Test Prep BUSINESS-ENVIRONMENT-AND-CONCEPTS Online Practice Questions and Exam Preparation

Test Prep BUSINESS-ENVIRONMENT-AND-CONCEPTS Online Questions & Answers

• Question 201:

  What would be the primary reason for a company to agree to a debt covenant limiting the percentage of its long-term debt?

  A. To cause the price of the company's stock to rise.
  B. To lower the company's bond rating.
  C. To reduce the risk for existing bondholders.
  D. To reduce the interest rate on the bonds being sold.
  D. To reduce the interest rate on the bonds being sold.

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  Note: The material tested in this question does not appear specifically on-point in our textbook, as the topic has rarely shown up on the CPA exam. The topics are covered in general in parts of our textbook, so we believe that our students

  would have answered this question correctly given the information they had. However, we have expanded our of this question to provide you with more detailed information.

  Choice "d" is correct. The primary reason for a company to agree to a debt covenant limiting the percentage of its long-term debt is to reduce the interest rate on NEW bonds being sold. A debt covenant is a provision in a bond indenture

  (contract between the bond issuer and the bond holders) that the bond issuer will either do (affirmative covenants) or not do (negative covenants) certain things. In this question, the issuer would agree not to issue bonds in the future over a

  certain percentage of its long-term debt.

  Such a provision would be good for the potential bondholders and would probably reduce the interest rate on the bonds being sold.

  Choice "a" is incorrect. The primary reason for a company to agree to a debt covenant limiting the percentage of its long-term debt is not to cause the price of the company's stock to rise. Bond covenants affect bonds, not equity (at least not

  directly).

  Choice "b" is incorrect. The primary reason for a company to agree to a debt covenant limiting the percentage of its long-term debt is not to lower the company's bond rating. Such a covenant might raise, not lower, a company's bond rating

  because there would be less risk. Besides, why would a bond covenant be signed if it would lower the company's bond rating?

  Choice "c" is incorrect. The primary reason for a company to agree to a debt covenant limiting the percentage of its long-term debt is not to reduce the risk of existing bondholders, although a reduction in the risk of the existing bondholders

  certainly might result from such a covenant. As a general rule, more debt means more risk, less debt means less risk. So less debt would reduce the risk of all bondholders.

  This answer is a very close second.

• Question 202:

  If Brewer Corporation's bonds are currently yielding 8 percent in the marketplace, why would the firm's cost of debt be lower?

  A. Market interest rates have increased.
  B. Additional debt can be issued more cheaply that the original debt.
  C. Interest is deductible for tax purposes.
  D. There is a mixture of old and new debt.
  C. Interest is deductible for tax purposes.

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  Choice "c" is correct. Because interest expense is a tax deduction, the cost to Brewer is lower than the market yield rate on debt. Choice "a" is incorrect. If market interest rates increase, then Brewer's bonds would have to be offered at a discount to stay competitive with the market. This discount would increase (not lower) Brewer's cost of debt. Choice "b" is incorrect. Issuance of cheaper additional debt will lower future cost of debt, but have no impact on current cost of debt. Choice "d" is incorrect. Presumably, the 8% yield already includes new and old debt.

• Question 203:

  Which of the following statements regarding the existence of substitute products is true?

  A. The impact of substitutes will have more of an effect on the competitive environment of a firm if the substitutes are readily available for customers to obtain.
  B. When the cost of buyers switching to new products is high, the effect of substitutes on the competitive environment of a firm is high.
  C. If many close substitutes exist, buyers have little choice of products and may be willing to pay a higher price for the products that are available.
  D. If substitutes have equal performance and are priced at or below the firm's product, the competitive force of substitutes with respect to the firm is weak.
  A. The impact of substitutes will have more of an effect on the competitive environment of a firm if the substitutes are readily available for customers to obtain.

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  Choice "a" is correct. The impact of substitutes will have more of an effect on the competitive environment of a firm if the substitutes are readily available to consumers. Choice "b" is incorrect. When the cost of buyers switching to new products is low (not high), the effect of substitutes on the competitive environment of a firm is high. Choice "c" is incorrect. If few (not many close) substitutes exist, buyers have little choice of products and may be willing to pay a higher price for the products that are available. Choice "d" is incorrect. If substitutes have equal performance and are priced at or below the firm's product, the competitive force of substitutes with respect to the firm is strong (not weak).

• Question 204:

  Which of the following parties is liable to repay an illegal distribution to a corporation?

  A. A director not breaching his or her duty in approving the distribution and the corporation is solvent.
  B. A director not breaching his or her duty in approving the distribution and the corporation is insolvent.
  C. A shareholder not knowing of the illegality of the distribution and the corporation is solvent.
  D. A shareholder knowing of the illegality of the distribution and the corporation is insolvent.
  D. A shareholder knowing of the illegality of the distribution and the corporation is insolvent.

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  Choice "d" is correct. Illegal dividends from an insolvent company must be repaid to the corporation for the benefit of the creditors. A shareholder who knowingly accepts an illegal dividend is liable to return it. Choices "a" and "b" are incorrect. If a director does not breach any duties in approving a distribution, the director is protected by the business judgment rule and is not liable for the distribution whether the corporation is solvent or insolvent. Choice "c" is incorrect. A shareholder of a solvent corporation who unknowingly accepts an illegal distribution is not obligated to repay the distribution.

• Question 205:

  Rivers and Lee want to form a partnership. For the partnership agreement to be enforceable, it must be in writing if:

  A. Rivers and Lee reside in different states.
  B. The agreement cannot be completed within one year from the date on which it will be entered into.
  C. Either Rivers or Lee is to contribute more than $500 in capital.
  D. The partnership intends to buy and sell real estate.
  B. The agreement cannot be completed within one year from the date on which it will be entered into.

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  Choice "b" is correct. A transaction which cannot be completed within a year must be in writing to be enforceable.

  Choice "a" is incorrect. Residence of the prospective partners is not relevant.

  Choice "c" is incorrect. The statute of frauds $500 threshold applies to the sale of goods only.

  Choice "d" is incorrect. Transactions in land are within the statute of frauds, but the possibility that a partnership may engage in a real estate transaction is not a transaction in land.

• Question 206:

  Patents are granted in order to encourage firms to invest in the research and development of new products. Patents are an example of:

  A. Market concentration.
  B. Entry barriers.
  C. Exclusionary practices.
  D. Collusion.
  B. Entry barriers.

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  Choice "b" is correct. Patents are an example of entry barriers. Patents prevent other rival firms (without patents) from entering the market and consequently, are a form of entry barriers. Patents can be "process-related" or "product-related." Choices "a", "c", and "d" are incorrect, per above Explanation.

• Question 207:

  When a firm finances each asset with a financial instrument of the same approximate maturity as the life of the asset, it is applying:

  A. Working capital management.
  B. Return maximization.
  C. Financial leverage.
  D. Operating leverage.
  A. Working capital management.

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  Choice "a" is correct. Appropriate working capital management matches the maturity life of each asset with the length of the financial instrument used to finance that asset. Choice "b" is incorrect. Return maximization seeks to obtain the optimal return rate by asset utilization. It is not necessarily related to the maturity of the asset. Choice "c" is incorrect. Financial leverage is the amount of debt used to finance an asset. Higher leverage equals more debt. It is unrelated to the maturity life of an asset. Choice "d" is incorrect. Operating leverage is the degree that fixed costs are used in the production process. Operating leverage is unrelated to the methods used to finance assets.

• Question 208:

  Under the Revised Model Business Corporation Act, which of the following must be contained in a corporation's articles of incorporation?

  A. Quorum voting requirements.
  B. Names of stockholders.
  C. Provisions for issuance of par and nonpar shares.
  D. The number of shares the corporation is authorized to issue.
  D. The number of shares the corporation is authorized to issue.

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  Choice "d" is correct. The articles must set out the corporation's authorized shares.

  Choice "a" is incorrect. Quorum requirements, if stated at all, usually are in the bylaws; they need not be included in the articles of incorporation.

  Choice "b" is incorrect. The articles need not include the names of stockholders.

  Choice "c" is incorrect. The RMBCA has eliminated the concept of par value and so does not have a requirement that par value be established in the articles.

• Question 209:

  The CPI jumps from 131 in year 1 to 136.5 in year 2. What is annual inflation rate?

  A. 4.2%
  B. 3%
  C. 1.38%
  D. 13.8%
  A. 4.2%

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  Choice "a" is correct. The inflation rate is measured as:

  

• Question 210:

  Which of the following is a requirement for a small business corporation to elect S corporation status?

  A. It has only one class of stock.
  B. It has at least one partnership as a shareholder.
  C. It has international ownership.
  D. It has more than 75 shareholders.
  A. It has only one class of stock.

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  Choice "a" is correct. A corporation may elect to be taxed like a partnership under Subchapter S only if it has only one class of stock. Choice "b" is incorrect. A corporation can elect S corporation status only if its shareholders are individuals,

  estates, or certain types of trusts.

  Choice "c" is incorrect. Foreign shareholders generally are prohibited in an S corporation.

  Choice "d" is incorrect. An S corporation can have up to 100 shareholders, but it may have fewer.