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Understanding Risk and Return in Business Structures

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This article explores the fundamental concepts of risk and return in investment decisions. It discusses different business structures including sole proprietorships, partnerships, limited liability companies (LLCs), and corporations. The analysis is anchored in finance principles such as cash inflows, profits, and standard deviation, providing real-world examples comparing fixed and variable returns from investments. Readers will gain insights into maximizing shareholder wealth and navigating the complexities of investment risks and returns.

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Understanding Risk and Return in Business Structures

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  1. Risk and Return, Business Structures By R. S. Miolla

  2. Risk and Return • Return • Cash inflows • Profits (net income) • Satisfaction • Risk • How wide a range of outcomes • Standard deviation • Only relevant if good and bad outcomes

  3. Risk and Return - Example • A) $10,000 to invest • At the bank in a cd paying 5% • In the stock market: will pay between -50% and +50 %. Mean of all possibilities is +5%. Which investment would you choose? Why?

  4. Risk and Return - Example • Still $10,000 to invest. • Still a bank cd paying 5%. • Invest in the stock market: return will be between -50% and +75%. The mean of the outcomes (expected value) is +25%. • Which investment would you invest in? Why?

  5. Finance Terms • Financial Capital: Cash or “money” • Real Capital: Long term plant and equipment • Capital Structure: The mix (%) of debt and equity used to finance the business. What your sources of capital are. • Inflation: Increase of prices over time. • The goal of finance is to maximize shareholder wealth.

  6. The Flow of Business • 1) obtain financing • 2) receive cash • 3) buy real assets • 4) produce net income in the period • 5) collect cash flows • 6) reinvest (retained earnings) or pay dividends

  7. Forms of Ownership • 1) Sole Proprietorship: • Single owner • Unlimited liability • Taxed as owner’s income • 2) Partnership: • Two or more owners, Unlimited liability • Articles of partnership: profits, withdrawal terms, ownership % • Limited Liability Partnership (LLP): General partner and limited partners

  8. Forms of Ownership, con’t • 3) Limited Liability Company (LLC): • Low reporting costs, taxed as partnership or Corp., limits liability • 4) Corporation: • A legal entity, limited liability • Many owners (shareholders) • Board of Directors • Profits taxed twice: corporate and dividends • Subchapter S Corp. – Income taxed once to shareholders, maximum of 75 shareholders

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