The Law of Corporations and Other Business Organizations

Chapter Review Answers

1. The owners of A & S Marketing, Inc.
need financing to expand their business.
A & S has only three shareholders and
few assets. However, the company does
have a marketing plan for substantial,
sustained growth in revenue. What type
of financing may be most beneficial to
the owners of A & S Marketing, Inc.?
Debt financing may be best, but equity
financing could be acceptable if the
reasoning is sound.

Why?

The advantages to A & S Marketing,
Inc. for debt financing include a lower
cost of raising capital, tax deductibility
of interest, and no loss of control by
the shareholders. However, because
there are few assets, students may argue
that A & S may have trouble obtaining
debt financing.

2. Assume that G&A Corporation, an established
manufacturing business, is owned
by six shareholders who all actively participate
in the business. G&A Corporation
has an opportunity to enter into a
very lucrative new contract, but the corporation
needs $500,000 in capital to hire
extra personnel and design and build the
new equipment it will need to fulfill the
contract. Why might current shareholders
want to issue preferred stock to raise the
funds it will need?

If the six current shareholders all actively
participate in the business, they
may wish to issue preferred stock
without voting rights. In doing so, the
six current shareholders would not lose
any control over the corporation.

3. Assume the same circumstances as in
Question 2. Why might the current
shareholders want to use debt capital to
fund their expansion?

As with the issuance of preferred stock
with no voting rights, the six current
shareholders would not lose any control
over the corporation if they issued
debt capital. In addition, payments of
interest on the debt capital would be
an income tax deduction for the corporation.

4. The articles of incorporation of the Jerry
Corporation authorize “10,000 shares of
stock, no par value.” No further information
is given in the articles. Are these
shares of common stock or preferred
stock?

Common stock

5. What two widely accepted requirements
must be granted to shareholders under the
MBCA?
At least one class of shareholders must
have full voting rights, and at least one
class must have the right to receive the
net assets of the corporation upon its
dissolution.
6. Are all common stockholders always
granted voting rights?

No

7. What are redemption rights?

They are rights granted to the holders
of certain shares of stock, usually preferred
stock, to sell their shares of
stock back to the corporation upon
terms and conditions set forth on the
stock certificate or in an agreement between
the shareholder and the corporation.

8. What are conversion rights?

They are rights often granted to preferred
shareholders with the issuance
of preferred stock that allow the preferred
shareholders to convert their
shares of preferred stock into common
stock at some specific point in time,
usually at the shareholders’ option.

9. What are some possible drawbacks to issuing
stock with a par value?

• Par value stock may not be issued
for consideration less than the par
value of the stock.
• Shareholders receiving “watered
shares” may be liable to the corporation
for the difference between
the consideration paid and the par
value of the stock.
• All consideration received for par
value stock is considered to be stated
capital up to the par value of the
stock.
• State filing fees and taxes may be
based on the par value of the stock.

10. What information is typically required to
be included on stock certificates?

• The name of the issuing corporation
• The state of domicile
• The name of the person to whom
the stock is issued
• The number and class of shares
and designation of the series represented
by the certificate
• A summary of the designations,
relative rights, preferences, and
limitations applicable to the class of
shares represented by the certificate
(when more than one class is
authorized)

11. The authorized stock of Rob’s Boatworks,
Inc. is 10,000 shares of common
stock, $1.00 par value. If Rob’s Boatworks
issues 1,000 shares to Bud Peterson
for $800, what term is used to describe
Mr. Peterson’s shares?

Mr. Peterson’s shares are “watered
shares.”

What are the possible consequences to
Mr. Peterson?

Mr. Peterson may be liable for the difference
($200) between the par value of
the shares and the actual consideration
paid to the corporation.