Exam 1 Solutions - Fall 2002 Exam 1 1. Which of the...

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Unformatted text preview: Fall 2002 Exam 1 1. Which of the following statements is most correct ? * A. An agency relationship arises whenever one or more individuals, called principals, hire another individual or organization, called an agent, to perform some service and delegate decision-making authority to that agent. In financial management, the primary agency relationships are between (1) stockholders and managers and (2) managers (on behalf of stockholders) and debtholders. B. An advantage of a sole proprietorship, versus a corporation, is that ownership of the sole proprietorship can be passed from one generation to the next, unlike ownership in a corporation, thus giving it unlimited life. C. There is a direct relationship between the price of a firm's stock and the level of net income, earnings per share, and dividends paid. For instance, if a firm takes on a project that leads to higher net income, which leads to higher earnings per share, and which then allows the firm to pay higher dividends, then the price of the firm's stock will automatically increase. Thus, the goal of management should be to maximize earnings per share. D. An example of an agency problem between managers and stockholders would be managements decision to increase the amount of debt outstanding, since this would lead to more risk, higher required rates of return, and would never be in the shareholders best interests. E. Proxy contests are an easy way for debtholders to resolve agency problems that may exist between themselves and management acting on behalf of the equity shareholders, since the debtholders have the ability to vote the board of directors (and hence management) out of office and replace the board with a team that will act in their best interests. 2. Which of the following statements is most incorrect ? A. One way to find the total market value of a firms equity is to take the free cash flows available to the equity shareholders in all future years, and then discount them back to the present at the shareholders required rate of return. B. If the price per share of a firms stock is above the book value per share, then the market value added will be positive and the market to book ratio will be greater than 1.0. C. One way to find the total market value of a firms equity is to take the free cash flows available to all investors in all future years, discount them back to the present at the firms weighted average cost of capital (WACC), and then subtract away the market value of the firms debt. D. If a firm has interest-paying debt in its capital structure, then NOPAT will always be more than the firms net income, even though NOPAT subtracts away the total tax that would be paid on the firms operation and does not consider the interest tax shelter that is created by the debt....
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This note was uploaded on 02/09/2011 for the course FIN 3403 taught by Professor Tapley during the Fall '06 term at University of Florida.

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Exam 1 Solutions - Fall 2002 Exam 1 1. Which of the...

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