Solutions Manual

CHAPTER 4
FORMS OF BUSINESS ORGANIZATION
SUGGESTED ANSWERS TO THE REVIEW QUESTIONS AND CASES
I. Questions
1. Refer to pages 35 through 40.
2. Of the three basic forms of business ownership, corporations have better
access to capital. The ability to raise capital in a sole proprietorship and
partnership is limited to the personal capacity of the owner(s) to attract
potential creditors and other investors.
3. The founder can eventually lose control of the firm if the business
continually incurs losses and uncontrolled indebtedness. The founder can
avoid losing control by ensuring that the business is operating profitably
and earnings are reinvested profitably.
4. In the corporate form of ownership, the shareholders are the owners of
the firm. The shareholders elect the directors of the corporation, who in
turn appoint the firms management. This separation of ownership from
control in the corporate form of organization is what causes agency
problems to exist. Management may act in its own or someone elses best
interests, rather than those of the shareholders. If such events occur, they
may contradict the goal of maximizing the share price of the equity of
the firm.
II. Multiple Choice Questions
1.
2.
3.

A
A
D

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Chapter 4

Forms of Business Organization

III. Cases
1. The advantages to a limited partnership are:
a) Reduction of personal liability. A sole proprietor has unlimited
liability, which can include the potential loss of all personal
assets except for at least one partner who assumes unlimited
liability.
b) Taxes. Forming a limited partnership may mean that more
expenses can be considered business expenses and be deducted
from the companys income.
c) Improved credibility. The business may have increased
credibility in the business world compared to a sole
proprietorship.
d) Ability to attract investment. Limited partnerships can raise
capital through the sale of equity or interest in the firm.
e) Continuous life. Sole proprietorships have a limited life, as
compared with limited partnerships which have potentially
longer life.
f) Transfer of ownership. It is easier to transfer ownership in a sole
proprietorship than in a partnership.
The biggest disadvantage is the potential cost, although the cost of
forming a limited partnership can be relatively small. There are also
other potential costs, including more expansive record-keeping.
2. Forming a corporation has the same advantages as forming a limited
partnership, except that costs are likely to be higher and in a corporation,
ownership is easier to transfer.
3. As a small company, changing to a limited partnership is probably the
most advantageous decision at the current time. If the company grows,
and Dee and Lyn are willing to sell more equity ownership, the company
can reorganize as a corporation at a later date. Additionally, forming a
limited partnership is likely to be less expensive than forming a
corporation.
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