Answer // a. Potential conflicts between stockholders and bondholders are increa
ID: 2665313 • Letter: A
Question
Answer
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a. Potential conflicts between stockholders and bondholders are increased if a firm's bonds are convertible into its common stock. b. Since in bankruptcy they must be paid in full before stockholders receive anything, corporate bondholders generally prefer to see corporate managers invest in high risk/high return projects rather than low risk/low return projects. c. One drawback of forming a corporation is that you lose the limited liability that you would otherwise receive as a sole proprietor. d. One advantage of operating a business as a corporation is that stockholders can deduct their pro rata share of the taxes the firm pays, thereby eliminating the double taxation investors would face in a partnership. e. Since bondholders receive fixed payments, they do not share in the gains if risky projects turn out to be highly successful. However, they do share in the losses if risky projects fail and drive the firm into bankruptcy. Therefore, bondholders generally prefer to see corporate managers invest in low risk/low return projects rather than high risk/high return projects.Explanation / Answer
a.Potential conflicts between stockholders and bondholders are increased if a firm's bonds are convertible into its common stock.