Exam 1 Solutions - Spring 2003 Exam 1 1. Which of the...

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Spring 2003 Exam 1 1. Which of the following statements is least correct (most incorrect)? A. Stockholder wealth maximization should be thought of as a long-term goal. For instance, assume that one action by a firm would increase its cash flow from a current level of $41 million to $51 million in six months and then to $61 million by the end of five years. This might not be as optimal as another action that kept cash flow at $41 million for several years, but then increased it to $81 million by year 5. B. The three principle forms of business organizations are the sole proprietorship, the partnership, and the corporation. In addition, there are other forms of business that we might call hybrids, such as limited partnerships, professional associations, etc. C. The price of a firm’s stock depends on the size of the firm’s cash flow, the timing of these cash flows, and their risk. * D. Since the threat of being fired is fairly low for corporate executives, and the threat of takeovers is almost non-existent, and the direct intervention by stockholders is virtually unheard of, the only way to motivate managers to act in the best interests of the stockholders is through the use of stock options. E. Agency problems may arise whenever you have one group of individuals (the agents) acting on behalf of others. Thus, management acts as agents for shareholders. Problems may arise because not only does management have access to more and better information than the shareholders (the owners), but management may also take actions that are in their own best interests rather than the best interests of the shareholders. 2. Which of the following statements is least correct (most incorrect)? A. While the balance sheet can be thought of as a snapshot of the firm’s financial position at a point in time, the income statement reports on operations over a period of time. Because of this, some people will use the average of beginning and ending balance sheet items when calculating ratios that contain both balance sheet and income statement data. B. If we find the present value of a firm’s future free cash flows by discounting these cash flows at the firms weighted average cost of capital (WACC), then this will be equal to the firm’s enterprise value or actual worth. If we then subtract away the market value of the firm’s debt and other liabilities, then what we will be left with is the value of the firm’s equity. * C. In the United States tax rates are regressive. That is, even though wealthy taxpayers may face a higher marginal tax rate on their taxable income, their average tax rate, as a percentage of taxable income, will actually be lower. D. It is possible for a firm to be financially healthy even if free cash flows have been negative for a number of years. In fact, we might expect firms to have negative free cash flow during the early years (that is, during their start-up phase), because of low NOPAT and large investments in net operating working capital
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Exam 1 Solutions - Spring 2003 Exam 1 1. Which of the...

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