FINANCE Exam 1 Study Guide

FINANCE Exam 1 Study Guide - CHAPTER 1 -Sole Proprietorship...

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CHAPTER 1 - Sole Proprietorship owned by one individual (80% of businesses) - Advantages: 1) easily and inexpensively formed 2) subject to few government regulations 3) business avoids corporate income taxes - Disadvantages: 1) difficult to obtain large sums of capital 2) unlimited personal liability 3) life of a business organized as a proprietorship is limited to the life of the individual who created it -Businesses started as proprietorship and then converted to corporations when their growth causes the disadvantages of being a proprietorship to outweigh the advantages - Partnership 2 or more people associate to conduct a business. -Advantages: 1) avoids corporate income taxes 2) low cost and the ease of formation (main) - Disadvantages: 1) unlimited liability 2) limited life of the organization 3) difficulty of transferring ownership 4) difficulty raising funds (no problem for slow growing businesses) - Corporation is a legal entity created by a state, and it is separate and distinct from its owners and managers (80% of sales in businesses) -Advantages : 1) unlimited life 2) easy transferability of ownership interest (stocks) 3) limited liability (losses are limited to the actual funds invested) all 3 make it easier to raise capital - Disadvantages : 1) corporate earnings may be subject to double taxation, the earnings of the corporation are taxed at a corporate level, and then any earnings paid out as dividends are taxed again as income to the stockholders 2) setting up a corporation, and filling the many required state and federal reports, is more complex and time consuming - To avoid double taxation , stockholders would prefer that corporations retain more its earnings because long-term capital gains are taxed at a lower rate than ordinary income - Enhancements of Corporations - Limited liability reduces the risks borne by investors, and, other things held constant, the lower the firm’s risk, higher its value - Firms value is dependant on its growth opportunity firm’s ability to attract capital -Value of an asset also depends on its liquidity , selling the asset and converting it to cash at a “fair market value” - Shareholders are owners of the corporation and elect directors who hire managers - Management’s primary goal is stockholder wealth maximization , or maximizing the price of the firm’s common stock, but they have other objectives as well - Maximizing stock price is a good thing for society because actions that maximize stock prices also benefit society 1) stock price maximization requires efficient, low-cost businesses that produce high-quality products at the lowest possible cost 2) development of products and services that consumers want and need, so it leads to new technology, products and jobs 3) necessitates efficient and courteous service, adequate stocks of merchandise, and well-located business establishment - Managers have personal goals that compete with shareholder wealth maximization - Agency relationship arises whenever one or more individuals, called
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This note was uploaded on 02/22/2011 for the course BMGT 340 taught by Professor White during the Spring '08 term at Maryland.

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FINANCE Exam 1 Study Guide - CHAPTER 1 -Sole Proprietorship...

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