chapter 2 mc

Question 1

which of the following business is the least likely to be operated as a partnership?

a. accounting firm
b. doctor’s office
c. lawyers’ office
d. steel foundry

Answer 1

d. steel foundry

Question 2

which of the following statements is false?

a. the limited liability partnership (LLP) is one of the two main partnerships forms
b. limited liability partnerships (LLP) have more tax advantages than income trusts.
c. in the limited and general partnerships form, the limited partners are passive investors
d. in the limited and general partnership form, the general partner has unlimited liability

Answer 2

b
the limited and general partnerships are generally formed for tax reasons. however, as long as a trust pays out all its income to its income holders, and owns the debt and equity, the use of debt can be maximized to reduce or eliminate corporate income tax.

Question 3

Which statement about sole proprietorships is false?

a. the business has unlimited liability
b. the business is easy to set up
c. the business is hard to sell
d. the income is taxed at a corporate rate

Answer 3

d

in a sole proprietorship, income is taxed at the personal tax rate

Question 4

which statement about trusts is correct?

a. compared with corporations, trusts provide greater tax advantages
b. compared with corporations, trusts provide fewer tax advantages.
c. income usually passes through trusts, with corporate tax paid by the unitholders
d. unitholders do not pay tax on the income received

Answer 4

a
a trust has more tax advantages than a corporation because income passes through trusts without any corporate tax to the unit owners. unit holders pay tax on the income received. it avoids the double taxation of a corporation.

Question 5

which statement about a corporation is correct.

a. there is double taxation: corporations pay corporate tax and shareholders pay tax on dividends received
b. there is no separation between ownership and control
c. corporations are taxed at the personal tax rate
d. corporations are not a popular as sole proprietorships as a form of business organization.

Answer 5

a
the corporate form is the most popular form of business. while its ownership and control are separated, it does have double taxation in that both the income of the business and income passed to shareholders are taxed.

Question 6

which of the following is the goal of a corporation?

a. operate in the legal sense
b. act in the “social interest”
c. maximize the wealth of its shareholders
d. all of the above

Answer 6

c

Question 7

which of the following is the main concern from the point of view of a company’s shareholders?

a. IRR of all divisions when investment is analyzed
b. preservation of the firm where risk is concerned
c. accounting return on investment when performance is appraised
d. market prices when performance is appraised

Answer 7

d

market prices are the main concern of shareholders

Question 8

what is the most important purpose of share incentive plans?

a. compensate straight salary
b. align the interests of managers and shareholders
c. reward management
d. boost the share price

Answer 8

b

Question 9

Which statement about the areas of disagreement between managers and shareholders is incorrect

a. performance appraisal: managers use market prices while shareholders use accounting numbers like return on investment or cash
b. investment analysis: managers use the internal rate of return of the best divisions while shareholders use weighted average cost of capital
c. The order of financing: managers prefer retentions to debt and prefer debt to new equity while shareholders prefer debt first
d. risk concern: managers’ main concern is the preservation of the firm while shareholders’ main concern is their portfolios

Answer 9

a

Question 10

which of the following is not a concern related to capital budgeting

a. the percentage of debt financing in the capital structure
b. whether or not to replace old equipment to boost output
c. whether to purchase or lease machinery
d. inventory level

Answer 10

a

all except choice a are concerns of capital budgeting

Question 11

who is the person in charge of the pure finance job has and credit management, risk management etc) in a company?

a. controller
b. treasurer
c. Chief operating officer
d. accountant

Answer 11

b

Question 12

which of the following responsibilities does not usually belong to the controller?

a. compliance
b. credit management
c. tax management
d. budgeting

Answer 12

b

the treasurer would usually have the responsibility of credit management

Question 13

List and define 4 major forms of business organizations

Answer 13

1. Sole proprietorship - a business owned and operated by one person
2. partnership - a business owned and operated by two or more people
3. trusts - a legal organization where assets are owned and managed, or controlled by different parties
4. corporation - a business organized as a separate legal entity under corporation law, with ownership divided into transferable shares

Question 14

Sate the main differences and similarities between sole proprietorship and partnerships

Answer 14

1. sole proprietorship is owned and operated by one person , but a partnership is owned and operated by two or more people
2. a sole proprietorship is easier to set up than a partnership
   similarities:
3. both forms the owner is not separate form the business and therefore has unlimited liability
4. income form the business is taxed at the personal tax rate

Question 15

summarize the main characteristics of a corporation

Answer 15

1. a corporation is a distinct legal identity, which means its life can continue on indefinitely
2. there is a very clear separation between ownership and control of the corporation
3. corporate owners have limited liability whereas sole proprietors have unlimited liability

Question 16

State the statutory responsibilities of directors that are described in the Canada Business Corporations act

Answer 16

Every director and officer of a corporation in exercising their powers and discharging their duties shall

a. act honestly and in good faith with a view to the best interests of the corporation; and
b. exercise the care, diligence, and skill that a reasonable prudent person would exercise in comparable circumstances.

Question 17

Trustco income fund is an income trust whose units trade on the TSX. On October 31, 2006 , just before the gov. of Canada announced new taxes for business organized as trusts, the price of each Trustco unit was $15.12. the firm had been making regular payments to its unitholders at a rate of $1.03 per year; this means that unitholders were getting a yield (or return) of 6.8% per year. the day after the gov’s announcement, the unti price fell to $12.26, but there was no immediate change in the payments to unitholders. what was the yield on Trustco units on Nov 1, 2006?

Answer 17

The fall unit price was mirrored by an increase in the yield. the new yield was (1.03/$12.26) = 8.4% per year

Question 18

Janice borrowed $100,000 form friends and family to start her company (a sole proprietorship). business has been poor recently, and Janice has decided to cease operations and liquidate the firm. she expects to obtain $108,000 from selling assets of the company. how much money will the debt holders receive, and how much will be left for Janice? would these figures be different if the company had been a corporation?

Answer 18

When operating as a sole proprietorship, all of the sassets of the company belong to the owner; the company’s debts are also the owner’s debts. Janice will have to pay her friends and family (the debtholders) the full $100,000 they are owed. this will leave her with $8,000

a Corporation exists independently from its owners. The $108,000 obtained from selling assets will first be used to pay the debtholders what they are owed. any remaining funds will be paid to Janice. because the value of the assets is greater than the money owed to the debtholders, the payments are the same as they were with sole proprietorship.

Question 19

Janice borrowed $100,000 form friends and family to start her company (a sole proprietorship). business has been poor recently, and Janice has decided to cease operations and liquidate the firm. she expects to obtain $108,000 from selling assets of the company.
Suppose Janice obtains only $93,000 when she sells all the assets of the firm. How much money would the debt holders receive If the business were a corporation? if it were a sole proprietorship? how much would Janice receive in each case?

Answer 19

The debtholders will receive the entire $93,000obtained form selling the assets. the remaining $7,000 that they were owed will not be paid because the company has no more funds. furthermore, the limited liability of shareholders in a corporation means that the debthodlers have no legal right to expect Janice to pay them the rest of the money. Nonetheless, Janice receives nothing from the asset sale .
if the business were a sole proprietorship, the debt holders would receive the $93,000 form the sale of assets. However, they would also have the right to force Janice to pay them the extra $7,000 they were owed. Janice would not only receive no money form the sale of the assets, she would have to pay the extra $7,000

Question 20

List the 4 areas of conflict of interest between shareholders and managers

Answer 20

1. Performance appraisal: managers use accounting numbers like the return on investment or cash while shareholders use market prices
2. Investment analysis: managers use the IRR of the best division while shareholders use the external WACC
3. the order of financing: managers prefer retentions to debt and prefer debt t new equity while shareholders prefer debt first
4. Risk concern: managers are concerned with the preservation of the firm while shareholders are concerned about their portfolios.

Question 21

When you hired Dan to manage your business, you agreed to pay him a bonus of 10% of profits at the end of each year. the company now has a choice between two projects (it can take on only one of them). Project A will generate profits of $50,000 per year, and detailed financial calculations show that it will increase the value of the firm by $123,100. Project B will generate profits of $40,000 per year but will increase the firm’s value by $125,000. which project is Dan likely to choose and why? which project would you, the owner of the firm prefer?

Answer 21

Dan is likely to prefer Project A because it will result in a $5,000 annual bonus for him, whereas Project B would provide only a $4,000 annual bonus. On the other hand, you (the owner) would be better off choosing Project B as it creates more value.

Question 22

Describe the compensation structure of top Canadian executives

Answer 22

Referring to Table 2-3, the major components of income are straight salary, annual bonus, share receipts or options, and other. Notice that in all cases, straight salary compensation is relatively low compared with the total package. Annual bonuses are generally somewhat larger, but the largest component by far in most cases is share compensation. This comes in two forms: grants of restricted stock awarded under incentive plans, and stock options, for which if the company’s stock price goes above a certain level, the executive gets the right to buy the stock at a fixed lower price.

Question 23

What is the objective behind the stock option plan of executives? in reality does it achieve this objective?

Answer 23

The idea behind a stock option plan is simply to have the best interests of CEOs and senior managers coincide with those of shareholders. But the actual impact is doubtful. In reality, when a company’s stock falls and makes existing options worthless, new ones are granted to continue to provide incentive for managers.
Additionally, some companies were investigated by regulatory institutions on the “back-dating” stock option issue. The fraud was that senior managers would get the compensation committee to award them stock options and then date them to an earlier period when the company’s stock price was low. Effectively, this meant that on the approval date, the stock was already worth a large amount of money, so there was little incentive value to the grant.

Question 24

List the basic areas of capital budgeting

Answer 24

Capital budgeting considers some basic questions:

1. How does a firm decide to expand its existing buildings or to construct or buy another building?
2. How does a firm decide to replace machinery and equipment? Just because it still works, does this mean that the firm should still use it?
3. How does a firm decide whether to buy or lease machinery and equipment?
4. How much stock or inventory should a firm carry? Should it keep stocks to meet every contingency or perhaps use just-in-time methods to reduce the investment?

Question 25

List the basic areas of financial management

Answer 25

Financial management includes the following areas.

1. How do firms decide to extend credit to customers to purchase their product?
2. How do firms manage their cash? This is a non-interest-bearing asset, so it seems that it should be minimized, but corporations have considerable amounts of money on deposit at banks.
3. How do firms manage any temporary surplus cash?
4. Finally, why do firms take minority stakes in other firms, or more generally, how do they decide to buy 100 percent or less of another firm? This question leads us into corporate acquisitions and valuation.

Question 26

List the basic questions related to corporate financing

Answer 26

Corporate financing considers the following basic questions.

1. How does a firm decide between raising money through debt or equity?
2. In terms of equity how does it raise the equity: through retaining earnings or through issuing new equity?
3. In fact, how does a firm decide to go public and issue shares to the general public versus remaining a non-traded private company?
4. If it decides to issue debt, what determines whether this is bank debt or bonds issued to the public debt market?
5. What determines whether firms access the short-term money market versus borrowing from a bank?

Question 27

List the major jobs available in the financial industry

Answer 27

The major jobs available in the financial industry include analysts, associates, managers, account managers, banking associates, security analysts, sales and trading people, private bankers, retail bankers, financial and investment analysts, portfolio managers, fixed income or equity traders, corporate finance associates and consultants. With financial innovations, more jobs are created.

Question 28

summarize the main responsibilities of the finance function (including CFO, treasurer and controller) in a non-financial company

Answer 28

The most senior person is the chief financial officer (CFO), or in more traditional companies, the senior vice-president of finance. Under the CFO are the two main finance jobs: the treasurer and the controller. The treasurer is responsible for forecasting, pension management, capital budgeting, cash management, credit management, financing, and risk management. The controller focuses on accounting issues such as compliance, tax management, internal auditing, and budgeting.

Question 29

As the CFO of your company, it falls to you to make the final decision on large expenditures. recently, your controller has proposed purchasing a new computer system at a cost of $50,000. he believes the system will deliver savings of $60,000 in the accounting department and could be useful to other departments as well. your treasurer takes a decidedly different view of the proposal. she claims that the company will have to borrow money to buy the computer system, and this will cost $11,000 in interest. as well, she is concerned that the amount of savings promised by the controller won’t materialize. should you purchase the computer system?

Answer 29

The controller’s numbers indicate that the computer system will add ($60,000 – $50,000) = $10,000 of value to the firm. That would indicate that you should proceed with the purchase.
In general, the corporate treasurer has responsibility for capital budgeting decisions of this sort, including estimating costs and savings, determining the need for financing, and considering any risks involved. In this case, the interest expense identified by the treasurer brings the net value created down to –$1,000. It would be best to heed the treasurer and not purchase the computer system.