Business Finance, - (For Complete File Download link at the end of ...

Business Finance, 12e Graham Peirson, Robert Brown, Steve Easton, Peter Howard, Sean Pinder (Solutions Manual All Chapter)

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Solutions manual to accompany Business Finance 12e by Peirson, Brown, Easton, Howard and Pinder 1 of 4 © McGraw-Hill Education (Australia) 2015 Chapter 1

Introduction

Solutions to questions

• In investment decisions, managers consider the amount invested in the assets of the

business and the composition of that investment. Managers of the business are, therefore, involved in the task of choosing, usually from a long list of available projects, those that are to be undertaken. In addition to decisions about the amount and composition of investments, managers have to decide how to finance them. These are financing decisions. This will involve generating funds internally, or raising funds from sources external to the business. Financing decisions also involve dividend decisions, because payment of dividends reduces the internally-generated funds that are available.

• (a) A sole proprietorship is a business owned by one person. Many small service

businesses, retail stores and professional practices are operated as sole proprietorships. Although the owner of a sole proprietorship is legally liable for its debts, the business should be regarded by the proprietor as a separate entity.(b) A partnership is a business owned by two or more people acting as partners.Partnerships are not separate legal entities, and the partners are therefore personally liable for the debts of the partnership. From the viewpoint of managing the business, however, a partnership is treated as an entity separate from the partners. Many small service businesses, retail stores and professional practices are operated as partnerships.(c) A company is a separate legal entity formed under the Corporations Act 2001. The owners of a company are called shareholders, because their ownership interests are represented by shares in the company’s capital. Separate legal entity status enables a company to conduct its operations in its own name as a legal entity. Companies vary greatly in size and objectives—the Corporations Act distinguishes between public companies, which may invite members of the public to invest in them, and proprietary companies, which have no such intention. 2 / 4

Solutions manual to accompany Business Finance 12e by Peirson, Brown, Easton, Howard and Pinder 2 of 4 © McGraw-Hill Education (Australia) 2015

3. The advantages of a sole proprietorship structure include:

(a) Control of the business rests with the owner, so it is relatively easy to make decisions, and there is no scope for disagreements between owners.(b) A sole proprietorship is easy and inexpensive to both form and dissolve. Initially, the owner makes an investment in the business, and may borrow money to supplement this investment. If it is decided to dissolve the business, the owner can simply cease operations, sell the assets, pay any amounts owing and keep any proceeds that remain.(c) A sole proprietorship is not treated as a separate entity for tax purposes. Any business profits belong to the owner, and therefore are taxed only once as part of the owner’s assessable income for the year.

The disadvantages of a sole proprietorship include:

(a) A sole proprietorship is not a separate legal entity, and therefore the owner has unlimited liability for debts incurred as a result of the business’s operations. In other words, all obligations of the business are personal obligations of the owner, so if the business fails and some of its debts are unpaid, then those to whom money is owed may be able to lay claim to the owner’s personal assets.(b) The size of the business is limited by the wealth of the owner and by the amount that can be borrowed. It can, therefore, be difficult to raise funds for a sole proprietorship, because lenders are usually reluctant to lend large amounts to an individual.(c) Ownership of a sole proprietorship can be transferred only by selling the business to a new owner. If a sole proprietorship is not sold, then it will cease to exist when the owner retires or dies.

4. The advantages of a partnership structure include:

(a) A partnership is easy and inexpensive to form, because there are no legal requirements that need to be met. All that is necessary is an agreement, preferably in writing, to avoid future disagreements by those forming the partnership.(b) A partnership can combine the wealth and talents of several individuals, and employees can be offered the prospect of becoming owners in the future.There are also important disadvantages of a partnership structure, which include: (a) Partnerships are not separate legal entities, and the partners are therefore personally liable for the debts of the partnership.(b) It can be difficult for partners to withdraw their investment, because the partnership will terminate if a partner’s interest in the partnership is sold or a partner dies. In either case, a new partnership will have to be formed.(c) Disputes between partners or former partners can be very damaging.

• Compared with sole proprietorships and partnerships, companies have the advantages of:

(a) limited liability of shareholders for debts incurred by those companies.(b) relative ease of transferring shares from one owner to another.(c) unlimited life. 3 / 4

Solutions manual to accompany Business Finance 12e by Peirson, Brown, Easton, Howard and Pinder 3 of 4 © McGraw-Hill Education (Australia) 2015

• Investors (shareholders) in companies have limited liability. Companies are separate

legal entities. A company is, therefore, treated as a legal entity with all the rights, duties and responsibilities of a person. As a result, the shareholders of most companies have limited liability. This means that shareholders’ obligation to contribute to the assets of the company is limited to any amount unpaid on the shares held in it. If a company fails, and is unable to pay its debts, then the owners of fully-paid shares are not obliged to contribute further funds to meet the company’s obligations to creditors. However, if the shares are partly paid, then shareholders can be obliged to contribute the unpaid amount of the subscription price.

• The value of an investment made by a company depends on the amount and timing of the

cash flows generated by the investment. Similarly, the value of debt securities or shares depends on the amount and timing of the cash flows to debtholders or shareholders. This gives rise to a fundamental principle of finance—that individuals prefer to receive a dollar today rather than a dollar in the future. This is because the dollar received today can be invested to receive income. This concept is referred to as the time value of money.

• This statement relates to the distinction between nominal and real amounts. During a

period of inflation, there is an increase in the general level of prices, with a consequent decrease in the general purchasing power of money. It is necessary, therefore, to distinguish between the nominal, or face value, of money and the real or inflation- adjusted value of money. For example, if the annual rate of inflation is 15 per cent, the real value of a dollar is decreasing annually by 15 per cent. Borrowing during times of high inflation means that a company will be repaying the loan in real dollars that have a much lower value than the nominal dollars borrowed.

• A difficulty facing the financial manager is to measure the riskiness of an investment and

to establish the trade-off between risk and expected return. A model that has been developed to assist managers in this task is the capital asset pricing model (CAPM). Risk

can be attributed to two sources:

(a) market-wide factors, such as interest rates and foreign exchange rates—this is referred to as non-diversifiable risk (also referred to as systematic, or market risk); (b) factors that are specific to a particular company—this is referred to as diversifiable risk (also referred to as unsystematic, or unique risk).

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