Part 3 Ch 01 - CHAPTER 1 ANSWERS 1-1 Proprietorship...

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CHAPTER 1 ANSWERS 1-1 Proprietorship, partnership, and corporation are the three principal forms of business organization. The advantages of the first two include the ease and low cost of formation. The advantages of the corporation include limited liability, indefinite life, ease of ownership transfer, and access to capital markets. The disadvantages of a proprietorship are (1) difficulty in obtaining large sums of capital; (2) unlimited personal liability for business debts; (3) limited life; and (4) difficulty of transferring ownership. The disadvantages of a partnership are the same as they are for a proprietorship. The disadvantages of a corporation are (1) double taxation of earnings and (2) setting up a corporation and filing required state and federal reports are complex and time- consuming. 1-2 No. The normal rate of return on investment would vary among industries, principally due to varying risk. The normal rate of return would be expected to change over time due to (1) underlying changes in the industry and (2) business cycles (economic factors). 1-3 An increase in the rate of inflation would most likely increase the relative importance of the financial manager. Virtually all of the manager’s functions, from obtaining funds for the firm to internal cost accounting, become more demanding in periods of high inflation. Usually, uncertainty is also increased by inflation, and, hence, the effects of a poor decision are magnified. 1-4 Stockholder wealth maximization is a long-run goal. Companies, and consequently the stockholders, prosper by management making decisions that will produce long-term increases in earnings and thus wealth. Actions that are continually short-sighted often “catch up” with a firm and, as a result, it might find itself unable to compete effectively against its competitors. There has been much criticism in recent years that U.S. firms are too short-run profit oriented. A prime example was when the U.S. auto industry was accused of building large “gas guzzler” automobiles in the 1980s because they had higher profit margins rather than retooling for smaller, more fuel-efficient models.
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