explain why a business might choose to operate as a corporation rather than as a sole proprietorship or a partnership?.
Which of the following could explain why a business might choose to operate as a corporation rather than as a sole proprietorship or a partnership?
Answer
Corporations generally find it relatively difficult to raise large amounts of capital.
Less of a corporation’s income is generally subjected to taxes than would be true if the firm were a partnership.
Corporate shareholders escape liability for the firm’s debts, but this factor may be offset by the tax disadvantages of the corporate form of organization.
Corporate investors are exposed to unlimited liability.
Corporations generally face relatively few regulations.
2 points
Cheers Inc. operates as a partnership. Now the partners have decided to convert the business into a regular corporation. Which of the following statements is CORRECT?
Answer
Assuming Cheers is profitable, less of its income will be subject to federal income taxes.
Cheers will now be subject to fewer regulations.
Cheers’ shareholders (the ex-partners) will now be exposed to less liability.
Cheers’ investors will be exposed to less liability, but they will find it more difficult to transfer their ownership.
Cheers will find it more difficult to raise additional capital.
Which of the following statements is CORRECT?
Answer
While the distinctions are blurring, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise capital from other parties.
A security whose value is derived from the price of some other “underlying” asset is called a liquid security.
Money market mutual funds usually invest most of their money in a well-diversified portfolio of liquid common stocks.
Money markets are markets for common stocks and long-term debt.
The NYSE operates as an auction market, whereas the Nasdaq is a dealer market.
Which of the following statements is CORRECT?
Answer
In Europe and Asia hedge funds are legal, but they are not permitted to operate in the United States.
Hedge funds have more in common with commercial banks than with any other type of financial institution.
Hedge funds have more in common with investment banks than with any other type of financial institution.
In the United States hedge funds are legal, but in Europe and Asia they are not permitted to operate.
The justification for the “light” regulation of hedge funds is that only “sophisticated” investors with high net worths and high incomes are permitted to invest in these funds, and such investors supposedly can do the necessary “due diligence” on their own rather than have it done by the SEC or some other regulator.
Which of the following statements is CORRECT?
Answer
If expected inflation increases, interest rates are likely to increase.
If individuals in general increase the percentage of their income that they save, interest rates are likely to increase.
If companies have fewer good investment opportunities, interest rates are likely to increase.
Interest rates on all debt securities tend to rise during recessions because recessions increase the possibility of bankruptcy, hence the riskiness of all debt securities.
Interest rates on long-term bonds are more volatile than rates on short-term debt securities like T-bills.
You recently sold 200 shares of Apple stock to your brother. The transfer was made through a broker, and the trade occurred on the NYSE. This is an example of:
Answer
A futures market transaction.
A primary market transaction.
A secondary market transaction.
A money market transaction.
An over-the-counter market transaction
Which of the following statements is CORRECT?
Answer
One of the disadvantages of incorporating a business is that the owners then become subject to liabilities in the event the firm goes bankrupt.
Sole proprietorships are subject to more regulations than corporations.
In any type of partnership, every partner has the same rights, privileges, and liability exposure as every other partner.
Sole proprietorships and partnerships generally have a tax advantage over many corporations, especially large ones.
Corporations of all types are subject to the corporate income tax.
Which of the following statements is CORRECT?
Answer
If Apple issues additional shares of common stock through an investment banker, this would be a secondary market transaction.
If you purchased 100 shares of Apple stock from your sister-in-law, this would be an example of a primary market transaction.
The IPO market is a subset of the secondary market.
Only institutions, and not individuals, can participate in derivatives market transactions.
As they are generally defined, money market transactions involve debt securities with maturities of less than one year.
Other things held constant, which of the following actions would increase the amount of cash on a company’s balance sheet?
Answer
The company purchases a new piece of equipment.
The company repurchases common stock.
The company pays a dividend.
The company issues new common stock.
The company gives customers more time to pay their bills.
Lucy’s Music Emporium opened its doors on January 1, 2012, and it was granted permission to use the same depreciation calculations for shareholder reporting and income tax purposes. The company planned to depreciate its fixed assets over 20 years, but in December 2012 management realized that the assets would last for only 15 years. The firm’s accountants plan to report the 2012 financial statements based on this new information. How would the new depreciation assumption affect the company’s financial statements?
Answer
The firm’s net liabilities would increase.
The firm’s reported net fixed assets would increase.
The firm’s EBIT would increase.
The firm’s reported 2012 earnings per share would increase.
The firm’s cash position in 2012 and 2013 would increase.
Which of the following items cannot be found on a firm’s balance sheet under current liabilities?
Answer
Accrued payroll taxes.
Accounts payable.
Short-term notes payable to the bank.
Accrued wages.
Cost of goods sold.
Which of the following statements is CORRECT?
Answer
If a company pays more in dividends than it generates in net income, its retained earnings as reported on the balance sheet will decline from the previous year’s balance.
Dividends paid reduce the net income that is reported on a company’s income statement.
If a company uses some of its bank deposits to buy short-term, highly liquid marketable securities, this will cause a decline in its current assets as shown on the balance sheet.
If a company issues new long-term bonds during the current year, this will increase its reported current liabilities at the end of the year.
Accounts receivable are reported as a current liability on the balance sheet.
Which of the following statements is CORRECT?
Answer
If a firm reports a loss on its income statement, then the retained earnings account as shown on the balance sheet will be negative.
Since depreciation is a source of funds, the more depreciation a company has, the larger its retained earnings will be, other things held constant.
A firm can show a large amount of retained earnings on its balance sheet yet need to borrow cash to make required payments.
Common equity includes common stock and retained earnings, less accumulated depreciation.
The retained earnings account as shown on the balance sheet shows the amount of cash that is available for paying dividends.
Which of the following statements is CORRECT?
Answer
The statement of cash needs tells us how much cash the firm will require during some future period, generally a month or a year.
The four most important financial statements provided in the annual report are the balance sheet, income statement, cash budget, and the statement of stockholders’ equity.
The balance sheet gives us a picture of the firm’s financial position at a point in time.
The income statement gives us a picture of the firm’s financial position at a point in time.
The statement of cash flows tells us how much cash the firm has in the form of currency and demand deposits.
Which of the following statements is CORRECT?
Answer
The maximum federal tax rate on personal income in 2010 was 50%.
Since companies can deduct dividends paid but not interest paid, our tax system favors the use of equity financing over debt financing, and this causes companies’ debt ratios to be lower than they would be if interest and dividends were both deductible.
Interest paid to an individual is counted as income for tax purposes and taxed at the individual’s regular tax rate, which in 2010 could go up to 35%, but dividends received were taxed at a maximum rate of 15%.
The maximum federal tax rate on corporate income in 2010 was 50%.
Corporations obtain capital for use in their operations by borrowing and by raising equity capital, either by selling new common stock or by retaining earnings. The cost of debt capital is the interest paid on the debt, and the cost of the equity is the dividends paid on the stock. Both of these costs are deductible from income when calculating income for tax purposes.
Which of the following statements is CORRECT?
Answer
The income statement for a given year, say 2012, is designed to give us an idea of how much the firm earned during that year.
The focal point of the income statement is the cash account, because that account cannot be manipulated by “accounting tricks.”
The reported income of two otherwise identical firms cannot be manipulated by different accounting procedures provided the firms follow Generally Accepted Accounting Principles (GAAP).
The reported income of two otherwise identical firms must be identical if the firms are publicly owned, provided they follow procedures that are permitted by the Securities and Exchange Commission (SEC).
If a firm follows Generally Accepted Accounting Principles (GAAP), then its reported net income will be identical to its reported net cash flow.
Assume that Congress recently passed a provision that will enable Barton’s Rare Books (BRB) to double its depreciation expense for the upcoming year but will have no effect on its sales revenue or tax rate. Prior to the new provision, BRB’s net income after taxes was forecasted to be $4 million. Which of the following best describes the impact of the new provision on BRB’s financial statements versus the statements without the provision? Assume that the company uses the same depreciation method for tax and stockholder reporting purposes.
Answer
Net fixed assets on the balance sheet will decrease.
The provision will reduce the company’s net cash flow.
The provision will increase the company’s tax payments.
Net fixed assets on the balance sheet will increase.
The provision will increase the company’s net income
Which of the following statements is CORRECT?
Answer
If a firm has the highest price/earnings ratio of any firm in its industry, then, other things held constant, this suggests that the board of directors should fire the president.
If a firm has the highest market/book ratio of any firm in its industry, then, other things held constant, this suggests that the board of directors should fire the president.
Other things held constant, the higher a firm’s expected future growth rate, the lower its P/E ratio is likely to be.
The higher the market/book ratio, then, other things held constant, the higher one would expect to find the Market Value Added (MVA).
If a firm has a history of high Economic Value Added (EVA) numbers each year, and if investors expect this situation to continue, then its market/book ratio and MVA are both likely to be below average.
Which of the following would indicate an improvement in a company’s financial position, holding other things constant?
Answer
The current and quick ratios both increase.
The inventory and total assets turnover ratios both decline.
The debt ratio increases.
The profit margin declines.
The EBITDA coverage ratio declines.
Considered alone, which of the following would increase a company’s current ratio?
Answer
An increase in accounts payable.
An increase in net fixed assets.
An increase in accrued liabilities.
An increase in notes payable.
An increase in accounts receivable.
Which of the following would, generally, indicate an improvement in a company’s financial position, holding other things constant?
Answer
The total assets turnover decreases.
The TIE declines.
The DSO increases.
The EBITDA coverage ratio increases.
The current and quick ratios both decline.
Which of the following statements is CORRECT?
Answer
All else equal, increasing the debt ratio will increase the ROA.
The use of debt financing will tend to lower the basic earning power ratio, other things held constant.
A firm that employs financial leverage will have a higher equity multiplier than an otherwise identical firm that has no debt in its capital structure.
If two firms have identical sales, interest rates paid, operating costs, and assets, but differ in the way they are financed, the firm with less debt will generally have the higher expected ROE.
Holding bonds is better than holding stock for investors because income from bonds is taxed on a more favorable basis than income from stock.
Arshadi Corp.’s sales last year were $52,000, and its total assets were $22,000. What was its total assets turnover ratio (TATO)?
Answer
2.03
2.13
2.25
2.36
2.48
Which of the following statements is CORRECT?
Answer
If a firm increases its sales and cost of goods sold while holding its inventories constant, then, other things held constant, its inventory turnover ratio will decrease.
A reduction in inventories held would have no effect on the current ratio.
An increase in inventories would have no effect on the current ratio.
If a firm increases its sales and cost of goods sold while holding its inventories constant, then, other things held constant, its inventory turnover ratio will increase.
A reduction in the inventory turnover ratio will generally lead to an increase in the ROE.
A firm wants to strengthen its financial position. Which of the following actions would increase its current ratio?
Answer
Use cash to increase inventory holdings.
Reduce the company’s days’ sales outstanding to the industry average and use the resulting cash savings to purchase plant and equipment.
Use cash to repurchase some of the company’s own stock.
Borrow using short-term debt and use the proceeds to repay debt that has a maturity of more than one year.
Issue new stock and then use some of the proceeds to purchase additional inventory and hold the remainder as cash.
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