ECO 550 WEEK 2 Quiz Chapter 1 & 2
Chapter 1Introduction and Goals of the Firm
MULTIPLE CHOICE
1. The form of economics most relevant to managerial decision-making within the firm is:
a. macroeconomics
b. welfare economics
c. free-enterprise economics
d. microeconomics
e. none of the above
2. If one defines incremental cost as the change in total cost resulting from a decision, and incremental revenue as the change in total revenue resulting from a decision, any business decision is profitable if:
a. it increases revenue more than costs or reduces costs more than revenue
b. it decreases some costs more than it increases others (assuming revenues remain constant)
c. it increases some revenues more than it decreases others (assuming costs remain constant)
d. all of the above
e. b and c only
3. In the shareholder wealth maximization model, the value of a firm’s stock is equal to the present value of all expected future ____ discounted at the stockholders’ required rate of return.
a. profits (cash flows)
b. revenues
c. outlays
d. costs
e. investments
4. Which of the following statements concerning the shareholder wealth maximization model is (are) true?
a. The timing of future profits is explicitly considered.
b. The model provides a conceptual basis for evaluating differential levels of risk.
c. The model is only valid for dividend-paying firms.
d. a and b
e. a, b, and c
5. According to the profit-maximization goal, the firm should attempt to maximize short-run profits since there is too much uncertainty associated with long-run profits.
a. true
b. false
6. According to the innovation theory of profit, above-normal profits are necessary to compensate the owners of the firm for the risk they assume when making their investments.
a. true
b. false
7. According to the managerial efficiency theory of profit, above-normal profits can arise because of high-quality managerial skills.
a. true
b. false
8. Which of the following (if any) is not a factor affecting the profit performance of firms:
a. differential risk
b. innovation
c. managerial skills
d. existence of monopoly power
e. all of the above are factors
9. Agency problems and costs are incurred whenever the owners of a firm delegate decision-making authority to management.
a. true
b. false
10. Economic profit is defined as the difference between revenue and ____.
a. explicit cost
b. total economic cost
c. implicit cost
d. shareholder wealth
e. none of the above
11. Income tax payments are an example of ____.
a. implicit costs
b. explicit costs
c. normal return on investment
d. shareholder wealth
e. none of the above
12. Various executive compensation plans have been employed to motivate managers to make decisions that maximize shareholder wealth. These include:
a. cash bonuses based on length of service with the firm
b. bonuses for resisting hostile takeovers
c. requiring officers to own stock in the company
d. large corporate staffs
e. a, b, and c only
13. The common factors that give rise to all principal-agent problems include the
a. unobservability of some manager-agent action
b. presence of random disturbances in team production
c. the greater number of agents relative to the number of principals
d. a and b only
e. none of the above
14. The Saturn Corporation (once a division of GM) was permanently closed in 2009. What went wrong with Saturn?
a. Saturns cars sold at prices higher than rivals Honda or Toyota, so they could not sell many cars.
b. Saturn sold cars below the prices of Honda or Toyota, earning a low 3% rate of return.
c. Saturn found that young buyers of Saturn automobiles were very loyal to Saturn and GM.
d. Saturn implemented a change management view that helped make first time Saturn purchasers trade up to Buick or Cadillac.
e. all of the above
15. A Real Option Value is:
a. An option that been deflated by the cost of living index makes it a real option.
b. An opportunity cost of capital.
c. An opportunity to implement a new cost savings or revenue expansion activity that arises from business plans that the managers adopt.
d. An objective function and a decision rule that comes from it.
e. Both a and b.
16. Which of the following will increase (V0), the shareholder wealth maximization model of the firm:
V0?(shares outstanding) = S¥t=1 (p t ) / (1+ke)t + Real Option Value.
a. Decrease the required rate of return (ke).
b. Decrease the stream of profits (pt).
c. Decrease the number of periods from ¥ to 10 periods.
d. Decrease the real option value.
e. All of the above.
17. The primary objective of a for-profit firm is to ___________.
a. maximize agency costs
b. minimize average cost
c. maximize total revenue
d. set output where total revenue equals total cost
e maximize shareholder value
18. Possible goals of Not-For-Profit (NFP) enterprises include all of the following EXCEPT:
a. maximize total costs
b. maximize output, subject to a breakeven constraint
c. maximize the happiness of the administrators of the NFP enterprise
d. maximize the utility of the contributors
e. a. and c.
19. The flat-screen plasma TVs are selling extremely well. The originators of this technology are earning higher profits. What theory of profit best reflects the performance of the plasma screen makers?
a. risk-bearing theory of profit
b. dynamic equilibrium theory of profit
c. innovation theory of profit
d. managerial efficiency theory of profit
e. stochastic optimization theory of profit
20. To reduce Agency Problems, executive compensation should be designed to:
a. create incentives so that managers act like owners of the firm.
b. avoid making the executives own shares in the company.
c. be an increasing function of the firm’s expenses.
d. be an increasing function of the sales revenue received by the firm.
e. all of the above
21. Recently, the American Medical Association changed its recommendations on the frequency of pap-smear exams for women. The new frequency recommendation was designed to address the family histories of the patients. The optimal frequency should be where the marginal benefit of an additional pap-test:
a. equals zero.
b. is greater than the marginal cost of the test
c. is lower than the marginal cost of an additional test
d. equals the marginal cost of the test
e. both a and b.
Chapter 2Fundamental Economic Concepts
MULTIPLE CHOICE
1. A change in the level of an economic activity is desirable and should be undertaken as long as the marginal benefits exceed the ____.
a. marginal returns
b. total costs
c. marginal costs
d. average costs
e. average benefits
2. The level of an economic activity should be increased to the point where the ____ is zero.
a. marginal cost
b. average cost
c. net marginal cost
d. net marginal benefit
e. none of the above
3. The net present value of an investment represents
a. an index of the desirability of the investment
b. the expected contribution of that investment to the goal of shareholder wealth maximization
c. the rate of return expected from the investment
d. a and b only
e. a and c only
4. Generally, investors expect that projects with high expected net present values also will be projects with
a. low risk
b. high risk
c. certain cash flows
d. short lives
e. none of the above
5. An closest example of a risk-free security is
a. General Motors bonds
b. AT&T commercial paper
c. U.S. Government Treasury bills
d. San Francisco municipal bonds
e. an I.O.U. that your cousin promises to pay you $100 in 3 months
6. The standard deviation is appropriate to compare the risk between two investments only if
a. the expected returns from the investments are approximately equal
b. the investments have similar life spans
c. objective estimates of each possible outcome is available
d. the coefficient of variation is equal to 1.0
e. none of the above
7. The approximate probability of a value occurring that is greater than one standard deviation from the mean is approximately (assuming a normal distribution)
a. 68.26%
b. 2.28%
c. 34%
d. 15.87%
e. none of the above
8. Based on risk-return tradeoffs observable in the financial marketplace, which of the following securities would you expect to offer higher expected returns than corporate bonds?
a. U.S. Government bonds
b. municipal bonds
c. common stock
d. commercial paper
e. none of the above
9. The primary difference(s) between the standard deviation and the coefficient of variation as measures of risk are:
a. the coefficient of variation is easier to compute
b. the standard deviation is a measure of relative risk whereas the coefficient of variation is a measure of absolute risk
c. the coefficient of variation is a measure of relative risk whereas the standard deviation is a measure of absolute risk
d. the standard deviation is rarely used in practice whereas the coefficient of variation is widely used
e. c and d
10. The ____ is the ratio of ____ to the ____.
a. standard deviation; covariance; expected value
b. coefficient of variation; expected value; standard deviation
c. correlation coefficient; standard deviation; expected value
d. coefficient of variation; standard deviation; expected value
e. none of the above
11. Sources of positive net present value projects include
a. buyer preferences for established brand names
b. economies of large-scale production and distribution
c. patent control of superior product designs or production techniques
d. a and b only
e. a, b, and c
12. Receiving $100 at the end of the next three years is worth more to me than receiving $260 right now, when my required interest rate is 10%.
a. True
b. False
13. The number of standard deviations z that a particular value of r is from the mean ? can be computed as z = (r – ?)/s. Suppose that you work as a commission-only insurance agent earning $1,000 per week on average. Suppose that your standard deviation of weekly earnings is $500. What is the probability that you zero in a week? Use the following brief z-table to help with this problem.
Z value Probability
-3 .0013
-2 .0228
-1 .1587
0 .5000
a. 1.3% chance of earning nothing in a week
b. 2.28% chance of earning nothing in a week
c. 15.87% chance of earning nothing in a week
d. 50% chance of earning nothing in a week
e. none of the above
14. Consider an investment with the following payoffs and probabilities:
State of the Economy Probability Return
Stability .50 1,000
Good Growth .50 2,000
Determine the expected return for this investment.
a. 1,300
b. 1,500
c. 1,700
d. 2,000
e. 3,000
15. Consider an investment with the following payoffs and probabilities:
State of the Economy Probability Return
GDP grows slowly .70 1,000
GDP grow fast .30 2,000
Let the expected value in this example be 1,300. How do we find the standard deviation of the investment?
a. s = Ö { (1000-1300)2 + (2000-1300)2 }
b. s = Ö { (1000-1300) + (2000-1300) }
c. s = Ö { (.5)(1000-1300)2 + (.5)(2000-1300)2 }
d. s = Ö { (.7)(1000-1300) + (.3)(2000-1300) }
e. s = Ö { (.7)(1000-1300)2 + (.3)(2000-1300)2 }
16. An investment advisor plans a portfolio your 85 year old risk-averse grandmother. Her portfolio currently consists of 60% bonds and 40% blue chip stocks. This portfolio is estimated to have an expected return of 6% and with a standard deviation 12%. What is the probability that she makes less than 0% in a year? [A portion of Appendix B1 is given below, where z = (x -m)/s,withmas the mean andsas the standard deviation.]
a. 2.28%
b. 6.68%
c. 15.87%
d. 30.85%
e. 50%
Table B1 for Z
Z Prob.
-3 .0013
-2.5 .0062
-2. .0228
-1.5 .0668
-1 .1587
-.5 ..3085
0 .5000
17. Two investments have the following expected returns (net present values) and standard deviations:
PROJECT Expected Value Standard Deviation
Q $100,000 $20,000
X $50,000 $16,000
Based on the Coefficient of Variation, where the C.V. is the standard deviation dividend by the expected value.
a. All coefficients of variation are always the same.
b. Project Q is riskier than Project X
c. Project X is riskier than Project Q
d. Both projects have the same relative risk profile
e. There is not enough information to find the coefficient of variation.
PROBLEMS
1. Suppose that the firm’s cost function is given in the following schedule (where Q is the level of output):
Output Total
Q (units) Cost
0 7
1 25
2 37
3 45
4 50
5 53
6 58
7 66
8 78
9 96
10 124
Determine the (a) marginal cost and (b) average total cost schedules
2. Complete the following table.
Total Marginal Average
Output Profit Profit Profit
0 -48 0 ______
1 -26 ______ ______
2 -8 ______ ______
3 6 ______ ______
4 16 ______ ______
5 22 ______ ______
6 24 ______ ______
7 22 ______ ______
8 16 ______ ______
9 6 ______ ______
10 -8 ______ ______
3. A firm has decided to invest in a piece of land. Management has estimated that the land can be sold in 5 years for the following possible prices:
Price Probability
10,000 .20
15,000 .30
20,000 .40
25,000 .10
(a) Determine the expected selling price for the land.
(b) Determine the standard deviation of the possible sales prices.
(c) Determine the coefficient of variation.
