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Test Bank for Corporate Finance, 5th Edition by Jonathan Berk, DeMarzo Chapter 1-31 A++
UPDATED Finance 1 for Business Summary
Test Bank For Corporate Finance The Core, 5th Edition by Jonathan Berk, Peter DeMarzo Chapter 1-19
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Tilburg University (UVT)
International Business Administration
Finance 1 (30J107B6)
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Finance 1 - Summary
Chapter 1 - The corporation
1.1 - The four types of firms
Four major types of firms exist with corporate finance:
1. Sole proprietorships
2. Partnerships
3. Limited liability companies
4. Corporations
1. Sole proprietorships
• Business owned, run by one person, small, few employees
• Straightforward to set up
>> many new businesses use this organizational form
• No separation between firm and owner (firm has only one owner)
• Owner has unlimited personal liability for any of the firm’s debts
>> lender can require the owner to repay the loan from personal
assets
>> owner unable to repay loan => declare personal bankruptcy
• Life of sole proprietorships is limited to the life of the owner
+ difficult to transfer ownership of life a sole proprietorship
• Taxes: one time tax (since business and owner are the same)
>> profit of business = income of individual
=> individual has to pay income tax (only this tax paid by
profit of business)
2. Partnership
• Identical to sole proprietorship except it has MORE than one owner
• All partners liable for firm’s debts
>> lender can require any partner to repay all the firm’s debts
• Partnership ends on death or withdrawal of any single partner
>> unless there is an agreement that provides alternatives (e.g.
buyout)
• Taxes: one time tax (since business and owner are the same)
>> profit of business = income of individual
=> individual has to pay income tax (only this tax paid by
profit of business)
Limited partnership
• Two kinds of owners
1) General partners: same rights and privileges as partners in
(general) partnerships
+ personally liable for the firm’s debts obligations
2) Limited partners: have limited liability = liability is limited to their
investment
=> private property can’t be seized to pay off the firm’s debts
=> death or withdrawal of a limited partner doesn’t dissolve
the partnership
, => ownership is transferable
3. Limited liability companies
• Limited partnership without a general partner
• All owners have limited liability >> CAN run the business
• Hybrid of partnership and corporation
• Business responsible for company’s debts
• Survives for limited time (determined when it is registered)
• Taxes: one time tax (since business and owner are the same) =>
income tax
4. Corporation
• Legal entity separate from its owners
>> has legal powers individuals have (buying assets, borrow money
etc.)
>> responsible for its own obligations (owners not liable)
• Ownership easily transferred => corporation doesn’t ‘die’
Corporation formation
• Must be legally formed => files a charter (license) with the state it
wishes to incorporate in >> the state “charters” the corporation
formally giving its consent
• Costly to start
• Have minimum capital in corporation (some cases)
Corporation ownership
• No limit on the number of owners
• Ownership is divided into shares = stock
>> equity: collection of all the outstanding shares of a corporation
>> shareholder/stakeholders/equity holder: owner of a stock
=> are entitled to dividend payments: distribution of the profit
(percentage decided by the shareholders)
Corporation tax implications
• Double taxation
>> on the profit (net income or earnings) - paid by corporation
>> on the dividend - paid by the individual owner
• S Corporations: corporations that elect subchapter S tax treatment
>> the firm’s profits (and losses) are not subject to corporate taxes,
but
instead are allocated directly to shareholders based on their
ownership share
• C Corporations: corporations subject to corporate taxes
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