Lecture-1-Understanding+Public+Financial+Management

Therefore if any partner is unable to meet his or her

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Unformatted text preview: ro rata liability in the event the partnership goes bankrupt, the remaining partners must make good on the unsatisfied claims, drawing on their personal assets to the extent necessary. assets The first three disadvantages—unlimited liability, The impermanence of the organization, and difficulty of transferring ownership—lead to the fourth, the difficulty partnerships have in attracting substantial amounts of 17 7 17 1 capital. This is generally not a problem for a slow-growing This business, but if a business’s products or services really catch on, and if it needs to raise large amounts of capital to capitalize on its opportunities, the difficulty in attracting capital becomes a real drawback. Thus, growth companies such as Hewlett-Packard and Thus, Microsoft generally begin life as a proprietorship or partnership, but at some point their founders find it necessary to convert to a corporation. necessary A corporation is a legal entity created by a state, and it is separate and distinct from its owners and managers. This separateness gives the corporation three major advantages: (1) Unlimited life. A corporation can continue after its original owners and managers are deceased. 18 8 18 1 (2) Easy transferability of ownership interest. (2) Ownership interests can be divided into shares of stock, which, in turn, can be transferred far more easily than can proprietorship or partnership interests. easily (3) Limited liability: Losses are limited to the actual (3) funds invested. For instance, if you invested $10,000 in the stock of a For corporation that then went bankrupt, your potential loss on the investment would be limited to your $10,000 investment. These three factors—unlimited life, easy transferability These of ownership interest, and limited liability—make it much easier for corporations than for proprietorships 19 19 19 or partnerships to raise money in the capital markets. or The value of any business other than a very small one will probably be maximized if it is organized as a corporation for these three reasons: 1. Limited liability reduces the risks borne by investors, and, other things held constant, the lower the firm’s risk, the higher its value. 2. A firm’s value depends on its growth opportunities, which, in turn, depend on the firm’s ability to attract capital. Because corporations can attract capital more easily than unincorporated businesses, they are better able to take advantage of growth opportunities. 3. The value of an asset also depends on its liquidity, which means the ease of selling the asset and converting it to cash at a “fair market value.” Because the stock of a corporation is much more liquid than a similar investment in a proprietorship 20 2 20 or partnership, this too enhances the value of a corporation. 0 Disadvantages of Corporations Cost and complexity to start. A corporation is more difficult and Cost costly to set up than are other forms of business organization. In the United States, a corporation is incorporated in a specific s...
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This note was uploaded on 02/11/2014 for the course FIN 9891 taught by Professor Wu during the Fall '11 term at Kazakhstan Institute of Management, Economics and Strategic Research.

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