TRUE/FALSE. Write 'T' if the statement is true and 'F' if the statement is false.

1)

The principal shortcoming of the sole proprietorship is the owner's legal liability for all obligations of the business.

1)

_______ 2)

A partnership is similar to a sole proprietorship except there is more than one owner.

2)

_______ 3)

In a sole proprietorship, the owner is personally responsible for only the first $335,000 of the company's debt.

3)

_______ 4)

There are no general partners in a limited partnership.

4)

_______ 5)

The ownership of a corporation can be transferred more easily than can the ownership of an individual proprietorship or partnership.

5)

_______ 6)

If a corporation goes bankrupt, the shareholders are responsible for the debts the corporation had incurred above and beyond their initial investment.

6)

_______ 7)

At present, corporations with taxable income between $335,000 and $10,000,000 pay an effective (or average) 34 percent rate on all their taxable income.

7)

_______ 8)

Corporations with taxable incomes less than $75,000 face an effective (or average) tax rate of 15 percent.

8)

_______ 9)

If a company must pay the alternative minimum tax (AMT), the tax rate will be 40 percent of minimum taxable income.

9)

_______

10)

For the corporation, depreciation charges are deductible for tax purposes.

10)

______

11)

A depreciable capital asset in a three-year property class (as published by the U.S. Treasury) is generally depreciated over four years.

11)

______

12)

Equity financing has a tax advantage since dividends paid out to shareholders reduce a firm's taxable income.

12)

______

13)

A corporation with $1,000,000 in taxable income, $10,000 of which is in the form of dividend income, normally owes federal taxes of $1,020 on the dividend income.

13)

______

14)

A capital gain is the amount by which the proceeds from the sale of a capital asset exceeds its depreciated (tax) book value.

14)

______

15)

For the corporation, interest received on corporate and Treasury securities is fully taxable at the federal level.

15)

______

16)

A Subchapter S corporation allows its owners to be taxed as though it were a partnership, while still allowing them to keep the corporate form of organization.

16)

______

17)

Financial markets exist because all economic units do not invest all their savings in real assets.

17)

______

18)

In a market economy, funds are allocated based on the size of the economic unit in need of funds and the industry in which it operates.

18)

______

19)

A new common stock issue would be sold in the primary capital market.

19)

______

20)

Financial intermediaries make the financial markets more convenient but less efficient.

20)

______

21)

Life insurance companies invest heavily in corporate bonds.

21)

______

22)

All common stocks listed on an organized exchange are also traded in the OTC market.

22)

______

23)

The greater the default risk of a security issuer, the greater the expected return of the security.

23)

______

24)

A security rated B by Moody's or S&P has very little default risk.

24)

______

25)

The more marketable a security, the faster it can be sold without reducing its price.

25)

______

26)

A yield curve shows the relationship between risk and yield on a graph.

26)

______

27)

The higher the expected rate of inflation, the higher the nominal yield on securities.

27)

______

28)

A limited liability company (LLC) generally must possess three or more corporate characteristics from 1) limited liability, 2) centralized management, 3) unlimited life, or 4) the ability to transfer ownership without the prior consent of the other owners.

28)

______

29)

Short-term interest rates fluctuate more than long-term interest rates.

29)

______

30)

A parallel limited liability company structure for service professionals is called the professional limited liability company (PLLC).

30)

______

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

31)

Which of the following is correct with regard to a sole proprietorship?

31)

______ A)

The owner is personally liable for all business obligations, including any lawsuits brought against the business.

B)

Transfer of ownership is considerably easier than with any other form of business organization. C)

Fringe benefits are legitimate business expenses and therefore deductible for tax purposes. D)

Double taxation is imposed, meaning that the owner pays income taxes first on the income of the business, then again as personal income.

32)

Which of the following statements is not correct with respect to the partnership as a form of business organization?

32)

______ A)

Limited partners do not participate in the day-to-day operation of the business. B)

It is similar to a sole proprietorship in all aspects except that there is more than one owner. C)

Decision-making in a partnership is streamlined and generally efficient. D)

A limited partnership must have at least one general partner.

33)

A limited partnership gets its name from the fact that the ________.

33)

______ A)

limited partner participates in the daily management of the business, even though the partner's liability for the debts and obligations of the business is limited

B)

distribution of profits to the limited partner is capped by the amount of capital contributed to the business

C)

limited partner does not participate in the daily operation of the business and his or her liability is limited to the amount of capital contributed to the business

D)

limited partner does not participate in the day-to-day management of the business, even though the partner's liability for the obligations of the firm is unlimited

34)

Which of the following is not correct with respect to the corporate form of business organization?

34)

______ A)

Corporations tend to be relatively larger (based on assets) than either partnerships or proprietorships. B)

Limited liability is a feature of corporate ownership. C)

The corporation is the easiest form of business to organize. D)

The corporation is the most important form of business organization today.

35)

A major advantage of the corporation relative to other forms of business organization is ________.

35)

______ A)

lower cost to organize

B)

limited owner liability C)

reduction of double taxation

D)

higher credit ratings

Corporate Taxable IncomeAt Least But Less than Tax Rate$ 0 $ 50,000 15% 50,000 75,000 25% 75,000 100,000 34% 100,000 335,000 39% 335,000 10,000,000 34%10,000,000 15,000,000 35%15,000,000 18,333,333 38%18,333,333 ---------- 35%

36)

Corporation XYZ has taxable income of $70,000 for the current year. It will owe taxes of ________.

36)

______ A)

$11,250.

B)

$25,500.

C)

$12,500.

D)

$18,750.

37)

Corporation XYZ has taxable income of $70,000 for the current year. The effective (or average) tax rate is closest to ________.

37)

______ A)

40.0%

B)

25.0%

C)

15.0%

D)

17.9%

38)

A corporation with taxable income of $20,000,000 finds itself in which marginal tax bracket?

38)

______ A)

15 percent

B)

25 percent C)

40 percent

D)

35 percent

39)

A corporation has taxable income of $12,000,000 for the current year. The effective (or average) tax rate is closest to ________.

39)

______ A)

34.6%

B)

34.0%

C)

34.2%

D)

35.0%

Corporate Taxable IncomeAt Least But Less than Tax Rate$ 0 $ 50,000 15% 50,000 75,000 25% 75,000 100,000 34% 100,000 335,000 39% 335,000 10,000,000 34%10,000,000 15,000,000 35%15,000,000 18,333,333 38%18,333,333 ---------- 35%

40)

Refer to the table above. ABC Inc., has taxable income of $1.4 million in the current year. It will owe taxes of ________.

40)

______ A)

$546,000

B)

$476,000

C)

$456,750

D)

$375,000

41)

U.S. corporations are required to pay ________.

41)

______ A)

estimated annual taxes paid quarterly B)

actual annual taxes by December 31 C)

estimated annual taxes by March 15 D)

25 percent of their taxes in a given year and 75 percent by the subsequent March 15

42)

Under the Revenue Reconciliation Act of 1993, ________.

42)

______ A)

corporate income is taxed at the personal income rate B)

the marginal tax rate becomes less with each increase in income bracket C)

capital gains are taxed at the ordinary corporate tax rate, or a maximum of 35 percent D)

the highest marginal tax rate for corporations is 50 percent

43)

Suppose an asset costs $20,000 and has a depreciable life of five years. If the firm used the straight-line method of depreciation, depreciation charges during the second year would be ________.

43)

______ A)

$6,400

B)

$4,000

C)

$4,800

D)

$8,000

44)

A corporation receives $35,000 in dividend income. If it is in the 34 percent marginal tax bracket, the tax on the dividend income alone generally amounts to ________.

44)

______ A)

$6,800

B)

$3,570

C)

$9,520

D)

$11,900

45)

MNM Corporation owns 22 percent of the stock of WMW Company and receives dividends on that stock. If it does not file a consolidated tax return, MNM must pay taxes on ________ percent of the dividend received.

45)

______ A)

20

B)

80

C)

30

D)

70

46)

If a corporation has an operating loss, it can be ________.

46)

______ A)

carried back 2 years and then forward 2 years B)

carried back 2 years and then forward 20 years C)

carried back 20 years and the forward 2 years D)

used to offset long-term capital gains

47)

The "carryback and carryforward" provision of the tax law applies to ________.

47)

______ A)

corporations only B)

corporations, partnerships, and proprietorships C)

proprietorships only D)

corporations and partnerships only

48)

A corporation purchases a depreciable asset for $100,000. The asset has a five-year class life and is depreciated using the MACRS method. If it is sold for $120,000 after two years, the capital gain on the sale is ________.

48)

______ A)

$20,000

B)

$56,400

C)

$84,000

D)

zero

49)

Which of the following statements does not apply to the personal income tax structure?

49)

______ A)

Interest received on municipal securities is fully taxable at the Federal level. B)

Interest received on Treasury securities is fully taxable at the Federal level. C)

Realized capital gains are taxed at a variety of rates depending on the holding period length. D)

Interest received on corporate securities is fully taxable at the Federal level.

50)

The owner of a Subchapter S corporation ________.

50)

______ A)

has unlimited liability for the debts of the organization B)

is taxed as if the corporation is a partnership C)

does not avoid the double taxation normally associated with dividend income D)

may not deduct any corporate operating losses against personal income on a pro rata basis

51)

Which of the following is a financial asset?

51)

______ A)

a building

B)

equipment C)

inventories

D)

bonds

52)

The purpose of financial markets is to ________.

52)

______ A)

control inflation B)

lower the yield on bonds C)

allocate savings efficiently D)

increase the price of common stocks

53)

A 30-year corporate bond issued in 1985 would now trade in the ________.

53)

______ A)

primary money market

B)

secondary capital market C)

primary capital market

D)

secondary money market

54)

Which of the following is not a financial intermediary?

54)

______ A)

Apple Computer Corporation B)

Chase Manhattan Bank C)

Prudential Insurance Company D)

Home Federal Savings & Loan

55)

Which of the following financial intermediaries invests heavily in corporate bonds?

55)

______ A)

property and casualty insurance companies B)

finance companies C)

savings and loan associations D)

life insurance companies

56)

When a company decides to raise funds by issuing new stocks or bonds, it usually uses the services of ________.

56)

______ A)

an investment banker

B)

a mortgage banker C)

a commercial banker

D)

an organized exchange

57)

The expected return on a security typically increases as ________.

57)

______ A)

taxability decreases

B)

maturity increases C)

default risk decreases

D)

marketability increases

58)

A security with which of the following Moody's ratings would have the lowest yield, other things equal?

58)

______ A)

Ca

B)

B

C)

Aaa

D)

Baa

59)

The term structure of interest rates refers to the relationship between yield and ________.

59)

______ A)

risk, for securities with the same maturity B)

rating, for securities with the same maturity C)

maturity, for the same security class D)

marketability, for securities with the same tax status

60)

When inflation is expected to occur over the foreseeable future, the nominal rate of interest on a security will be ________ the real rate of interest.

60)

______ A)

equal to

B)

half C)

more than

D)

less than

61)

An investor is concerned about the ability to resell a security after holding it for a short period of time without a major price concession. The investor is concerned about ________.

61)

______ A)

marketability

B)

maturity C)

default risk

D)

taxability

62)

Which of the following characteristics is most likely to be found in a limited liability company (LLC)?

62)

______ A)

unlimited liability

B)

ease of ownership transfer C)

centralized management

D)

unlimited life

63)

Which of the following pairs of characteristics is least likely to be found with a limited liability company (LLC)?

63)

______ A)

centralized management and unlimited life B)

ease of ownership transfer and unlimited life C)

limited liability and unlimited life D)

centralized management and limited liability

64)

Money market mutual funds ________.

64)

______ A)

are available only to wealthy individuals B)

are involved in acquiring and placing mortgages C)

are also known as finance companies D)

enable individuals and small businesses to invest indirectly in money-market instruments

65)

Assume that a recent temporary (U.S. federal tax related) first-year bonus depreciation of 50 percent applies to a new, $150,000 piece of equipment purchased by Rattatier Clothier, Inc. The asset has a $15,000 estimated final salvage value. If this asset is fully depreciated for tax purposes over its useful life, the overall amount that Rattatier will have depreciated for tax purposes is closest to ________.

65)

______ A)

$54,000

B)

$150,000

C)

$135,000

D)

$60,000

66)

A ________ generally possesses no more than two of the following characteristics 1) limited liability, 2) centralized management, 3) unlimited life, or 4) the ability to transfer ownership without the prior consent of the other owners.

66)

______ A)

limited liability company (LLC) B)

sole proprietorship C)

corporation D)

All of the above generally possess two or fewer of the above business characteristics

SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question.

67)

Dolly Dayton holds 1000 shares of Richfield Mining stock. Her dividend received for the current tax year is $5,000. If Dolly has a 15 percent marginal tax rate, what would her federal taxes be on this dividend?

67)

_____________

68)

Ken Vicars maintains a portfolio of stocks and bonds in order to supplement his income as a salesman. Last year, he received $1,500 in interest on his City of Dallas municipal bonds, $1,000 in interest on Treasury bonds, and $3,100 in dividends on common stock. In addition, he sold stock and realized a long-term gain of $5,000. If Ken is single, and in the 28 percent marginal tax bracket, what taxes will he pay on his investment income and gains?

68)

_____________

69)

This year, Kelso Construction, Inc. had taxable income of $1,000,000. Calculate its federal income tax.

69)

_____________

70)

Harris Industries, Inc. owns $1 million in 10 percent Tripoli Products bonds and 20,000 shares of Tripoli common stock. There are 5 million shares of Tripoli common stock outstanding. During the past year, Tripoli paid the interest on its bonds, as well as a $5 per share dividend on its common stock. If Harris has a marginal tax rate of 34 percent, what taxes must it pay on the dividend and interest income?

70)

_____________

71)

A restaurant buys new kitchen equipment that falls in the 3-year property class. If the equipment costs $30,000, what are the MACRS depreciation charges?

71)

_____________

72)

A company buys a $10,000 piece of equipment that falls in the 5-year property class. What are the MACRS depreciation charges?

72)

_____________

73)

Calculate the taxes paid and/or refunds received for a corporation with the following taxable income:Year 1: $75,000Year 2: $380,000Year 3: 0Year 4: $45,000Year 5: -$40,000

73)

_____________

74)

Parks Promotions, Inc. is able to borrow at an interest rate of 11 percent for one year. During that year, market participants expect 6 percent inflation.

a. What approximate real rate of return does the lender expect?b. If inflation proves to be 4 percent for the year, does the lender suffer? Does the borrower suffer?c. If inflation proves to be 8 percent, who gains and who loses?

74)

_____________

75)

A $10,000 asset in the five-year property class is depreciated using the MACRS method. The half-year convention is employed in the first year. What are the depreciation charges in each of the years?

75)

_____________

1)

TRUE 2)

TRUE 3)

FALSE 4)

FALSE 5)

TRUE 6)

FALSE 7)

TRUE 8)

FALSE 9)

FALSE 10)

TRUE 11)

TRUE 12)

FALSE 13)

TRUE 14)

FALSE 15)

TRUE 16)

TRUE 17)

TRUE 18)

FALSE 19)

TRUE 20)

FALSE 21)

TRUE 22)

FALSE 23)

TRUE 24)

FALSE 25)

TRUE 26)

FALSE 27)

TRUE 28)

FALSE 29)

TRUE 30)

TRUE 31)

A 32)

C 33)

C 34)

C 35)

B 36)

C 37)

D 38)

D 39)

C 40)

B 41)

A 42)

C 43)

B 44)

B 45)

A 46)

B 47)

A 48)

A 49)

A 50)

B 51)

D 52)

C 53)

B 54)

A 55)

D 56)

A 57)

B 58)

C 59)

C 60)

C 61)

A 62)

C 63)

B 64)

D 65)

B 66)

A 67)

Dividends are taxed at the ordinary income tax rate: ($5,000)(0.15) = $750. 68)

The municipal bond income is not taxable and the Tax Reform Act of 1986 made long-term capital gains subject to ordinary income tax rates. This is still the case under the Revenue Reconciliation Act of 1993.Total taxes: (0.28)($1,000 + $3,100 + $5,000) = $2,548

69)

Corporations with income between $335,000 and $10,000,000 are subject to a flat 34 percent tax rate: (0.34)($1,000,000) = $340,000

70)

All of the bond interest is taxable but only 30 percent of the stock dividends are taxable.Total taxes: ($100,000)(0.34) + ($100,000)(0.30)(0.34) = $44,200

71)

Year 1: ($30,000)(0.3333) = $ 9,999Year 2: ($30,000)(0.4445) = $13,335Year 3: ($30,000)(0.1481) = $ 4,443Year 4: ($30,000)(0.0741) = $ 2,223

72)

Year 1: ($10,000)(0.2000) = $2,000Year 2: ($10,000)(0.3200) = $3,200Year 3: ($10,000)(0.1920) = $1,920Year 4: ($10,000)(0.1152) = $1,152Year 5: ($10,000)(0.1152) = $1,152Year 6: ($10,000)(0.0576) = $ 576

73)

Year 1: $13,750Year 2: ($380,000)(0.34) = $129,200Year 3: 0Year 4: ($45,000)(0.15) = $6,750Year 5: The $40,000 loss is carried back 1 year to Year 4. Note that we could go back up to 2 years, but the firm did not have taxable income in Year 3.

Tax recomputed: ($45,000 - 40,000)(0.15) = $750Refund received in Year 5: $6,750 - $750 = $6,000

74)

a. Nominal Rate - Inflation Rate = Real Rate11 percent - 6 percent = 5 percentb. The lender benefits because the real return was actually 7% (11% - 4%) when the risk and maturity characteristics of the loan only warranted a 5% real return. Parks Promotions suffers, because if inflation had been anticipated accurately, the loan would only have cost 5% real rate plus 4% inflation = 9%.c. Parks Promotions gains, because if inflation had been anticipated accurately, the loan would have cost 5% real rate + 8% inflation = 13%. The lender has to absorb the loss in purchasing power.

75)

Year 1: ($10,000)(0.2000) = $2,000Year 2: ($10,000)(0.3200) = $3,200Year 3: ($10,000)(0.1920) = $1,920Year 4: ($10,000)(0.1152) = $1,152Year 5: ($10,000)(0.1152) = $1,152Year 6: ($10,000)(0.0576) = $ 576