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Chapter 1

ADMS 3530 Chapter Notes - Chapter 1: Barings Bank, Prince Edward Islands, British Columbia Securities Commission


Department
Administrative Studies
Course Code
ADMS 3530
Professor
Lois King
Chapter
1

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Brealey 5CE
Solutions to Chapter 1
1. real
executive airplanes
brand names
financial
stock
investment
capital budgeting
financing
2. A firm might cut its labour force dramatically which could reduce immediate expenses
and increase profits in the short term. Over the long term, however, the firm might not
be able to serve its customers properly or it might alienate its remaining workers; if so,
future profits will decrease, and the stock price will decrease in anticipation of these
problems.
Similarly, a firm can boost profits over the short term by using less costly materials even
if this reduces the quality of the product. Once customers catch on, sales will decrease
and profits will fall in the future. The stock price will fall.
The moral of these examples is that, because stock prices reflect present and future
profitability, the firm should not necessarily sacrifice future prospects for short-term
gains.
3. The key advantage of separating ownership and management in a large corporation
is that it gives the corporation permanence. The corporation continues to exist if
managers are replaced or if stockholders sell their ownership interests to other
investors. The corporation’s permanence is an essential characteristic in allowing
corporations to obtain the large amounts of financing required by many business
entities.
Both public and private corporations are distinct legal entity, separate from its
owners (ie., its shareholders). The key difference between public and private
corporations are the rules governing the sale of their common shares. The common
shares of a public corporation are listed for trading on a stock exchange and
investors can freely buy and sell the corporation’s shares at the current stock price.
The common shares of a private corporations are not listed for trading on a stock
exchange. Shareholders of private corporations must negotiate directly with
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potential buyers and are subject to resale restrictions.
To learn more about the risks associated with investing in private companies, see this
website run by the British Columbia Securities Commission:
http://www.investright.org/private_company_investing.aspx
4. A sole proprietorship is easy to set up with a minimum of legal work. The business itself
is not taxed. For tax purposes, the income of the proprietorship is treated as the income
of the proprietor. The main disadvantages of a proprietorship are the proprietor’s
unlimited liability for the debts of the firm, and difficulty in raising large amounts of
financing as the business grows.
A partnership has the same tax advantage as the proprietorship. The partnership per se
does not pay taxes. The partnership files a tax return, but all of the partnership income
is allocated to the partners and treated as personal income. Also, it is fairly easy to set
up a partnership. Because there can be many partners, a partnership can raise capital
more easily than a proprietorship. However, like sole proprietors, partners have
unlimited liability for the debts of the firm. In fact, each partner has unlimited liability
for all the businesss debts, not just his or her share.
Corporate organization has the advantage of limited liability. Its owners, the
shareholders, are not personally responsible for the debts of the corporation. It also
allows for separation of ownership and management, since shares in the firm can be
traded without changing management. A public corporation has the added advantage of
easier access to equity financing because its shares are traded in public stock markets.
The major disadvantage of corporate organization is the double taxation of income.
Corporations pay taxes on their income, and that income is taxed again when it is passed
through to shareholders in the form of dividends. Another disadvantage of corporate
organization is the extra time and cost required in order to manage a corporation’s legal
affairs. These costs arise because the corporation must be chartered and is considered a
distinct legal entity. Such administrative costs are significant only for small
corporations, however. Furthermore, public corporations must provide investors with
detailed financial information in their annual reports and inform investors about
significant events. Disclosure takes time and resources and may also be costly in the
sense that competitor firms learn what is going on too.
LLP’s may be considered to be hybrid organizations to the extent that while individual
partners have unlimited liability, they are not liable for the actions of their partners.
5. Double taxation means that a corporation’s income is taxed first at the corporate tax
rate, and then, when the income is distributed to shareholders as dividends, the
income is taxed again at the shareholder’s personal tax rate.
6. a, c, d.
7. On the website, www.td.com, the various businesses are listed in a table in the
middle of the page. Click a business, such as TD Canada Trust, and the main
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business activities appear in a box under the table. To work as an investment banker,
you would work for TD Securities, listed under the heading “Wholesale Banking”.
Clicking on “TD Securities” and then on “Learn more” takes you to a webpage,
www.tdsecurities.com/tds/content/AU_AboutUs1?language=en_CA that says:
With more than 2,700 people in 15 14 offices around the world, TD Securities
provides a wide range of capital market products and services to corporate,
government and institutional clients who choose us for our knowledge, innovation
and experience in the following key areas of finance:
Investment and Corporate Banking
Capital Markets
Interest Rate, Currency and Derivative Products
Commodities
Our services include the underwriting and distribution of new debt and equity issues,
providing advice on strategic acquisitions and divestitures, and executing daily
trading and investment needs.With our history of delivering results, we’ve developed
considerable strengths, including recognized trading expertise and street-level
market intelligence that we use to consistently create value for our clients.
To trade securities, join TD Asset Management,
http://www.tdassetmanagement.com/Content/Homepage/p_Homepage.asp, a highly
diversified North American investment management firm with leading market positions in
active, quantitative and passive portfolio management. The firm serves a large and
diversified client base including pension funds, corporations, institutions, endowments,
foundations and high net worth individuals. We also offer private money management
services and manage retail mutual funds.” To work as retail investment advisor, join TD
Waterhouse Private Client services, http://www.tdwaterhouse.ca/pcs/pia/index.jsp
8. a. A share of stock financial
b. A personal IOU financial
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