Principles of Finance - Test 1
Decision making (relationship to accounting)
-Accountants devote most of their attention to the collection and presentation of financial data -Financial managers evaluate the accounting statements, develop additional data, and make decisions based on their assessment of the associated returns and risks
international equity market
-Allows corporations to sell blocks of shares to investors in a number of different countries simultaneously
Sarbanes-Oxley Act of 2002
-An act aimed at eliminating corporate disclosure and conflict of interest problems -Contains provisions concerning corporate financial disclosures and the relationships among corporations, analysts, auditors, attorneys, directors, officers, and shareholders
Ethics and share price
-An effective ethics program can enhance corporate value by producing positive benefits -Ethical behavior is for achieving the firm's goal of owner wealth maximization
Normal yield curve
-An upward-sloping yield curve indicates that long-term interest rates are generally higher than short-term interest rates
Behavioral Finance
-Argues that stock prices and prices of other securities can deviate from their true values for extended periods and that these deviations may lead to predictable patterns in stock prices
Spillover effects and recovery from the great recession
-As banks came under intense financial pressure in 2008, they tightened their lending standards and dramatically reduced the quantity of loans they made -Corporations found that they could no longer raise money in the money market, or could only do so at extraordinarily high rates -As a consequence, businesses began to hoard cash and cut back on expenditures, and economic activity contracted
The role of business ethics
-Business ethics are the standards of conduct or moral judgment that apply to persons engaged in commerce -The goal of such standards is to motivate business and market participants to adhere to both the letter and the spirit of laws and regulations concerned with business and professional practice
Sole proprietorship
-Businesses owned by one person and operated for his or her own profit -Unlimited liability
Partnerships
-Businesses owned by two or more people and operated for profit -articles of partnership
Yield to Maturity (YTM)
-Compound annual rate of return earned on a debt security purchased on a given day and held to maturity -An estimate of the market's required return on a particular bond
Private Equity (issuing common stock)
-External equity financing that is raised via a private placement, typically by private early-stage firms with attractive growth prospects -Angel Investors (Angels) -Venture Capitalists (VC's)
Investment bank
-Financial intermediary that specializes in selling new security issues and advising firms with regard to major financial transactions
Eurocurrency market (part of money market)
-International equivalent of the domestic money market -It is a market for short-term bank deposits denominated in U.S. dollars or other marketable currencies -The Eurocurrency market has grown rapidly mainly because it is unregulated and because it meets the needs of international borrowers and lenders -Nearly all Eurodollar deposits are time deposits
Ethical guidelines
-Is the action arbitrary or capricious? Does it unfairly single out an individual or group? -Does the action violate the moral or legal rights of any individual or group? -Does the action conform to accepted moral standards? -Are there alternative courses of action that are less likely to cause actual or potential harm?
Corporations
-Legal business entities with rights and duties similar to those of individuals but with a legal identity distinct from its owners -stockholders -limited liability -stock -dividends -board of directors -CEO
Other limited liability organizations
-Limited partnership (LP) -S corporation (S corp) -Limited liability company (LLC) -Limited liability partnership (LLP)
Dealer Markets
-Markets, like the NASDAQ, in which the buyer and seller are not brought together directly but instead have their orders executed by securities dealers that "make markets" in the given security -The dealer market has no centralized trading floors (It is made up of a large number of market makers who are linked together via a mass-telecommunications network) -As compensation for executing orders, market makers make money on the bid/ask spread (ask price − bid price) -Secondary Market -transaction costs are higher in dealer markets than broker markets
Flaws in neglecting shareholder wealth maximization
-Maximizing shareholder wealth does not in any way imply that managers should ignore the interests of everyone connected to a firm who is not a shareholder -To maximize shareholder value, managers must necessarily assess the long-term consequences of their actions -The stakeholder perspective is intrinsically difficult to implement, and advocates of the idea that managers should consider all stakeholders' interests along with those of shareholders do not typically indicate how managers should carry it out -Many people misinterpret the statement that managers should maximize shareholder wealth as implying that managers should take any action, including illegal or unethical actions, that increases the stock price
subprime mortgages
-Mortgage loans made to borrowers with lower incomes and poorer credit histories as compared to "prime" borrowers
Ordinary Income vs. Capital Gains
-Ordinary income is income earned by a business through the sale of goods or services while capital gains is income earned by selling an asset for more than it cost -for corporations, ordinary income and capital gains are treated the same for tax purposes
Security Exchanges
-Organizations that provide the marketplace in which firms can raise funds through the sale of new securities and in which purchasers can resell securities
Quiet Period
-Period during which the law places restrictions on what company officials may say about the company
After 2018 (tax cuts and jobs act)
-Proprietorships and partnerships still taxed according to a (revised) progressive rate structure -Corporations taxed at a flat rate of 21% -Under a flat tax, the marginal and average tax rates are equal
Prior to 2018
-Proprietorships and partnerships taxed according to the same progressive rate structure as individual taxpayers -Corporations taxed according to an alternative, mostly progressive rate structure
4. Dodd Frank Wall Street Reform & Consumer Protection Act
-Realigns the duties of several existing agencies and requires existing and new agencies to report to Congress regularly -Nearly a decade after Dodd-Frank became law, the various agencies affected or created by the new law were still writing rules specifying how the new law's provisions would be implemented -Tight control on financial industry.
1. Securities Act of 1933
-Regulates the sale of securities to the public via the primary market -Requires sellers of new securities to provide extensive disclosures to the potential buyers of those securities
2. Securities Exchange Act of 1934
-Regulates the trading of securities in the secondary market -Created the Securities Exchange Commission -Requires ongoing disclosure by companies whose securities trade in secondary markets (e.g., 10-Q, 10-K) -Imposes limits on the extent to which "insiders" can trade in their firm's securities
Falling home prices and delinquent mortgages
-Rising home prices between 1987 and 2006 kept mortgage default rates low -Lenders relaxed standards for borrowers and created subprime mortgages -As housing prices fell from 2006 to 2009, many borrowers had trouble making payments, but were unable to refinance -As a result, there was a sharp increase in the number of delinquencies and foreclosures
The Efficient-Market Hypotheses
-Securities are typically in equilibrium, which means they are fairly priced and their expected returns equal their required returns -At any point in time, security prices fully reflect all information available about the firm and its securities, and these prices react swiftly to new information -Because stocks are fully and fairly priced, investors need not waste their time trying to find mispriced (undervalued or overvalued) securities
Broker Markets
-Securities exchanges in which the two sides of a transaction, the buyer and the seller, are brought together to trade securities -Trading takes place on centralized trading floors of national exchanges, such as NYSE Euronext, as well as regional exchanges -Secondary market
Stock options
-Securities that allow managers to buy shares of stock at a fixed price
Mortgage-Backed Securities
-Securities that represent claims on the cash flows generated by a pool of mortgages -A primary risk associated with mortgage-backed securities is that homeowners may not be able to, or may choose not to, repay their loans
Restricted stock
-Shares of stock paid out as part of a compensation package that do not fully transfer from the company to the employee until certain conditions are met
Deal Structure and Pricing (of issuing common stock)
-The deal structure allocates responsibilities and ownership interests between the existing owners (typically the founders) and the venture capitalist, and its terms depend on numerous factors related to the founders; the business structure, stage of development, and outlook; and other market and timing issues -Venture capitalists will require more equity ownership and pay less for it the riskier and less developed the business
IPO Market Price
-The final trading price on the first day in the secondary market
private placement
-The firm sells new securities directly to an investor or group of investors
Rights offering
-The firm sells new shares to existing stockholders
Public offering
-The firm sells new shares to the general public
Initial public offering (IPO)
-The first public sale of a firm's stock, typically made by small, rapidly growing companies that either require additional capital to continue growing or have met a milestone for going public that was established in an earlier agreement to obtain VC funding
Originating investment bank
-The investment bank initially hired by the issuing firm; it brings other investment banks in as partners to form an underwriting syndicate
Tombstone
-The list of underwriting syndicate banks, presented in such a way to indicate a syndicate member's level of involvement, located at the bottom of the IPO prospectus cover page
Marginal vs. Average Tax Rate
-The marginal tax rate represents the rate at which the next dollar of income is taxed while the average tax rate equals taxes paid divided by taxable income -The marginal rate does not usually equal the average rate under a progressive tax rate structure
eurobond market
-The market where corporations and governments typically issue bonds denominated in dollars and sell them to investors located outside the United States
Risk Premiums: Issuer and Issue Charaacteristics
-The nominal rate of interest for security j is equal to the risk-free rate, consisting of the real rate of interest plus the expected inflation rate, plus the risk premium -The risk premium varies with specific issuer and issue characteristics
IPO underpricing
-The percentage change from the final IPO offer price to the IPO market price, which is the final trading price on the first day in the secondary market; this is also called the IPO initial return IPO Underpricing = (Market Price − Offer Price) ÷ Offer Pric
IPO Offer price
-The price at which the issuing firm sells its securities
Market Price
-The price of the firm's shares as determined by the interaction of buyers and sellers in the secondary market
3. Securities and Exchange Commission
-The primary government agency responsible for enforcing federal securities laws -Information disclosure requirement for firm's IPO, and continuing disclosure requirement for public companies.
Primary market vs. Secondary market
-The primary market is the financial market in which securities are initially issued; the only market in which the issuer is directly involved in the transaction -Secondary markets are financial markets in which preowned securities (those that are not new issues) are traded
Real Rate of Interest
-The rate of return on an investment measured not in dollars but in the increase in purchasing power that the investment provides -The real rate of interest measures the rate of increase in purchasing power
Term Structure of interest rates
-The relationship between the maturity and rate of return for bonds with similar levels of risk
Underwriting
-The role of the investment bank in bearing the risk of reselling, at a profit, the securities purchased from an issuing corporation at an agreed-on price
Corporate Governance (ways to help principle-agent problems)
-The rules, processes, and laws by which companies are operated, controlled, and regulated -Internal Corporate Governance Mechanisms (stock options and restricted stock) -External Corporate Governance Mechanisms (individual vs. institutional investors, activist investors, and the threat of takeover) -Government Regulation (Sarbanes-Oxley Act of 2002)
Expectations Theory
-The theory that the yield curve reflects investor expectations about future interest rates - an expectation of rising interest rates results in an upward-sloping yield curve, and an expectation of declining rates results in a downward-sloping yield curve
Total Proceeds
-The total amount of proceeds for all shares sold in the IPO Total Proceeds = (IPO Offer Price × # of IPO Shares Issued)
Market Capitalization
-The total market value of a publicly traded firm's outstanding stock Market Capitalization = (Market Price of Stock × # of Shares of Stock Outstanding)
Liquidity Preference Theory
-Theory suggesting that long-term rates are generally higher than short-term rates because investors perceive short-term investments as more liquid and less risky than long-term investments -Borrowers must offer higher rates on long-term bonds to entice investors away from their preferred short-term securities -only theory that contributes to an upward sloping yield curve
Market Segmentation theory
-Theory suggesting that the market for loans is segmented on the basis of maturity and that the supply of and demand for loans within each segment determine its prevailing interest rate; the slope of the yield curve is determined by the general relationship between the prevailing rates in each market segment
principles that guide managers decisions
-Time Value of Money -Tradeoff between Return and Risk -Cash Is King (focus more on cash flow than accounting profit) -Competitive Financial Markets (keep a firm's competitive position in the market environment is the way to survive and win, and managers have to be sensitive to market signals) -Incentives Are Important
Common stock
-Units of ownership interest or equity in a corporation
Interest Rate
-Usually applied to debt instruments such as bank loans or bonds; the compensation paid by the borrower of funds to the lender; from the borrower's point of view, the cost of borrowing funds -Broadly speaking, interest rates are determined by the interaction of supply and demand
Negative Interest Rates
-When a loan carries an interest rate below zero, the lender essentially pays interest to the borrower rather than the other way around -A natural question is, why would anyone buy an investment if it paid an interest rate below zero? -The answer is that there is no good, safe alternative offering a better return
Crisis of confidence in banks
-With delinquency rates rising, the value of mortgage-backed securities began to fall and so did the fortunes of financial institutions that had invested heavily in real estate assets -Only 3 banks failed in 2007, but 25 failed in 2008, 140 failed in 2009, peaking at 157 bank failures in 2010 -It was not until 2015 that bank failures fell back into the single digits
International capital markets
-eurobond market -foreign bond market -international equity market
Finance (in business context) involves
-how firms raise money from investors -how firms invest money in an attempt to earn a profit -how firms decide whether to reinvest profits in the business or distribute them back to investors
The investment Banks Role (issuing common stock)
-investment bank -underwriting -IPO Offer price -Originating investment bank -underwriting syndicate -Tombstone -Selling Group -Total proceeds -Market Price -Market Capitalization -IPO Market Price -IPO underpricing
Issuing common stock
-private equity -Organization & investment Stages -deal structure -going public -investment banks role
Going public (with issuing common stock)
-private placement -rights offering -public offering -Initial public offering (IPO) -Prospectus -Red Herring -Quiet Period -Roadshow
Nominal and Real interest rates equation
(1 + NOMINAL interest rate) = (1 + REAL interest rate) (1 + EXPECTED inflation rate) REAL interest rate approximately equals NOMINAL - EXPECTED inflation rate
The money market
- a market where investors trade highly liquid securities with maturities of 1 year or less -Most money market transactions are made in marketable securities which are short-term debt instruments (such as: US Treasury bills issued by fed govt, commercial paper issued by businesses, and negotiable certificates of deposit issued by financial institutions) -Investors generally consider marketable securities to be among the least risky investments available -Eurocurrency Market
preferred stock
- a special form of ownership that has features of both a bond and common stock
Inverted yield curve
-A downward-sloping yield curve indicates that short-term interest rates are generally higher than long-term interest rates
The shape of the yield curve may affect the firms financing decisions...
-A financial manager who faces a downward-sloping yield curve may be tempted to rely more heavily on cheaper, long-term financing -Yield curve can be regarded as an indicator for future market and economy, giving investors either an optimistic or a pessimistic view or forecasting about future economy.
What is a firm
-A firm is a business organization that sells goods or services -Firms exist because investors want access to risky investment opportunities
deflation
-A general trend of falling prices
Yield Curve
-A graphic depiction of the term structure of interest rates
underwriting syndicate
-A group of other banks formed by the originating investment bank to share the financial risk associated with underwriting new securities
Selling Group
-A large number of brokerage firms that join the originating investment bank(s); each accepts responsibility for selling a certain portion of a new security issue on a commission basis
foreign bond market
-A market for bonds issued by a foreign corporation or government that is denominated in the investor's home currency and sold in the investor's home market
The capital market
-A market that enables suppliers and demanders of long-term funds to make transactions -Key Securities Traded: Bonds and Stocks - AND T NOTES and T BONDS (Securities traded in the capital market fall into two broad categories: debt and equity) -Broker Markets and Dealer Markets (security exchanges, broker markets, and dealer markets) -Primary and secondary markets are capital markets
Prospectus
-A portion of a security registration statement that describes the key aspects of the issue, the issuer, and its management and financial position
Red Herring
-A preliminary prospectus made available to prospective investors during the waiting period between the registration statement's filing with the SEC and its approval
Roadshow
-A series of presentations to potential investors around the country, providing investors with information about the new issue -Sessions help investment banks gauge demand for the offering and set a preliminary offer price range
Flat yield curve
-A yield curve that indicates that interest rates do not vary much at different maturities
Why firms are NOT supposed to set Maximize Stakeholders' Welfare as the goal?
1) competitive market environment already facilitates a mechanism interests of firm and interests of stakeholders are consistent. Manager cannot max the value of a firm if all stakeholders are constantly dissatisfied. 2) Maximize firm owners' wealth not necessarily a short-run strategy or sacrifice stakeholders' benefit, as some argument claimed. 3) Stakeholder perspective varies, and it is difficult to implement. There is no a general rule to rank them, to make all parties evenly satisfied. 4) Misinterpret the statement that firm should maximize shareholder wealth. Actually, these actions MUST be within legal or ethical boundary without adversely impact on stakeholders' welfare.
Federal Reserve banks Monetary Policy tools
1. Expansionary monetary policy 2. Contractionary monetary policy
Regulations governing financial INSTITUTIONS
1. Glass-Steagall Act 2. FDIC 3. Gramm-Leach-Bliley Act 4. Dodd Frank Wall Street Reform & Consumer Protection Act
3 major factors that influence equilibrium interest rates
1. Inflation 2. Risk 3. Liquidity Preference
Financial Managers Key Decisions
1. Investment Decisions -how company invests its capital to generate wealth for shareholders 2. Capital Budgeting Decisions (aka working capital decisions) -day to day management of a firms short term resources 3. Financing Decisions (capital structure decisions and working capital decisions) -how company raises capital it needs to invest
What is the goal of a firm?
1. Maximize shareholder wealth -In most instances this is equivalent to maximizing the stock price 2. Maximize profit 3.Maximize Stakeholders' Welfare -stakeholders are employees, suppliers, customers, and local community (stockholders are owners)
Regulations governing financial MARKETS
1. Securities Act of 1933 2. Securities Exchange Act of 1934 3. Securities and Exchange Commission
In total, ________ accounted for almost three-quarters of the number of business establishments in operation, but they earned just 10% of all business income. _______ on the other hand, accounted for just 17% of the number of businesses, but they earned almost two-thirds of all business income.
1. Sole proprietorships 2. Corporations
Key suppliers and demanders of funds of financial institutions are
1. individuals (net supplier of funds) 2. businesses and governments (net demanders of funds)
Transactions in short-term marketable securities take place in the __________ while transactions in long-term securities take place in the __________
1. money market 2. capital market
In calculating their taxes, corporations can deduct ___________ expenses, as well as _________ expenses they pay to lenders
1. operating 2. interest -The tax deductibility of these expenses reduces their after-tax cost
Interest received by corporations is taxed as ________, while ________ received get a special tax break that moderates the effect of double taxation
1. ordinary income 2. dividends
Dividends received by the firm for stock held in other corporations are usually subject to a _____ exclusion for tax purposes
50% -The dividend exclusion in effect eliminates half of the potential tax liability from dividends received by the second and any subsequent corporations
Liquidity Preference
A general tendency for investors to prefer short-term (i.e., more liquid) securities
Shadow Banking System (non-bank financial institution)
A group of institutions that engage in lending activities, much like traditional banks, but that do not accept deposits and therefore are not subject to the same regulations as traditional banks
Limited Liability
A legal provision that limits stockholders' liability for a corporation's debt to the amount they initially invested in the firm by purchasing stock
Principal-agent Problem
A problem that arises because the owners of a firm and its managers are not the same people and the agent does not act in the interest of the principal -shareholders = principles -managers = agents
Inflation
A rising trend in the prices of most goods and services
Stock
A security that represents an ownership interest in a corporation
Double taxation
A situation facing corporations in which income from the business is taxed twice—once at the business level and once at the individual level when cash is distributed to shareholders
3. Gramm-Leach-Bliley Act
Allows mergers between commercial banks, investment banks, and insurance companies and thus permits these institutions to compete in markets that prior regulations prohibited them from entering -Lifted tight control for financial institutions allowing them to do mixed financial business, therefore promoted competition in financial services industry.
2. FDIC (federal deposit insurance corporation)
An agency created by the Glass-Steagall Act that provides insurance for deposits at banks and monitors banks to ensure their safety and soundness
Investment Banks
Assist companies in raising capital, advise firms on major transactions such as mergers or financial restructurings, and engage in trading and market making activities
Generally, individuals plan, monitor, and assess their financial activities using ______ over a given period, typically a month or a year
Cash flows
Contractual Provision risk
Conditions that are often included in a debt agreement or a stock issue. Some of these reduce risk, whereas others may increase risk. For example, a provision allowing a bond issuer to retire its bonds prior to their maturity under favorable terms increases the bond's risk.
president or chief executive officer (CEO)
Corporate official responsible for managing the firm's day-to-day operations and carrying out the policies established by the board of directors
agency costs
Costs that shareholders bear due to managers' pursuit of their own interests
2. Contractionary monetary policy
DECREASE Money Supply INCREASE Interest Rate
working capital decisions
Decisions that refer to the management of a firm's short-term resources
Marginal cost benefit analysis
Economic principle that states that financial decisions should be made and actions taken only when the marginal benefits exceed the marginal costs
Risk
Expect a higher return on investment compensation for bearing the higher risk
What is Finance?
Finance is defined as the science and art of how individuals and firms raise, allocate, and invest money. at the personal level, finance is concerned with individuals decisions about: -how much of their earnings they spend -how much they save -how they invest their savings
Venture Capitalists
Formal business entities that take in private equity capital from many individual investors, often institutional investors such as endowments and pension funds or individuals of high net worth, and make private equity investment decisions on their behalf
Board of Directors
Group elected by the firm's stockholders and typically responsible for approving strategic goals and plans, setting general policy, guiding corporate affairs, and approving major expenditures
1. Expansionary monetary policy
INCREASE Money Supply DECREASE Interest Rate
Commercial Banks
Institutions that provide savers with a secure place to invest their funds offer loans to individual and business borrowers -the traditional business model is taking in and paying interest on savings deposits and investing or lending those funds back out at higher interest rates
Risk premium, nominal interest rates are also affected by risk....
Investors demand a higher nominal rate of return on risky investments. The associated risk adds additional "price" upon the investment which is risk premium (RP)
Activist Investors
Investors who specialize in influencing management (and can force managers to improve the firm's performance)
Bonds
Long-term debt instruments used by businesses and government to raise large sums of money, generally from a diverse group of lenders
Dividends
Periodic distributions of cash to the stockholders of a firm
1. Glass-Steagall Act
Prohibited institutions that took deposits from engaging in activities such as securities underwriting and trading, thereby effectively separating commercial banks from investment banks -created the FDIC
Accrual basis
Recognizes revenue at the time of sale and recognizes expenses when they are incurred
Cash basis
Recognizes revenues and expenses only with respect to actual inflows and outflows of cash
Risk Free Rate Equation
Risk Free Rate = Real Interest Rate + Expected inflation rate
What determines an equilibrium interest rate?
Supply and Demand of fund in the entire economy
Nominal Rate of Interest
The actual rate of interest charged by the supplier of funds and paid by the demander
Unlimited Liability
The condition of a sole proprietorship, giving creditors the right to make claims against the owner's personal assets to recover debts owed by the business
capital structure decisions
The money that firms raise to finance their activities
Stockholders
The owners of a corporation, whose ownership, or equity, takes the form of common stock or, less frequently, preferred stock -expect to earn a return by receiving dividends or by realizing gains through increases in share price
Default Risk
The possibility that the issuer of debt will not pay the contractual interest or principal as scheduled. The greater the uncertainty as to the borrower's ability to meet these payments, the greater the risk premium. High bond ratings reflect low default risk, and low bond ratings reflect high default risk.
Securitization
The process of pooling mortgages or other types of loans and then selling claims or securities against that pool in the secondary market
Required Return
Usually applied to equity instruments such as common stock; the cost of funds obtained by selling an ownership interest
Organization and investment stages (issuing common stock)
VC limited partnership is the most common structure
Angel Investors
Wealthy individual investors who make their own investment decisions and are willing to invest in promising startups in exchange for a portion of the firm's equity
What lesson can we learn from the Great Recession of 2008?
a) Financial institutions lost their risk management in the abnormally rising housing markets. b) Government did not have a series of specific available regulation to control financial institution's aggressive risk-taking businesses.
Financial Markets
are forums in which suppliers of funds and demanders of funds can transact business directly
Financial institutions
are intermediaries that channel the savings of individuals, businesses, and governments into loans or investments.
Private placement
involves the sale of a new security directly to an investor or group of investors
Managerial finance concerns
the duties of the financial manager in a business -Financial managers 1. administer the financial affairs of all types of businesses: private and public, large and small, profit seeking and not for profit 2. perform such varied tasks as developing a financial plan or budget, extending credit to customers, evaluating proposed large expenditures, and raising money to fund the firm's operations
Bid price
the highest price a buyer is willing to pay for a security
Ask price
the lowest price a seller is willing to accept for a security
Term structure of interest stands for
the relationship between the maturity and rate of return for bonds with similar levels of risk. (only compare bonds in similar risk category)
Risk free Rate (further explained)
the return on this investment is not affected by delinquency or default risk, i.e., completely free of risk, but it is affected by investors' inflation expectations. - the US T-Bill is a common proxy for the risk free rate
Most firms, however, raise money through a public offering of securities, which is
the sale of either bonds or stocks to the general public
Partnership strengths
•Can raise more funds than sole proprietorships •Borrowing power enhanced by more owners •More available brain power and managerial skill •Income included and taxed on partner's personal tax return
Developing skills for your career
•Critical Thinking •Communication and Collaboration •Financial Computing Skills
Sole proprietorship weaknesses
•Owner has unlimited liability in that total wealth can be taken to satisfy debts •Limited fund-raising power tends to inhibit growth •Proprietor must be jack-of-all-trades •Difficult to give employees long-run career opportunities •Lacks continuity when proprietor dies
Sole proprietorship strengths
•Owner receives all profits (and sustains all losses) •Low organizational costs •Income included and taxed on proprietor's personal tax return •Independence •Secrecy •Ease of dissolution
Corporation strengths
•Owners have limited liability, which guarantees that they cannot lose more than they invested •Can achieve large size via sale of ownership (stock) •Ownership (stock) is readily transferable •Long life of firm •Can hire professional managers •Has better access to financing
Partnership weaknesses
•Owners have unlimited liability and may have to cover debts of other partners •Partnership is dissolved when a partner dies •Difficult to liquidate or transfer partnership
Corporation weaknesses
•Taxes are generally higher because corporate income is taxed, and dividends paid to owners are also taxed at a maximum 15% rate •More expensive to organize than other business forms •Subject to greater government regulation •Lacks secrecy because regulations require firms to disclose financial results
Articles of Partnership
•The written contract used to formally establish a business partnership
