Chapter 8 & 17 Flashcards
Sole proprietorship
a firm owned by a single individual and not organized as a corporation
Partnership
a firm owned jointly by two or more persons and not organized as a corporation
Corporation
a form of business that provides owners with legal protection from losing more than their investment should the business fail
Liability
varies considerably across the various types of firms
Limited liability
legal provision that shields owners from losing more than they have invested in the firm
Corporations
if you owned stock in Apple & they got in trouble you could lose value of stock but no further liability
makes investing in firms easier for INDIVIDUALS
facilitates raising funds for the FIRM
Unlimited liability
no legal distinction is made between the assets of the firm and the assets of its owners
Sole proprietorships & partnerships
Assets
anything of value owned by a person or a firm
Advantages & Disadvantaged of Sole Proprietorships
+ control by owner
+ no layers of management
- unlimited personal liability
- limited ability to raise funds
Advantages & Disadvantaged of Partnerships
+ ability to share ownership responsibilities
+ ability to share risks
- unlimited personal liability
- limited ability to raise funds
Advantages & Disadvantages of Corporations
+ limited personal liability
+ greater ability to raise funds
- costly to organize
- profits may be subject to double taxation (corporation profits & profits paid out to investors)
T/F there is no single “best” business structure
TRUE
What type of firm is most prominent?
sole proprietorships
What type of firm makes the most revenue?
corporations
What type of firm makes the most profits?
corporations
Governance of sole proprietorships & partnerships
owners typically have day-to-day involvement in decisions at the firm
Governance of large corporations
separation of ownership from control, top management (not shareholders) control day-to-day operations
Structure of large corporations
owners/shareholders elect a board of directors who appoint a C-suite executives (top managers) to oversee day-to-day operations
Principal-Agent Problem
the conflict between the interests of shareholders (owners/the principal) and the interests of top management (the agent hired by the principal)
Efforts to reduce the effect of the principal-agent problem
- closely link top management compensation to firm profit and/or stock price
- significant use of stock and stock options in top management compensation
- integration of outside directors
What are the three principal methods of raising funds for small business owners?
- retained earnings (profits that are reinvested in the firm)
- recruit additional owners
- borrow (from financial institutions, friends, or family)
Indirect finance
firms can borrow from banks, which act as financial intermediaries, permitting indirect finance of the firm by the bank’s account holders
Direct finance
the flow of funds from investors to firms through financial markets, such as a stock exchange.
Two main types of financial securities
- bonds: promise to repay a fixed amount of funds
- stocks: partial ownership of a firm
Bonds
financial security that is essentially a loan
Face Value of a bond
promising to repay a principal (ex. $1000) at the end of some maturity (ex. 30 yrs)
Coupon payments of a bond
intermediate interest payments that will be made to the bond-holder (ex. $40 every year)
Interest rate
the cost of borrowing funds, usually expressed as a percentage of the amount borrowed ($40/$1000 = 4%)
What can influence interest rate
- investor confidence in the company issuing the bond
- investor expectations regarding inflation
how do you calculate interest rate?
coupon payment/face value
Stocks
financial security that represents partial ownership of a firm, when corporations sell stock new shareholders acquire ownership in small fraction of the firm
The profits that corporations make are either:
- reinvested in the firm can lead to capital gain
- paid out to the firm’s shareholders as dividends
Two solutions for challenges that small investors face when trying to diversify their investments
- mutual funds - can only be sold back to the management company
- exchange-traded funds - can be traded directly between investors
- invest in a portfolio of assets & sell shares to investors
Most government funding relies on taxation which includes:
- individual income taxes - occur at the federal level & in 42 states
- social insurance taxes - such as social security & medicare
- corporate income taxes
- sales taxes - leveled by most states and by many local governments
- property taxes - leveled by many local governments on homes, offices, factories
- excise taxes - occur at the federal and state levels on such goods as gasoline, cigarettes, beer
What taxes constitute the majority of the federal government’s tax revenue?
social insurance (social security, medicare & payroll taxes) and individual income taxes
What is the largest source of revenue for state and local governments?
grants from the federal government
T/F Sales tax, property tax, income tax vary by state
TRUE
Regressive Tax
people with LOWER incomes pay a HIGHER percentage of their income in tax than people with higher incomes (sales & social security payroll taxes)
Progressive Tax
people with LOWER incomes pay a LOWER percentage of their income in tax than people with higher incomes (federal income and estate taxes)
Proportional Tax
people pay the same percentage of income regardless of income level (some state income taxes)
T/F Taxes in the US are generally proportional
FALSE, they are generally progressive
Who pays the most in federal income taxes
- top 20% = 83%
- top 1% = 37%
- bottom 40% = -3%
Why did corporate income tax rates become flat in 2017?
had to deal with competitiveness with other countires
Ability-To-Pay Principle
people who have a greater ability to pay should bear a greater share of the tax burden
Benefits-Received Principle
people who receive the benefits from a government program should pay the taxes that support the program
Goal of attaining social objectives
making the interest paid on home mortgages tax deductible
What shape best describes the distribution of income in the US
Diamond
What does the federal poverty line measure?
FOOD required for nutrition of a family
Problems with measuring poverty and the distribution of income
- most people don’t stay in poverty
- ignores income mobility over time
- ignores the effects of government programs meant to reduce poverty
Income inequality
measures the extent to which the distribution of income is unequal.
