Ch. 13

Question 1

Rewards of Equity Financing

Answer 1

• Generate a return on your equity investment

- Psychological (ego) Reward - “I own a Business”

Question 2

Risks of Equity Financing

Answer 2

• Not receiving a good return

- Receive a negative return

Question 3

Rewards of Debt Financing

Answer 3

• Financial Leverage - occurs when the return from borrowed funds is greater than the cost of borrowed funds

Question 4

Risk of Debt Financing

Answer 4

• Financial Risk - the chance a company might default on its debt obligations

Question 5

Sole Prop & Partnerships

Answer 5

Advantages: Easy to form, Income only taxed once
Disadvantages: Unlimited Liability, Hard to raise large amount of capital
- Use an account call capital

Question 6

Owners Capital

Answer 6

• Capital account represents the owner’s equity placed into the business
  a) Owner’s Capital is increased by contributions (asset placed into business)
  b) Owner’s Capital is increased by any net income
  c) Owner’s Capital in decreased by any net loss
  d) Owner’s Capital is decreased by any withdrawals

Question 7

Ways to divide Partnership Income

Answer 7

1. Fixed Ratio
2. Ratio Capital Balances
3. Salary & Interest Allowance
4. Divide the Remainder

Question 8

Corporations

Answer 8

• Advantage: Limited Liability, Can raise large amounts of capital, Unlimited life
• Disadvantage: Double Taxation

Question 9

Common Stock

Answer 9

• Right to vote
• Right to sell shared of stock
• Preemptive Right - First right to purchase the newly issued shares
• Right to share in any dividends
• Right to share in any liquidation
• Last in line to receive assets of the corporation in the event of bankruptcy

Question 10

Preferred Stock

Answer 10

• P/S is paid first on any dividends declared
• P/S is paid first on any liquidation
• P/S usually has no voting say in the company

Question 11

Dividends in Arrears

Answer 11

• Unpaid P/S dividend Unpaid P/S dividends

Question 12

Shares Authorized

Answer 12

• Total number of shares a state has approved a corp to to sell

Question 13

Shares Issued

Answer 13

• Actual shares sold to the public

Question 14

Treasury Stock

Answer 14

• Shares of a corporation’s own stock that have been repurchased

Question 15

Shares Outstanding

Answer 15

= Shares Issued - Treasury Stock shares

Question 16

Par Value

Answer 16

• Arbitrary value assigned by the corp. & the state

Question 17

Legal Capital

Answer 17

=> Par Value * Number of Shares Issued

- Is used to protect creditors in the case of bankruptcy

Question 18

Corporation Dividends

Answer 18

• Distributions from the corporation to the investor
• Dividends can be cash, stock, or property
• Dividends are not an expense of the corporation ( they represent a return of capital)

Question 19

Stock Splits

Answer 19

• Reduce the price of the stock (more people can purchase the stock at a lower price (increase the liquidity of the stock))
• Require no journal entries ( memorandum entry should be made)
• Reduce the par value proportionately
• Increase the # of shares outstanding

Question 20

Increasing Liquidity

Answer 20

• Increase the ease of buying and selling stocks

Question 21

S Corporations

Answer 21

• Limited Liability
• Only 100 Shareholders allowed
• All shareholders must be US citizens
• Class of Stock - Only one class
• Minutes must be taken each year
• More liability protection across different states
• A pass-through entity - Income taxed at individual taxpayer level

Question 22

Limited Liability Company (LLC)

Answer 22

• Limited Liability
• Less paperwork vs corporation
• A pass-through entity - income taxed at individual taxpayer level