Question

1. Green desires to form a new company to manufacture lawn mowers. Green is concerned about having his personal assets exposed to liability for the new company’s contracts and torts. Furthermore, he wants to retain control over the company’s operations and growth for the next few years. He will need an infusion of equity capital to begin operations. He hopes to take the company public in about five years if it is advantageous to do so at the time. Which of the following types of business associations would be best for Green’s new company? (A) Corporation (B) General partnership (C) Limited partnership (D) Member-managed limited-liability company

2. If a firm increases its regular quarterly dividend payment, the increase could indicate which of the following? I. Improved earnings prospects for the firm II. A reduction in agency problems of free cash flow III. A reduction in tax payments for shareholders (A) I only (B) II only (C) I and II only (D) II and III only

3. The term “net working capital” refers to (A) inventories, receivables, and current notes and investments (B) assets divided by liabilities (C) current assets less short-term liabilities (D) net assets left over after subtracting cost of goods sold

4. A firm that would like to know whether it has enough cash to meet its bills would be most likely to use which category of financial ratio? (A) Liquidity (B) Leverage (C) Efficiency (D) Profitability

Answer 1

1. A corporation is owned and controlled by its members. Corporation is a separate legal identity from its members. So, the members have limited liability , their personal assets are not liable in the case of business losses. A corporation can raise funds and members need not have to raise capital as in the case of a partnership or sole proprietorship.

In a general partnership, all the partners have unlimited liability, that is their personal assets are also used to pay for losses and expenses of the firm.

In a limited liability, the members have limited liability only till the extent of the capital contributed by them. In this case, the members do not have direct influence over the business operations.

But, since Green desires to have control over the operations then he must go for a member-managed limited partnership, but might not be able to raise funds through equity infusion, the members of the partnership fund has to arrange for funds.

So, the correct option is option A.

2.So, yes excess cash when distributed as dividends signifies better earnings prospects and also solves the agency problems between managers and shareholders.

So, the correct option is option C.

3. The net working capital : means the amount of funds to meet the current financial obligations.

So, current assets - short term liabilities.

4. When the company is assessing the liquidity position , that is if the company has sufficient cash to meet its bills. Then the company looks into the liquidity ratio.

So, the correct option is option A.

Leverage ratios looks at the amount of debt in the company.

Efficiency ratios : looks at how the company effiiciently manages its asses and liabilities

profitability ratios measures the net and gross profit.