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Proprietorships

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									Chapter 11—The Firm and Financial Markets


TRUE/FALSE

  1. Proprietorships tend to be relatively small firms because individuals often lack the financial capital
     necessary to finance large-scale operations.

      ANS: T                 PTS: 1

  2. Proprietorships are common in retail and service industries.

      ANS: T                 PTS: 1

  3. Proprietorships face unlimited liability for the debts of the firm.

      ANS: T                 PTS: 1

  4. One disadvantage of proprietorship is that owners are solely responsible for the debts of the firm.

      ANS: T                 PTS: 1

  5. One disadvantage of proprietorships is that owners are subject to double taxation.

      ANS: F                 PTS: 1

  6. A partnership allows two or more persons to pool resources to operate a larger business than can a sole
     proprietor.

      ANS: T                 PTS: 1

  7. Partnerships are relatively easy to set up and have limited liability.

      ANS: F                 PTS: 1

  8. Corporations account for the majority of all business revenues in the United States.

      ANS: T                 PTS: 1

  9. The most common form of business organization in the United States is the corporation.

      ANS: F                 PTS: 1

 10. S corporations face limited liability and avoid double taxation.

      ANS: T                 PTS: 1

 11. One advantage of corporations is that owners are subject to limited liability for the debts of the firm.

      ANS: T                 PTS: 1

 12. Preferred stockholders have a higher priority than bondholders and common stockholders when debts
     of the firm are settled.
      ANS: F                 PTS: 1

 13. Corporations can acquire additional financial resources by issuing new shares of stock and reinvesting
     profits.

      ANS: T                 PTS: 1

 14. Firms are more likely to issue new shares of stock and increase expenditures on new capital equipment
     in periods of optimism.

      ANS: T                 PTS: 1


MULTIPLE CHOICE

  1. Sole proprietorships are
     a. listed on major stock exchanges, such as the New York Stock Exchange.
     b. businesses owned by only one person.
     c. the least common form of business organization in the United States.
     d. subject to double taxation.
      ANS: B                 PTS: 1

  2. Proprietorships are
     a. subject to double taxation.
     b. subject to limited liability for the debts of the company.
     c. the most common form of business organization in the United States.
     d. typically large companies with significant reserves of financial capital.
      ANS: C                 PTS: 1

  3. Proprietorships are common in
     a. retail industries.
     b. service industries.
     c. the electric generator industry.
     d. both a and b.
      ANS: D                 PTS: 1

  4. Limited liability is a characteristic of
     a. proprietorships.
     b. partnerships.
     c. corporations.
     d. all of the above.
     e. both a and b.
      ANS: C                 PTS: 1

  5. Responsibility for the debts of a sole proprietorship fall on the
     a. shareholders.
     b. partners.
     c. bondholders.
     d. owner.
      ANS: D                 PTS: 1
 6. The advantages of a proprietorship include
    a. fewer taxes than owners of corporations.
    b. fewer legal obligations than corporations.
    c. complete control of the business.
    d. all of the above.
     ANS: D                PTS: 1

 7. The disadvantages of a proprietorship include
    a. complete control of the business.
    b. unlimited liability for the debts of the business.
    c. a higher tax rate than paid by corporations.
    d. fewer legal obligations than a corporation.
     ANS: B                PTS: 1

 8. Which of the following is not characteristic of proprietorships?
    a. They face unlimited liability.
    b. They generate most private sector business revenues in the United States.
    c. They are the most common forms of business organization in the United States.
    d. Their owners have complete control over the business.
     ANS: B                PTS: 1

 9. One advantage of a partnership is that
    a. it faces limited liability.
    b. it faces no legal complications when a change in ownership occurs.
    c. it is relatively easy to set up.
    d. it faces unlimited liability.
     ANS: C                PTS: 1

10. A disadvantage of a partnership is that
    a. the owners of the firm face limited liability.
    b. owners are subject to double taxation.
    c. a partnership is difficult to set up.
    d. the owners of the firm face unlimited liability.
     ANS: D                PTS: 1

11. A key difference between a partnership and a sole proprietorship is that
    a. partnerships pay corporate taxes and sole proprietorships are taxed as personal income.
    b. partnerships are subject to limited liability and sole proprietorships are subject to
       unlimited liability.
    c. partnerships have multiple owners, while sole proprietorships are owned by a single
       individual or household.
    d. partnerships are subject to unlimited liability and sole proprietorships are subject to
       limited liability.
     ANS: C                PTS: 1

12. A key difference between a partnership and a corporation is that
    a. corporations have multiple owners, while partnerships do not.
    b. partnerships face unlimited liability, while owners of corporations face limited liability.
    c. partnerships face limited liability, while owners of corporations face unlimited liability.
     d. the legal status of a partnership is relatively unaffected by a change in ownership, while
        the legal status of a corporation is significantly affected by a change in ownership.
     ANS: B                PTS: 1

13. A key difference between a proprietorship and a corporation is that
    a. proprietorships face limited liability, while owners of a corporation face unlimited
       liability.
    b. owners of proprietorships are subject to double taxation, while owners of corporations are
       not.
    c. owners of corporations are subject to double taxation, while owners of proprietorships are
       not.
    d. ownership and control are usually separated in proprietorships, but not in corporations.
     ANS: C                PTS: 1

14. Which of the following is not characteristic of corporations?
    a. They generate most U.S. private sector business revenues.
    b. They are the most common form of business organization in the United States.
    c. They have many shareholders.
    d. They are subject to double taxation.
     ANS: B                PTS: 1

15. A corporation’s stockholders
    a. are personally liable for all of the debts incurred by the corporation.
    b. may receive profits in the form of dividends.
    c. may receive profits in the form of capital gains when selling shares of stock.
    d. are characterized by all of the above.
    e. are characterized by b and c only.
     ANS: E                PTS: 1

16. When some separation between ownership and the management of a firm is in place,
    a. managers may have interests that diverge from that of owners.
    b. managers may strive for power rather than profit maximization.
    c. a typical shareholder has little voice in the making of decisions.
    d. all of the above may occur.
     ANS: D                PTS: 1

17. “Double taxation” means that
    a. corporations pay taxes on firm profits at twice the rate that proprietorships do.
    b. shareholder income is taxed first as corporate profits and then when paid as dividends or
       capital gains.
    c. a firm’s products are taxed at both the wholesale and retail level.
    d. corporations pay taxes on profits and customers pay sales taxes when a firm’s products are
       purchased.
     ANS: B                PTS: 1

18. Owners of stock in U.S. corporations include
    a. pension funds.
    b. insurance companies.
    c. mutual funds.
    d. all of the above.
     ANS: D                 PTS: 1

19. Preferred stockholders
    a. assume greater risks than do common stockholders.
    b. receive payment before common stockholders in the event of liquidation.
    c. receive payment before bondholders in the event of liquidation.
    d. are characterized by all of the above.
     ANS: B                 PTS: 1

20. Ownership of a share of stock in a corporation is different from ownership of a corporate bond in that
    a. the owner of a share of stock receives payment before a bondholder in the event of a
       corporation’s liquidation.
    b. a bondholder receives a fixed interest payment plus a lump sum payment at maturity,
       whereas a stockholder may receive income in the form of dividends and capital gains.
    c. a bondholder has voting rights, a shareholder does not.
    d. a bondholder bears greater business risk than does a shareholder.
     ANS: B                 PTS: 1

21. Corporations can finance their growth
    a. by issuing bonds.
    b. by issuing new shares of stock.
    c. through plowbacks.
    d. by all of the above.
    e. by either a or b.
     ANS: D                 PTS: 1

22. Stock prices are influenced by
    a. concern over inflation.
    b. the economic policies of the government.
    c. business conditions in foreign economies.
    d. expectations about corporate earnings.
    e. all of the above.
     ANS: E                 PTS: 1

23. The random walk theory suggests
    a. that stock prices fluctuate in highly predictable ways.
    b. that it is extremely difficult without inside information to consistently pick winners in the
       stock market.
    c. that if stock price fluctuations are scrutinized carefully, one can consistently pick winners
       in the stock market.
    d. that information filters sufficiently slowly that one can consistently profit by trading on
       newly released information.
     ANS: B                 PTS: 1

24. A relatively high P/E ratio
    a. may indicate that investors expect future earnings to rise.
    b. may indicate that investors expect future earnings to fall.
    c. indicates that a stock is undervalued.
    d. indicates that the stock is trading at a price that is low relative to earnings.
      ANS: A                 PTS: 1

 25. A stock’s P/E ratio
     a. is calculated by dividing the 52-week high price by the earnings per share of the firm over
         the past year.
     b. is calculated by dividing the 52-week low price by the earnings per share over the past
         year.
     c. indicates that the stock is overvalued if the P/E ratio is relatively low.
     d. indicates that investors may expect future earnings to fall if the P/E ratio is relatively low.
      ANS: D                 PTS: 1

      Use the following stock table to answer the following question(s).

      52-week                                                           Previous Day
       High   Low        Company       Symbol     Div.   Yield    P/E     High     Low     Close     Change
      60.50 36.42     General Elec.       GE       .64     1.5     33    44.10    43.20    43.50        -.10
      63.22 23.45     Hewlett-Pack       HWP       .32     1.3     19    25.25    24.20    24.66       +.45

 26. If a typical P/E ratio for companies that supply services and products comparable to General Electric is
     20, then
     a. purchasing General Electric stock at this time cannot possibly be a wise decision.
     b. GE’s P/E ratio suggests that its stock may be overvalued at this time.
     c. GE’s P/E ratio suggests that its stock may be undervalued at this time.
     d. GE’s P/E ratio suggests that investors may expect the stock price to rise in the near future.
     e. either b or d could be indicated by the information in the table.
      ANS: E                 PTS: 1

 27. If a typical P/E ratio for companies that supply services and products comparable to Hewlett-Packard
     is 40, then
     a. purchasing Hewlett-Packard stock at this time cannot possibly be a wise decision.
     b. Hewlett-Packard’s P/E ratio suggests that its stock may be overvalued at this time.
     c. Hewlett-Packard’s P/E ratio suggests that its stock may be undervalued at this time.
     d. Hewlett-Packard’s P/E ratio suggests that investors may expect the stock price to rise in
          the near future.
     e. either c or d is indicated by the information in the table.
      ANS: C                 PTS: 1

 28. Based on the information in the preceding table, which of the following is true?
     a. Both General Electric and Hewlett-Packard stocks increased in price compared to the
        previous day’s close.
     b. Both General Electric and Hewlett-Packard stocks decreased in price compared to the
        previous day’s close.
     c. General Electric stock decreased in price from the previous day’s close, while Hewlett-
        Packard’s stock increased in price from the previous day’s close.
     d. Both General Electric and Hewlett-Packard stocks are trading near their 52-week highs.
      ANS: C                 PTS: 1


PROBLEM

  1. Which of the following characteristics belong to sole proprietorships? Partnerships? Corporations?
     a. Double taxation
   b.   Relative ease of transferring ownership
   c.   Unlimited liability
   d.   Limited liability
   e.   Shared ownership among multiple individuals

   ANS:
   a. Corporations
   b. Corporations
   c. Sole proprietorships, Partnerships
   d. Corporations
   e. Partnerships, Corporations

   PTS: 1

2. Explain how owners of a corporation are subject to double taxation.

   ANS:
   Corporations must pay corporate profits taxes. After those taxes are paid, when earnings are paid out
   as dividends or kept as retained earnings, increasing the value of stocks, owners must also pay
   individual income taxes on the dividends or capital gains (when they sell their stocks).

   PTS: 1

3. The separation of ownership and management in corporations creates what is known as a principal-
   agent problem (because management’s interests may diverge from that of owners). Suggest ways to
   ensure that management will act in the best interest of shareholders.

   ANS:
   There are several ways to mitigate the principal-agent problem, which include monitoring the agents
   more carefully and aligning their interests more closely with owners, by giving performance-based
   income, as with stock options.

   PTS: 1

4. With which form of business organization is it easiest to raise large sums of financial capital? How?

   ANS:
   Corporations can more readily raise large sums of capital by issuing new shares of stock, issuing
   bonds, or retaining corporation profits to finance economic growth.

   PTS: 1

5. Why are firms less likely to issue new shares of stock when consumers or businesses are pessimistic
   about economic conditions?

   ANS:
   When economic conditions result in consumer and/or producer pessimism, share prices are likely to
   fall. Firms must issue a much larger number of new shares of stock to raise a particular sum of money
   under these conditions. Additionally, when economic conditions are not ideal, firms are less likely to
   invest in new capital and therefore less in need of financing.

   PTS: 1
6. In the event of a corporate bankruptcy, would you rather be a bondholder, a preferred stockholder, or a
   stockholder in the ailing corporation? Explain.

   ANS:
   It would be better to be a bondholder in the event of corporate bankruptcy, followed by a preferred
   stockholder. When a firm goes bankrupt, bondholders are paid before preferred stockholders, who are
   paid before stockholders.

   PTS: 1

7. Obtain the business section of a recent newspaper. Look up current stock information for Chevron
   under the NYSE listings. Find the 52-week high, 52-week low, yield, price-earnings ratio, dividend,
   closing price, and the dollar change from the previous day’s closing price.

   ANS:
   Answers will vary.

   PTS: 1

								
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