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Understanding Double Taxation in Corporations

The document contains an answer key for a chapter on corporate governance and financial management, covering topics such as capital budgeting, financing decisions, and the roles of various business structures. It includes multiple-choice questions that test knowledge on the goals of financial management, capital structure, and the responsibilities of corporate boards. Key concepts include agency problems, the distinction between real and financial assets, and the implications of corporate forms of organization.

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17 views6 pages

Understanding Double Taxation in Corporations

The document contains an answer key for a chapter on corporate governance and financial management, covering topics such as capital budgeting, financing decisions, and the roles of various business structures. It includes multiple-choice questions that test knowledge on the goals of financial management, capital structure, and the responsibilities of corporate boards. Key concepts include agency problems, the distinction between real and financial assets, and the implications of corporate forms of organization.

Uploaded by

caggllayan47
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

Chapter 1

Goals and Governance of the Corporation


Answer Key

1. Corporations that do not issue financial securities such as stock or debt obligations:
A. will not be able to increase sales.
B. cannot be profitable.
C. may not be able to generate sufficient funds to fulfill their needs.
D. do not face double taxation of their profits.

2. A financial manager facing a capital budgeting decision must decide whether to:
A. issue stock or debt securities.
B. use the money market or capital market.
C. use primary markets or secondary markets.
D. buy new machinery or repair the old.

3. The primary goal of financial management is to:


A. maximize current dividends per share of the existing stock.
B. maximize the current value per share of the existing stock.
C. minimize operational costs and maximize firm efficiency.
D. maintain steady growth in both sales and net earnings.

4. The overall goal of capital budgeting projects should be to:


A. decrease the firm's reliance on debt.
B. increase the firm's sales.
C. increase the firm's outstanding shares of stock.
D. increase the wealth of the firm's shareholders.

5. Capital structure decisions include consideration of the amount of:


I. long-term debt to issue.
II. equity to raise.
III. current assets and liabilities.
IV. net working capital.
A. I and II only
B. II and III only
C. III and IV only
D. I, II, and IV only

6. An example of a firm's financing decision would be:


A. acquiring a competitive firm.
B. determining how much to pay for a specific asset.
C. issuing 10-year versus 20-year bonds.
D. deciding whether or not to increase the price of its products.

7. Which of the following is not a financing decision?


A. Should the firm borrow money from a bank or sell bonds?
B. Should the firm shut down an unprofitable factory?
C. How much equity should the firm raise?
D. Should the firm issue bonds or common stock?
8. Long-term financing arrangements occur in the:
A. money markets.
B. capital markets.
C. secondary markets.
D. foreign exchange markets.

9. The term "capital structure" refers to:


A. the manner in which a firm obtains its long-term sources of funding.
B. the length of time needed to repay debt.
C. whether the firm invests in capital budgeting projects.
D. which specific assets the firm should invest in.

10. When a corporation decides to issue long-term debt in order to pay for the acquisition of
real assets, it has made a:
A. capital budgeting decision.
B. financing decision.
C. money market decision.
D. secondary market decision.

11. A firm decides to pay for a small investment project through a $1 million increase in
short-term bank loans. This is best described as an example of a(n):
A. financing decision.
B. investment decision.
C. capital budgeting decision.
D. capital market decision.

12. Which of the following represents a financing decision?


A. A decision to borrow $10 million through a bank loan
B. A decision to invest in the common stock of another corporation
C. A decision to buy a new mainframe computer
D. A decision to pay $1 million of accounts payable

13. Which of the following would not be considered a real asset?


A. A corporate bond
B. A machine
C. A patent
D. A factory

14. Which of the following statements best distinguishes the difference between real and
financial assets?
A. Real assets have less value than financial assets.
B. Real assets are tangible; financial assets are not.
C. Financial assets represent claims to income that is generated by real assets.
D. Financial assets appreciate in value; real assets depreciate in value.

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15. Which of the following would not be considered a financial asset?
A. A patent
B. A bond
C. A checking account balance
D. A share of stock

16. A business created as a distinct legal entity composed of one or more individuals or
entities is called a:
A. corporation.
B. sole proprietorship.
C. limited partnership.
D. unlimited liability company.

17. The stockholders in a sole proprietorship are represented by:


A. the owner of the firm.
B. the general partner of the firm.
C. the board of directors of the firm.
D. no one; sole proprietorships have no stockholders.

18. Which of the following would be considered an advantage of the sole proprietorship form
of organization?
A. Wide access to capital markets
B. Unlimited liability
C. A pool of expertise
D. Profits taxed at only one level

19. Which of the following would correctly differentiate general partners from limited
partners in a limited partnership?
A. General partners have more job experience.
B. General partners have an ownership interest.
C. General partners are subject to double taxation.
D. General partners have unlimited personal liability.

20. One common reason for partnerships to convert to a corporate form of organization is that
the partnership:
A. faces rapidly growing financing requirements.
B. wishes to avoid double taxation of profits.
C. wants to have unlimited liability.
D. agreement expires after ten 10 years.

21. Which of the following is not an advantage to incorporating a business?


A. Easier access to financial markets
B. Limited liability
C. Becoming a permanent legal entity
D. Profits taxed at the corporate level and the shareholder level

3
22. Unlimited liability is faced by the owners of:
A. corporations.
B. partnerships and corporations.
C. sole proprietorships and partnerships.
D. all forms of business organization.

23. Which of the following statements is generally not true for an investor who faces
unlimited liability on an investment?
A. The investor has invested in a partnership.
B. The investor has invested in a sole proprietorship.
C. The investor is subject to double taxation.
D. The investor is responsible for managing the firm.

24. A board of directors is elected as a representative of the corporation's:


A. top management.
B. stakeholders.
C. shareholders.
D. customers.

25. The legal "life" of a corporation is:


A. coincidental with that of its CEO.
B. equal to the life of its board of directors.
C. permanent, as long as shareholders don't change.
D. permanent, regardless of current ownership.

26. When the management of a business is conducted by individuals other than the owners,
the business is more likely to be a:
A. corporation.
B. sole proprietorship.
C. partnership.
D. general partner.

27. "Double taxation" refers to:


A. all partners paying equal taxes on profits.
B. corporations paying taxes on both dividends and retained earnings.
C. paying taxes on profits at the corporate level and on dividends at the personal level.
D. the fact that marginal tax rates are doubled for corporations.

28. A corporation is considered to be closely held when:


A. only a few shareholders exist.
B. the market value of the shares is stable.
C. it operates in a small geographic area.
D. management also serves as the board of directors.

29. Corporations are referred to as public companies when their:


A. shareholders have no tax liability.
B. shares are held by the federal or state government.
C. stock is publicly traded.
D. products or services are available to the public.

4
30. Which of the firm's financial managers is most likely to be involved with obtaining
financing for the firm?
A. Treasurer
B. Controller
C. Chief Operating Officer
D. Board of directors

31. In a large corporation, budget preparation would most likely be conducted by the:
A. treasurer.
B. controller.
C. chief financial officer.
D. chief operating officer.

32. A chief financial officer would typically:


A. report to the treasurer, but supervise the controller.
B. report to the controller, but supervise the treasurer.
C. report to both the treasurer and controller.
D. supervise both the treasurer and controller.

33. Investment banks like Merrill Lynch or Goldman Sachs:


A. collect deposits and relend the cash to corporations and individuals.
B. help companies sell their securities to investors.
C. design and sell insurance policies for businesses.
D. lend to corporations and investors in commercial real estate.

34. Which of the following appears to be the most appropriate goal for corporate
management?
A. Maximizing the market value of the company's shares
B. Maximizing the company's outstanding number of shares
C. Maximizing the current profits of the company
D. Minimizing the company's liabilities

35. A corporate board of directors should provide support for the top management team:
A. under all circumstances.
B. in all decisions related to cash dividends.
C. only when the board has confidence in management's actions.
D. if shareholders are not pleased with the firm's performance.

36. A corporation's board of directors:


A. is selected by and can be removed by management.
B. can be voted out of power by the shareholders.
C. has a lifetime appointment to the board.
D. is selected by a vote of all corporate stakeholders.

37. Agency problems can best be characterized as:


A. dislike of firm's bondholders by its equity holders.
B. differing incentives between managers and owners.
C. spending of corporate resources.
D. difference between the primary and secondary markets.

5
38. Which of the following groups is least likely to be considered a stakeholder of the firm?
A. Shareholders
B. Bondholders
C. Competitors
D. Employees

39. One problem with managerial compensation plans, such as bonuses paid to the manager in
the form of firm shares, is that:
A. these plans increase agency problems.
B. managers prefer fixed salaries.
C. their effectiveness is difficult to evaluate.
D. these plans do not reward shareholders.

40. In which of the following organizations would agency problems be least likely to occur?
A. A sole proprietorship
B. A partnership
C. A corporation
D. A closely held corporation

41. When managers' compensation plans are tied in a meaningful manner to the share prices
of the firm, agency problems:
A. can be reduced.
B. will be created.
C. are shifted to other stakeholders.
D. are eliminated entirely from the firm.

42. Which of the following forms of compensation is most likely to align the interests of
managers and shareholders?
A. A fixed salary
B. A salary that is linked to company profits
C. A salary that is paid partly in the form of the company's shares
D. A salary that is linked to the company's total book value

Common questions

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Capital structure decisions impact a corporation's financial strategy by determining the optimal mix of debt and equity financing. This includes considerations on the amount of long-term debt to issue, equity to raise, and net working capital, as indicated by components I, II, and IV in the choices for capital structure considerations . These decisions affect the firm’s leverage and influence its risk profile and cost of capital .

The legal structure of a business affects its financial performance and governance by determining factors such as liability, taxation, and access to capital. For instance, a corporation provides limited liability and access to capital markets, but faces double taxation . In contrast, a sole proprietorship avoids double taxation and profits are taxed once, but it carries unlimited personal liability . The chosen structure influences risk exposure, taxation efficiency, and the ability to raise funds .

The primary goal of financial management in a corporation is to maximize the current value per share of the existing stock, as stated in the document . This goal supports overall shareholder wealth as it directly aims to increase the wealth of the firm's shareholders by potentially increasing the market value of their shares .

A closely-held corporation, where only a few shareholders exist and possibly management serves as the board, impacts governance by potentially consolidating control and decision-making processes among a limited group . This can lead to quicker decision-making and alignment with founder intentions but may also limit diverse perspectives and reduce transparency, affecting strategic decisions and potentially leading to risks of insular governance .

The selection between primary and secondary markets influences financing decisions as primary markets involve issuing new securities to raise capital directly from investors, suitable for raising large amounts of capital for major projects . In contrast, secondary markets involve the trading of existing securities, impacting liquidity and market valuation indirectly but not raising new funds . The choice depends on whether a corporation needs new capital or wishes to optimize its liquidity and market perception .

Under stakeholder theory, firms consider groups such as employees, bondholders, and even competitors, aside from just focusing on shareholders . These considerations can affect managerial decisions by broadening the focus from maximizing shareholder returns to creating value for all stakeholders, which may involve investing in employee welfare or sustainable practices, potentially leading to long-term success and stability .

A partnership might convert to a corporate form to meet rapidly growing financing requirements, as corporations have more access to capital markets . This transition would allow for easier acquisition of funds to support expansion strategies, but it also introduces double taxation and more stringent regulatory requirements . Strategically, a corporation can scale its operations more effectively and potentially increase its market presence .

Agency problems arise from differing incentives between managers and owners, where managers may not always act in the best interest of shareholders . Compensation strategies that can minimize these issues include tying managers' compensation plans to share prices, such as a salary partly in the form of the company's shares, which would align managers' interests with those of shareholders . This approach incentivizes managers to focus on increasing share value .

"Double taxation" in corporations refers to the taxation of profits at both the corporate level and on dividends at the personal level . This impacts investor decision-making as they might seek to avoid the additional tax burden by choosing investments in entities like sole proprietorships or partnerships, which are taxed only once . However, the limited liability and potential for growth in corporations can still attract investors despite this disadvantage .

Real assets are tangible and represent physical objects like machines or factories, while financial assets are intangible and represent claims to income generated by real assets, such as bonds or stocks . These differences influence corporate investment decisions as real asset investments involve considerations of physical utility and depreciation, whereas financial assets involve evaluating potential income streams and market conditions for those securities .

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