Test Bank
Entrepreneurial Finance
2nd Edition
Janet Kiholm Smith and Richard L. Smith
Questions and problems in this test bank are intended to assess student understanding of the most
central concepts from each chapter. Except where student understanding and recollection of
Test Bank for Entrepreneurial Finance, Smith and Smith 2ed. Copyright 2004
,mathematical models is central to a basic understanding of chapter material, the questions and
problems emphasize concepts over memorization.
Test Bank for Entrepreneurial Finance, Smith and Smith 2ed. Copyright 2004 2
,Chapter 1:
1. A sound investment decision is to seek out and acquire assets that are worth more
than they cost. Ultimately, the worth, or value, of an investment depends on:
A) the expected future prices of the investment’s assets.
B) the current market prices of the investment’s assets.
C) the investment’s ability to generate cash flows and the riskiness of those cash flows.
D) all of the above.
Answer: C
2. Empirical studies show that the most new ventures fail because of:
A) neglect and inexperience.
B) economic and financial troubles.
C) unsuccessful idea and implementation.
D) all of the above.
Answer: B
3. What are the most important differences between corporate finance and
entrepreneurial finance?
Answer:
The separability of investment decisions from financing decisions
The role of diversification of risk as a determinant of investment value
The extent of managerial involvement by outside investors
The importance of options as a determent of project value
The effect of information problems on the firm’s ability to undertake a project
The role of contracting to resolve incentive problems
The importance of harvesting as an aspect of valuation and the investment decision
The focus on maximizing value for the entrepreneur as distinct from maximizing value
for shareholders
4. Unlike in corporate finance, entrepreneurial investing and financing decisions are
highly interdependent. Explain.
Answer:
The entrepreneur usually is required to invest substantially more capital than outside investors,
which in turn affects the required rate of return and creates a difference in valuation between the
entrepreneur and the outside investors. In some cases, the entrepreneur will be willing to invest
in a project only if a substantial amount of the project financing will be generated from outside
investors (on terms favorable to the entrepreneur).
Test Bank for Entrepreneurial Finance, Smith and Smith 2ed. Copyright 2004 3
, 5. Why is it valuable to emphasize the concept of “real options” in entrepreneurial
finance?
Answer:
The value of real options associated with an investment depends on the level of uncertainty
surrounding the investment. Because the uncertainty surrounding a start-up is usually high, the
values of real options become important. In fact, a new venture can be viewed as a portfolio of
real options.
6. Which of the following are examples of “real options” that arise in a new venture
setting?
A) The investor has the right to abandon the project if a particular performance
milestone is not met.
B) If a milestone is met, the entrepreneur has the right to invest additional cash.
C) The entrepreneur and investor each has the right to “wait and see” how the project
develops before deciding to invest more time and money.
D) All of the above.
E) None of the above.
Answer: D
7. Why does the objective of “maximizing value for the entrepreneur” result in
different decisions than the objective of “maximizing value for the investor”?
Provide an example.
Answer:
An entrepreneur generally will hold an undiversified position in the venture. An investor, on the
other hand, generally will hold a diversified portfolio. Therefore, given an expected cash flow
stream, the entrepreneur will place a lower value on the cash flows of the venture than will the
diversified investor.
8. How does an entrepreneur decide whether to pursue a venture?
Answer:
The entrepreneur must weigh the expected benefits of the venture, including any nonpecuniary
benefits he or she anticipates (associated with being self-employed, for example), against the
expected costs, including opportunity costs of being employed elsewhere. In making the
decision, the entrepreneur’s objective is to maximize the value of the financial claims and other
benefits that the entrepreneur is able to retain in the business.
Test Bank for Entrepreneurial Finance, Smith and Smith 2ed. Copyright 2004 4
Entrepreneurial Finance
2nd Edition
Janet Kiholm Smith and Richard L. Smith
Questions and problems in this test bank are intended to assess student understanding of the most
central concepts from each chapter. Except where student understanding and recollection of
Test Bank for Entrepreneurial Finance, Smith and Smith 2ed. Copyright 2004
,mathematical models is central to a basic understanding of chapter material, the questions and
problems emphasize concepts over memorization.
Test Bank for Entrepreneurial Finance, Smith and Smith 2ed. Copyright 2004 2
,Chapter 1:
1. A sound investment decision is to seek out and acquire assets that are worth more
than they cost. Ultimately, the worth, or value, of an investment depends on:
A) the expected future prices of the investment’s assets.
B) the current market prices of the investment’s assets.
C) the investment’s ability to generate cash flows and the riskiness of those cash flows.
D) all of the above.
Answer: C
2. Empirical studies show that the most new ventures fail because of:
A) neglect and inexperience.
B) economic and financial troubles.
C) unsuccessful idea and implementation.
D) all of the above.
Answer: B
3. What are the most important differences between corporate finance and
entrepreneurial finance?
Answer:
The separability of investment decisions from financing decisions
The role of diversification of risk as a determinant of investment value
The extent of managerial involvement by outside investors
The importance of options as a determent of project value
The effect of information problems on the firm’s ability to undertake a project
The role of contracting to resolve incentive problems
The importance of harvesting as an aspect of valuation and the investment decision
The focus on maximizing value for the entrepreneur as distinct from maximizing value
for shareholders
4. Unlike in corporate finance, entrepreneurial investing and financing decisions are
highly interdependent. Explain.
Answer:
The entrepreneur usually is required to invest substantially more capital than outside investors,
which in turn affects the required rate of return and creates a difference in valuation between the
entrepreneur and the outside investors. In some cases, the entrepreneur will be willing to invest
in a project only if a substantial amount of the project financing will be generated from outside
investors (on terms favorable to the entrepreneur).
Test Bank for Entrepreneurial Finance, Smith and Smith 2ed. Copyright 2004 3
, 5. Why is it valuable to emphasize the concept of “real options” in entrepreneurial
finance?
Answer:
The value of real options associated with an investment depends on the level of uncertainty
surrounding the investment. Because the uncertainty surrounding a start-up is usually high, the
values of real options become important. In fact, a new venture can be viewed as a portfolio of
real options.
6. Which of the following are examples of “real options” that arise in a new venture
setting?
A) The investor has the right to abandon the project if a particular performance
milestone is not met.
B) If a milestone is met, the entrepreneur has the right to invest additional cash.
C) The entrepreneur and investor each has the right to “wait and see” how the project
develops before deciding to invest more time and money.
D) All of the above.
E) None of the above.
Answer: D
7. Why does the objective of “maximizing value for the entrepreneur” result in
different decisions than the objective of “maximizing value for the investor”?
Provide an example.
Answer:
An entrepreneur generally will hold an undiversified position in the venture. An investor, on the
other hand, generally will hold a diversified portfolio. Therefore, given an expected cash flow
stream, the entrepreneur will place a lower value on the cash flows of the venture than will the
diversified investor.
8. How does an entrepreneur decide whether to pursue a venture?
Answer:
The entrepreneur must weigh the expected benefits of the venture, including any nonpecuniary
benefits he or she anticipates (associated with being self-employed, for example), against the
expected costs, including opportunity costs of being employed elsewhere. In making the
decision, the entrepreneur’s objective is to maximize the value of the financial claims and other
benefits that the entrepreneur is able to retain in the business.
Test Bank for Entrepreneurial Finance, Smith and Smith 2ed. Copyright 2004 4
