Briefly discuss why financial decision makers must focus on incremental cash flows when evaluating new projects.

Briefly discuss why financial decision makers must focus on incremental cash flows when evaluating new projects.

Answer:  Incremental cash flows describe the total cash effect on the company, looking at the difference between total cash flow to the company with the cash flow, and without the cash flow. The company can then value these cash flows and see if the company is worth more with the project or without the project.

Discuss the risk/return tradeoff and how it relates to finance.

Answer:  As people are risk averse, they need a higher return as the risk gets higher. This means that investors will need a higher return on bonds that they do not consider to be as safe as other bonds, and they will need a higher return on stock when the company in question's stock seems to be riskier than the stock of other companies.

Why do you think many companies compensate executives with options based on long-term increases in the value of the company's stock?

Answer:  Tying executive compensation to long-term increases in the stock price makes sense because they are supposed to be working to maximize shareholder wealth.  Stock-based compensation plans imply that decisions made to benefit shareholders will also benefit themselves.

The price of Netflix stock dropped sharply after customers responded negatively to a change in pricing policies.

 Investors prefer $1 today versus $1 in the future due to

A) time value of money.

B) response to incentives.

C) the need for immediate gratification.

D) A and B.

The price of Netflix stock dropped sharply after customers responded negatively to a change in pricing policies.  The change in stock price illustrates which principle?

A) Market prices reflect information.

B) Individuals respond to incentives.

C) Cash flows are the source of value.

D) The time-value of money.

For the risk-return principle implies that the more risky a given course of action, the higher the expected return must be.

Answer:  TRUE

The financial manager should examine available risk-return trade-offs and make his decision based upon the greatest expected return.

Answer:  FALSE

Only a few financial decisions involve some sort of risk-return tradeoff.

Answer:  FALSE

In efficient markets, price adjustments to new information are gradual.

Answer:  FALSE

Rewarding executives for increasing quarterly earnings will motivate them to act in the long-term best interests of shareholders.

Answer:  FALSE

In an efficient market, prices will quickly adjust to new information.

Answer:  TRUE

Why do investors prefer receiving cash sooner rather than later, according to finance theory?

Why do investors prefer receiving cash sooner rather than later, according to finance theory?

A) Incremental profits are greater than accounting profits.

B) Money received earlier can be reinvested and returns can be increased.

C) Tax considerations are important when investing.

D) Diversification leads to increased value.

Investors choose to invest in higher risk investments because these investments offer higher

A) expected returns.

B) inflation.

C) actual returns.

D) future consumption.

Foregoing the earning potential of a dollar today is referred to as the

A) time value of money.

B) opportunity cost concept.

C) risk/return tradeoff.

D) creation of wealth.

In measuring value, the focus should be on

A) cash flow.

B) accounting profits.

C) time value of money.

D) earnings per share.

Which of the following is a characteristic of an efficient market?

A) Small number of individuals

B) Opportunities exist for investors to profit from publicly available information.

C) Security prices reflect fair value of the firm.

D) Immediate response occurs for new public information.

Which of the following factors is most important in investment decisions?

A) The change in earnings before taxes.

B) The change in gross sales revenue.

C) The change in net income.

D) The change in after-tax cash flow.

If an investor had a choice of receiving $1,000 today, or $1,000 in five years, which would the average investor prefer?

If an investor had a choice of receiving $1,000 today, or $1,000 in five years, which would the average investor prefer?

A) $1,000 in five years because they are not good at saving money.

B) $1,000 today because it will be worth more than $1,000 received in five years.

C) $1,000 in five years because it will be worth more than $1,000 received today.

D) Investors would be indifferent to when they would receive the $1,000.

E) None of the above. 

Which of the following should be considered when assessing the financial impact of business decisions?

A) The amount of projected earnings

B) The risk-return tradeoff

C) The timing of projected earnings; i.e., when they are expected to occur

D) All of the above

Which of the following is most likely to motivate executives to maximize shareholder wealth?

A) Tying bonuses to cost reductions and meeting budget goals

B) Offering them relatively high salaries

C) Tying annual bonuses to increases in annual profits

D) Compensating them with stock options that can only be exercised after five years

If one security has a greater risk than another security, how will investors respond?

A) They will require a lower rate of return for the investment that has greater risk.

B) They would be indifferent regarding their expectation of rates of return for either investment.

C) They will require a higher rate of return for the investment that has greater risk.

D) None of the above.

How could you compensate an investor for taking on a significant amount of risk?

A) Increase the expected rate of return

B) Raise more debt capital

C) Offer stock at a higher price

D) Increase sales

Consider the following equally likely project outcomes:

 Consider the following equally likely project outcomes:

                                                     Profit

                                                                   X             Y

Pessimistic prediction                             $      0     $500

Expected outcome                                     $  500    $500

Optimistic prediction                              $1000    $500

A) Investors will prefer project X because it potentially offers a higher profit.

B) Investors will reject both projects because the profit is too low.

C) Investors will prefer project Y because the expected return is the same as for project X but the outcome is certain.

D) Since Projects X and Y have the same expected outcomes of $500, investors will view them as identical in value.

 Consider the timing of the profits of the following certain investment projects:

                                         Profit

                                 L                    S

Year 1                $       0            $ 3000

Year 2                $ 3000           $       0

A) Project S is preferred to Project L.

B) Project L is preferred to Project S.

C) Projects S and L are equally desirable.

D) A goal of profit maximization would favor Project S only.

In finance, we assume that investors are generally

A) neutral to risk.

B) averse to risk.

C) fond of risk.

D) none of the above.

Consider cash flows for Projects X and Y such as:

                                 Project X        Project Y

Year 1                        $3000             $      0

Year 2                        $      0              $3000

A rational person would prefer receiving cash flows sooner because

A) the money can be reinvested.

B) the money is nice to have around.

C) the investor may be tired of a particular investment.

D) the investor is indifferent to either proposal.

Briefly discuss the incentives for financial managers to conduct their business in an ethical manner.

Briefly discuss the incentives for financial managers to conduct their business in an ethical manner.

Answer:  Extreme ethical lapses such as those evident in the Madoff Ponzi scheme may also break laws and result in fines or imprisonment.  In less extreme cases, deceptive accounting practices or sales techniques once exposed lead to a loss of trust.  Because individuals and firms are reluctant to do business with those they mistrust, a reputation for unethical behavior over the long run leads to adversarial relations with business partners, a loss of customers, and destruction of the firm's value.

 

The goal of maximize shareholder wealth inevitably conflicts with socially responsible behavior on the part of corporation.

The Sarbane-Oxley Act addresses insider trading by members of Congress.

Answer:  FALSE

 A reputation for unethical behavior can negatively affect the value of a company's stock.

Answer:  TRUE

The agency problem arises due to the separation of ownership and control in a corporation.

Answer:  TRUE

In regard to the agency problem, ________ are the principal owners of a corporation.

In regard to the agency problem, ________ are the principal owners of a corporation.

A) shareholders

B) managers

C) employees

D) suppliers

Serious ethical violations by corporations such as Enron led to the passage of

A) the Dodd-Frank Act.

B) the Insider Trading Act of 1988.

C) the Sarbanes-Oxley Act.

D) All of the above.

The goal of the firm should be the maximization of profit.

Answer:  FALSE

One of the problems associated with profit maximization is that it ignores the timing of a project's return.

Answer:  TRUE

The goal of profit maximization is equivalent to the goal of maximization of share value.

Answer:  FALSE

The goal of profit maximization ignores the timing of profit.

Answer:  TRUE