. Ms. Anderson has $60,000 income this year and $40,000 next year. The market interest

rate is 10% per year. Suppose Ms. Anderson consumes $80,000 this year. What will be her

consumption next year?

A. $60,000

B. $30,000

C. $70,000

D. $18,000

74. The line that connects the maximum that one can consume this year (now) and the

maximum one can consume next year:

A. Has a slope of (1 + r)

B. Has a slope of -(1 + r)

C. Has a slope of r

D. Has a slope of 1/r


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75. Ms. Newcastle has $60,000 income this year and $40,000 next year. The market interest

rate is 10% per year. Suppose Ms. Newcastle wishes to consume $62,000 next year. What will

be her consumption this year?

A. $60,000

B. $40,000

C. $70,000

D. $19,000

76. Mr. Smith has an income of $40,000 this year and $60,000 next year. He can invest in a

project that costs $30,000 this year, which generates an income of $36,000 next year. The

market interest rate is 10%. What will be his consumption next year, if Mr. Smith invests in

the project and consumes $50,000 this year?

A. $40,000

B. $52,000

C. $60,000



77. Briefly explain how individuals can adjust their preferences for current and future

consumption.


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Chapter 01 Goals and Governance of the Firm Answer Key


1. Finance, generally, deals with:

I) Money; II) Markets; III) People

A. I only

B. I and II only

C. I and III only

D. I, II and III

Type: Easy

2. This book is mainly about:

A. financial decisions made by households

B. financial decisions made by corporations

C. financial decisions made by governments


Type: Easy

3. The following are examples of the United States-based corporations except:

I) Boeing; II) Microsoft; III) Bank of America; IV) Sony

A. I only

B. I and II only

C. I, II, and III only

D. IV only

Type: Easy


1-19

4. The following are examples of foreign-based corporations except:

I) British Petroleum; II) General Electric; III) Sony; IV) Volkswagen

A. I only

B. II only

C. II and III only

D. I, II, & IV only

Type: Easy

5. Shareholders of a corporation may be, among others:

I) Individuals; II) Pension Funds; III) Insurance Companies

A. I only

B. I and II only

C. II only

D. I, II and III

Type: Medium

6. Generally, a corporation is owned by the:

I) Managers; II) Board of Directors; III) Shareholders

A. I only

B. II and III

C. III only

D. I, II and III

Type: Easy

7. Corporations, potentially, have infinite life because:

A. it is a legal entity

B. of separation of ownership and management

C. it has limited liability


Type: Medium


1-20

8. Limited liability is an important feature of:

A. Sole proprietorships

B. Partnerships

C. Corporations

D. All of the above

Type: Easy

9. As a legal entity a corporation can perform the following functions except:

I) borrow money; II) lend money; III) sue and be sued; IV) vote

A. I and II only


C. IV only


Type: Medium

10. The following are examples of intangible assets except:

A. Building

B. Trademarks

C. Patents

D. Technical expertise

Type: Medium


A. Machinery

B. Factories

C. Trademarks

D. Offices

Type: Medium


1-21

12. A firm's investment decision is also called the:

A. Financing decision

B. Liquidity decision

C. Capital budgeting decision


Type: Medium

13. The following are examples of financial assets except:

A. Common stock

B. Bank loan

C. Preferred stock

D. Buildings

Type: Medium

14. The treasurer usually oversees the following functions of a corporation except:

I) Preparation of financial statements; II) Investor relationships; III) Cash management; IV)

raising new capital

A. I only

B. I and II only


D. III only

Type: Difficult

15. The treasurer is usually responsible the following functions of a corporation:

I) Tax obligations; II) Investor relationships; III) Cash management; IV) raising new capital

A. I only

B. I and II only



Type: Difficult


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16. The controller usually oversees the following functions of a corporation:

I) Preparation of financial statements; II) Internal accounting; III) Cash management and IV)

Taxes


B. III only

C. I and II only

D. II and III

Type: Difficult

17. The controller is usually responsible for the following functions of a corporation except:

I) Preparation of financial statements; II) Internal accounting; III) Cash management; IV)

Taxes

A. I only

B. III only

C. I and II only

D. IV only

Type: Difficult

18. The following are important functions of financial markets:

I) Source of financing; II) Provide liquidity; III) Reduce risk; IV) Source of information

A. I only

B. I and II only

C. I, II, III, and IV

D. IV only

Type: Medium

19. The Chief Financial Officer (CFO) of a corporation oversees:

A. Treasurer's functions

B. Controller's functions

C. Both A and B


Type: Easy


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20. Conflicts of interest between shareholders and managers of a firm result in:

A. Principal-agent problem

B. Increased agency costs

C. Both A and B

D. Managers owning the firm

Type: Medium

21. In the principal-agent framework:

A. Shareholders are the principals

B. Managers are the principals

C. Managers are the agents

D. A and D

Type: Medium

22. Costs associated with the conflicts of interest between the bondholders and the

shareholders of a corporation are called:

A. Legal costs

B. Bankruptcy costs

C. Administrative costs

D. Agency costs

Type: Difficult

23. Agency costs are incurred by a corporation because:

A. managers may not attempt to maximize the value of the firm to shareholders

B. shareholders incur monitoring cost

C. separation of ownership and management

D. all of the above

Type: Medium


1-24

24. The following groups are some of the claimants to a firm's income stream:

I) Shareholders; II) Bondholders; III) Employees; IV) Management and V) Government

A. I and II only


C. I, II, III and IV only


Type: Medium


A. Maximize profits

B. Maximize sales

C. Maximize the value of the firm for the shareholders

D. Maximize managers' benefits

Type: Difficult

26. The purchase of real assets is also referred to as the:

A. Capital decision

B. CFO decision



Type: Easy

27. The sale of financial assets is also referred to as the:

A. Capital decision

B. CFO decision



Type: Easy


1-25

28. The mixture of debt and equity, used to finance a corporation is also known as:

A. Capital budgeting

B. Capital structure

C. Investing

D. Treasury

Type: Easy

29. Which of the following is not a common function of the firm's chief financial officer?

A. Hiring CEO

B. Hiring controller

C. Investing capital

D. Paying dividends

Type: Medium

30. Of the following list, which is a stakeholder?

I) Employee; II) Customer; III) Community; IV) Supplier


B. III only

C. I and II only

D. All

Type: Medium

31. The following are examples of real assets:

I) Machinery; II) Office buildings; III) Warehouse; IV) Common stock

A. I, II, and III only

B. I and II only

C. IV only

D. I only

Type: Easy


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I) Machinery; II) Office buildings; III) Warehouse; IV) Training for employees

A. I only

B. I and II only

C. IV only

D. I, II, and III only

Type: Easy


A. Minimize stockholder wealth

B. Maximize profit

C. Maximize value of the corporation to the stockholders

D. Decrease job security

Type: Easy

34. Managers' actions are monitored by:

A. The board of directors

B. Commercial banks that have loaned funds to the firm

C. The Wall Street analysts

D. All of the above

Type: Medium

35. The following are some of the actions shareholders can take if the corporation is not

performing well:

A. Replace the board of directors in an election.

B. Force the board of directors to change the management team.

C. Sell their shares of stock in the corporation.

D. Any of the above

Type: Medium


1-27

36. The idea of "maximizing shareholder value" is widely accepted in:


A. I only

B. I and II only



Type: Medium

37. The idea that "firms should be run for stakeholders welfare " is accepted in:


A. I only

B. I and II only



Type: Medium

38. The Sarbanes-Oxley Act of 2002 (SOX) was passed largely in response to:

A. the corporate accounting scandals of the previous years

B. the increase in the budget deficits

C. the increase in the trade deficits


Type: Medium

39. A major advantage of the Sarbanes-Oxley Act of 2002 (SOX) is:





Type: Difficult


1-28

40. Major disadvantages of the Sarbanes-Oxley Act of 2002 (SOX) are the following except:





Type: Difficult

True / False Questions

41. The board of directors is ultimately responsible for all large investment decisions.

TRUE

Type: Medium

42. A corporation has a legal existence of its own and is based on "articles of incorporation."

TRUE

Type: Easy

43. Real assets of a corporation are claims on their financial assets.

FALSE

Type: Medium

44. Since the investment and financing decisions are analyzed separately, the financial

manager can completely ignore investors and financial markets when analyzing capital

investment projects.

FALSE

Type: Difficult


1-29

45. The treasurer's responsibilities include preparation of financial statements.

FALSE

Type: Medium

46. In large firms, there is usually a Chief Financial Officer (CFO) who oversees both the

treasurer and controller's work.

TRUE

Type: Easy

47. The controller's responsibilities include banking relations and cash management.

FALSE

Type: Medium

48. A firm's overall value belongs entirely to the shareholders.

FALSE

Type: Medium

49. Managers, Shareholders, and lenders of firm have identical information about the value

of the firm.

FALSE

Type: Medium



1-30

50. Explain the term "corporation."

A corporation is a legal entity and has an existence of its own. Generally, large businesses are

organized as corporations.

Type: Easy

51. Briefly explain the term limited liability.

The shareholders of a corporation cannot be held personally responsible for the debt of the

corporation. This is called limited liability. Hence a shareholder's loss is limited to the amount

he or she has invested in a corporation. This is an attractive feature for the investors.

Type: Medium

52. Briefly explain the advantages of a corporation as a form of business organization.

Corporations have infinite life.

Corporations have very many owners called shareholders and therefore corporations can

raise funds more easily than other forms of business.

There is a separation of ownership and management that is helpful in running the

corporation on a day-to-day basis.

It is very easy to transfer ownership in a corporation.

Corporations have limited liability.

Type: Medium

53. Briefly explain the sequence flow of cash between financial markets and the firm.

Cash is raised by selling financial assets to investors.

Cash is invested in the firm's operation and used to purchase real assets.

Cash is generated by the firm's operations.

Cash is reinvested or returned to investors.

Type: Medium


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54. Briefly explain the functions of financial markets.

There are five important functions of financial markets. They are:

a source of financing for corporations.

provide liquidity for the investors.

reduce risk for the investors.

source of information.

monitor of firms' financial performance.

Type: Medium

55. Briefly discuss the role of the financial managers.

Chief Financial Officer (CFO): Supervises the treasurer and the controller in a large

corporation. CFO is involved in corporate planning and financial policy.

Treasurer: Is responsible for obtaining funds, managing cash, banking relationships and

investor relationships.

Controller: Is responsible for accounting functions, payroll and taxes.

Type: Medium

56. Briefly explain the term "Agency costs" as related to a corporation.

Agency costs arise in a corporation as a result of principal-agent problems. For example;

managers may not act in the best interests of the shareholders while making decisions. Hence

the shareholders incur monitoring costs that are called agency costs. It also arises as result of

informational asymmetry between managers and other stakeholders of a firm. Agency costs

tend to reduce the value of a firm.

Type: Medium


1-32

57. Briefly discuss principal - agent problems as related to a corporation

Principal-agent problems arise in a corporation as a result of the separation of ownership and

management. Managers may not act in the best interests of the shareholders while making

decisions. Hence the shareholders incur monitoring and bonding costs, which are a part of

agency costs. It also arises as result of informational asymmetry between managers and other

stakeholders of a firm. Agency costs tend to reduce the value of a firm.

Type: Medium

58. What function does the Securities and Exchange Commission play in protecting

investors?

The U.S. Securities and Exchange Commission (SEC) sets accounting and reporting standards

for public companies to ensure consistency and transparency. The SEC also prohibits insider

trading, that is, the purchase or sale of shares based on information that is not available to

public investors.

Type: Medium

59. What items of good corporate governance serve to mitigate the tension between owners

and managers?

There are legal and regulatory requirements imposed on managers. Owners can also develop

compensation plans designed to incentivize good behavior. A board of directors, which serves

the interests of the shareholders as well as proper monitoring devices, such as audits, reduce

tensions. A well functioning capital market and the threat of hostile takeover also provides an

incentive for managers to work in harmony with shareholders.

Type: Medium


1-33

60. Explain why "maximization of shareholders' wealth" is the appropriate goal of the firm.

Under perfect market conditions, everyone can borrow or lend at the same interest rate. This

implies that differences in consumption patterns can be adjusted in the capital markets. Given

this, all investors will agree that they are better off if the firm maximizes their current wealth,

i.e. maximizing shareholders' wealth.

Type: Difficult

61. Briefly explain some of the institutional arrangements that ensure that managers work

toward increasing the value of a firm.

The board of directors who are elected by the shareholders scrutinizes managers' actions.

Competition among managers.

The threat of takeover that brings a new management team.

Incentive schemes that are closely tied to the value of the firm like stock options.

Type: Medium

62. Briefly explain different views taken in different countries about the corporation's goals.

The idea of maximizing the shareholder value as the goal of a corporation is widely accepted

in the U.S.A. and the U.K. In Germany, France and Japan the idea that the corporation is

responsible for all the stakeholders is prevalent.

Type: Medium

63. Briefly explain the reasons for enacting the Sarbanes-Oxley Act of 2002.

The corporate accounting scandals involving the bankruptcy of Enron and Worldcom

corporations led to the enactment of Sarbanes-Oxley Act of 2002.

Type: Medium


1-34

64. Briefly explain the advantages and disadvantages of Sarbanes-Oxley Act of 2002 (SOX).

The main advantage of SOX is investor protection. Disadvantages are: high cost of

compliance, constraints on the managers' ability to conduct business and might also hinder the

development of human capital in the firm.

Type: Medium

65. Briefly explain the major provisions of the Sarbanes-Oxley Act of 2002 (SOX).

Sarbanes-Oxley Act of 2002 deals with auditor oversight, accounting and reporting, and

corporate governance. An important provision deals with increased level of accountability

required of the corporate officers. The Act requires a public company's principal executive

officer (CEO) and principal financial officer (CFO) to personally certify that, to the best of

their knowledge, the company's financial statements filed with SEC are accurate and

complete. Failure to meet these requirements can lead to significant consequences for a

company's CEO and CFO. Another important provision deals with compliance. The Act

requires that managers state their responsibility for establishing and maintaining adequate

internal controls for financial reporting. The cost of compliance could be quite high.

Type: Difficult

66. What are the main purposes of the Sarbanes-Oxley Act of 2002 (SOX).

The purposes of Sarbenes-Oxley Act (SOX) are to: (1) increase the role and authority of

independent directors, (2) give shareholders more opportunity to monitor and participate in

the governance of companies, and (3) establish new controls and enforcement mechanisms.

Type: Difficult


1-35

67. What is Toyota's business philosophy?

Toyota's business philosophy is to achieve stable, long-term growth, through the development

of business activities that contribute to society by recognizing the importance of harmonious

relationships between individuals, society, the global environment, and the world economy. It

is also to share the benefits of growth with everyone involved with the firm, including

customers, shareholders, employees, and trading associates.

Type: Medium


68. Mr. Free has $100 dollars income this year and zero income next year. The market interest

rate is 10% per year. If Mr. Free consumes $30 this year, and invests the rest in the market,

what will be his consumption next year?

A. $50

B. $100

C. $77

D. $55

Consumption next year = (100 - 30) * (1.1) = 77 (See Figure-1)

Type: Difficult


1-36

69. Mr. Bird has $100 income this year and zero income next year. The market interest rate is

10% per year. Mr. Bird also has an investment opportunity in which he can invest $50 today

and receive $80 next year. Suppose Mr. Bird consumes $30 this year and invests in the

project. What will be his consumption next year?

A. $88

B. $102

C. $80

D. $100

Consumption next year = (100 - 30 - 50) * 1.1 + 80 = 102

Type: Difficult

70. Ms. Venus has $100 income this year and $110 next year. The market interest rate is 10%

per year. Suppose Ms. Venus consumes $60 this year. What will be her consumption next

year?

A. $154

B. $170

C. $120


Consumption next year = (100 - 60) * 1.1 + 110 = 154

Type: Difficult

71. Mr. Thomas has $100 income this year and zero income next year. The market interest

rate is 10% per year. Mr. Thomas also has an investment opportunity in which he can invest

$50 this year and receive $80 next year. Suppose Mr. Thomas consumes $50 this year and

invests in the project. What will be his consumption next year?

A. $55

B. $80

C. $50


Mr. Thomas' investment this year = 100 - 50 = 50. His income next year by taking the

investment opportunity is equal to 80.

Type: Difficult


1-37

72. Mr. Dell has $100 income this year and zero income next year. The market interest rate is

10% per year. Mr. Dell also has an investment opportunity in which he can invest $50 this

year and receive $80 next year. Suppose Mr. Dell consumes $50 this year and invests in the

project. What is the NPV of the investment opportunity?

A. $5

B. $22.73

C. $0 (zero)

D. None of the above.

NPV = (80/1.1) - 50 = + 22.73

Type: Difficult

73. Ms. Anderson has $60,000 income this year and $40,000 next year. The market interest

rate is 10% per year. Suppose Ms. Anderson consumes $80,000 this year. What will be her

consumption next year?

A. $60,000

B. $30,000

C. $70,000

D. $18,000

Borrow $20,000 this year to consume 60,000 + 20,000 = 80,000 Consumption next year =

40,000 - (20,000 * 1.1) = 18,000

Type: Difficult

74. The line that connects the maximum that one can consume this year (now) and the

maximum one can consume next year:

A. Has a slope of (1 + r)

B. Has a slope of -(1 + r)

C. Has a slope of r

D. Has a slope of 1/r

Type: Difficult


1-38

75. Ms. Newcastle has $60,000 income this year and $40,000 next year. The market interest

rate is 10% per year. Suppose Ms. Newcastle wishes to consume $62,000 next year. What will

be her consumption this year?

A. $60,000

B. $40,000

C. $70,000

D. $19,000

Consumption this year = 60,000 - (22,000/1.1) = 40,000

Type: Difficult

76. Mr. Smith has an income of $40,000 this year and $60,000 next year. He can invest in a

project that costs $30,000 this year, which generates an income of $36,000 next year. The

market interest rate is 10%. What will be his consumption next year, if Mr. Smith invests in

the project and consumes $50,000 this year?

A. $40,000

B. $52,000

C. $60,000


Consumption next year = [40,000 - 30,000 - 50,000] * 1.1 + (60,000 + 36,000) = 52,000

Type: Difficult


77. Briefly explain how individuals can adjust their preferences for current and future

consumption.

Individuals can adjust their preferences for consumption by borrowing or lending in the

financial market. The appropriate balance between present and future consumption that each

individual will choose depends on personal preferences. But individuals with different

preferences can adjust their preferences using financial market.

Type: Difficult

chap 001

Documents

following functions

cash management iv taxes

sony iv volkswagen

financial decisions

examples of financial

bank of america iv sony

examples of tangible

examples of intangible