Income is paid out in the form of dividends it will

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income is paid out in the form of dividends it will be taxed twice, first as corporate income and then as dividend income (generally 5% or 15% depending upon the individual’s tax bracket). While taxation of income is a key factor in deciding which form of business organization to select, two other factors are also important. In a partnership, each partner has unlimited liability and may have to cover debts of other partners while corporate owners have limited liability that guarantees that they cannot lose more than they have invested in the corporation. The third major consideration is ease of transfer of the business . Partnerships are harder to transfer and are technically dissolved when a partner dies while a corporation can have a very long life with ownership readily transferred through the sale of stock.
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Chapter 1 The Role and Environment of Managerial Finance 11 If a third party was asked to decide which legal form of business A&J Tax Preparation should take, it would be useful to have the following information: Marital status and tax situation of each partner Expectation of the longevity of the firm Age of the current owners Current plan of succession Risk tolerance of the owners Expectation of future tax law changes Capital needs of the firm Growth prospects of the firm Reasons for each partner’s view of the preferred form of ownership E1-2. Sunk costs Answer: Marginal cost-benefit analysis ignores sunk costs, so the $2.5 million dollars is irrelevant to the current decision that must be made. At this point there are two questions that must be answered. First, will the $10,000 additional investment generate a PV of expected revenue that will exceed the $10,000 investment? In other words, will the project generate a positive net PV ? If it does, the project must be considered further to see if it is the best use of capital. If the firm has a need to ration capital, the project must then be compared to other projects competing for the limited capital to see if it is viable. The fact that the project’s technology has been surpassed by new technology does not immediately disqualify the project since new technology does not ensure a positive cost-benefit result. In this case, a small $10,000 investment might avoid a heavy expenditure in new technology. Depending upon the industry, however, failure to keep up with competitors can be devastating. The key may well lie in the description “the project has little chance to be viable,” which indicates that approving the $10,000 is likely to be throwing good money after bad. E1-3. Cash flow vs. accrued profits Answer: It is not unusual for a firm to be profitable yet experience a cash crunch. The most common cause is when expenses have a shorter due date than expected revenue. In such cases the firm must arrange short term financing to meet its debt obligations before the revenue arrives. If the forthcoming cash crunch is not a new situation for this firm, management should probably
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