Corporations generally have a tax advantage over partnerships and proprietorships

CH1:
Part 1: True or False
1. In most corporations, the CEO ranks under the CFO - False
2. The Chairman of the Board must also be the CEO - False
3. Corporations generally have a tax advantage over partnerships and proprietorships. - False
4. An advantage of the corporate form of organization is that corporations are generally highly
regulated than proprietorships and partnerships. - False
5. One advantage of the corporate form of organization is that it avoids double taxation. – False
6. One danger of starting a proprietorship is that you may be exposed to personal liability if the
business goes bankrupt. This problem would be avoided if you formed a corporation to operate
the business. - True
7. If a corporation elects to be taxed as an S corporation, then it can avoid the corporate tax.
However, its stockholders will have to pay personal taxes on the firm's net income. - True
8. It is generally less expensive to form a corporation than a proprietorship because, with a
proprietorship, extensive legal documents are required. - False
9. The less capital a firm is likely to require, the greater the probability that it will be organized as a
corporation. - False
10. One disadvantage of forming a corporation rather than a partnership is that this makes it
more difficult for the firm's investors to transfer their ownership interests. - False
11. In order to maximize its shareholders' value, a firm's management must attempt to
maximize the stock price on a specific target date. - False
12. If a stock's intrinsic value is greater than its market price, then the stock is overvalued and
should be sold. - False
13. If a firm's board of directors wants to maximize value for its stockholders in general (as opposed
to some specific stockholders), it should design an executive compensation system whose focus is
on the firm's long-term value. - True
Part 2: Multiple Choice Questions
1.Which of the following statements is CORRECT?
a. One advantage of forming a corporation is that equity investors are usually exposed to
less liability than they would be in a partnership.
b. Corporations face fewer regulations than proprietorships.
c. One disadvantage of operating a business as a proprietor is that the firm is subject to double
taxation, because taxes are levied at both the firm level and the owner level.
d. It is generally less expensive to form a corporation than a proprietorship because, with a
proprietorship, extensive legal documents are required.
e. If a partnership goes bankrupt, each partner is exposed to liabilities only up to the amount of
his or her investment in the business.
Ans. a.
2. Which of the following statements is CORRECT?
a. Corporations generally face fewer regulations than proprietorships.

b. Corporate shareholders are exposed to unlimited liability.
c. It is usually easier to transfer ownership in a corporation than in a partnership.
d. Corporate shareholders are exposed to unlimited liability, but this factor is offset by the tax
advantages of incorporation.
e. There is a tax disadvantage to incorporation, and there is no way any corporation can escape
this disadvantage, even if it is very small.
Ans. c.
3. The primary operating goal of a publicly-owned firm interested in serving its stockholders should be
to
a. Maximize its expected total corporate income.
b. Maximize its expected EPS.
c. Minimize the chances of losses.
d. Maximize the stock price per share over the long run, which is the stock's intrinsic value.
e. Maximize the stock price on a specific target date.
Ans. d.
4. Which of the following statements is CORRECT?
a. One drawback of forming a corporation is that it generally subjects the firm to additional
regulations.
b. One drawback of forming a corporation is that it subjects the firm's investors to increased
personal liabilities.
c. One drawback of forming a corporation is that it makes it more difficult for the firm to raise
capital.
d. One advantage of forming a corporation is that it subjects the firm's investors to fewer taxes.
e. One disadvantage of forming a corporation is that it is more difficult for the firm's investors to
transfer their ownership interests.
Ans. a.
5. Which of the following actions would be likely to encourage a firm's managers to make decisions that
are in the best interests of shareholders?
a. The percentage of executive compensation that comes in the form of cash is increased and the
percentage coming from long-term stock options is reduced.
b. The state legislature passes a law that makes it more difficult to successfully complete a
hostile takeover.
c. The percentage of the firm's stock that is held by institutional investors such as mutual funds,
pension funds, and hedge funds rather than by small individual investors rises from 10% to
80%.
d. The firm's founder, who is also president and chairman of the board, sells 90% of her shares.
e. The firm's board of directors gives the firm's managers greater freedom to take whatever
actions they think best without obtaining board approval.

Ans. c.
6. Which of the following statements is CORRECT?
a. Hostile takeovers are most likely to occur when a firm's stock is selling below its intrinsic
value as a result of poor management.
b. The efficiency of the U.S. economy would probably be increased if hostile takeovers were
absolutely forbidden.
c. The managers of established, stable companies sometimes attempt to get their state
legislatures to remove rules that make it more difficult for raiders to succeed with hostile
takeovers.
d. In general, it is more in bondholders' interests than stockholders' interests for a firm to shift its
investment focus away from safe, stable investments and into risky investments, especially
those that primarily involve research and development.
e. Stockholders in general would be better off if managers never disclosed favorable events and
therefore caused the price of the firm's stock to sell at a price below its intrinsic value.
Ans. a.
Part 3: short answers
Q1. What is a firm’s intrinsic value? Its current stock price? Is the stock’s
“true” long-run value
more closely related to its intrinsic value or to its current price?
A1.
Firm’s intrinsic value is the estimate of a stock’s true value, intrinsic value
can be estimated based on risk and return data for the stock. It is not
possible to precisely measure the intrinsic value; it can only be estimated.
Intrinsic value is not normally equal to the current stock price.
The “true” long run value of the stock is more closely related to its intrinsic
value, as intrinsic value of the stock is its true value, which would be
reflected in the market price of the stock in the long run.
Q3. Suppose three honest individuals gave you their estimates of Stock X’s
intrinsic value. One person is your current roommate, the second person is a
professional security analyst with an excellent reputation on Wall Street, and
the third person is Company X’s CFO. If the three estimates differed, in which
one would you have the most confidence? Why?
A3.