Sample Chapter

INSTANT DOWNLOAD COMPLETE TEST BANK WITH ANSWERS

 

Test Bank Of Essentials Of Entrepreneurship And Small Business Management 6th Edition by Norman M. Scarborough

 

 

SAMPLE QUESTIONS

 

Essentials of Entrepreneurship & Small Business Management, 6e (Scarborough)

Chapter 3   Designing a Competitive Business Model and Building a Solid Strategic Plan

 

1) Which of the following is not one of the three components of intellectual capital?

  1. A) Human
  2. B) Structural
  3. C) Competitor
  4. D) Customer

Answer:  C

Diff: 2             Page Ref: 70

AACSB:  Analytic Skills

 

2) ________ involves developing a game plan to guide a company as it strives to accomplish its mission, goals, and objectives to keep it on its desired course.

  1. A) Competitive advantage
  2. B) Mission
  3. C) Strategic management
  4. D) Market segmentation

Answer:  C

Diff: 1             Page Ref: 71

AACSB:  Analytic Skills

 

3) The aggregation of factors that sets a company apart from its competitors and gives it a unique position in the market superior to its competition is its:

  1. A) mission statement.
  2. B) competitive advantage.
  3. C) competitive profile.
  4. D) strategic plan.

Answer:  B

Diff: 1             Page Ref: 71

AACSB:  Analytic Skills

 

4) A strategic plan serves as a blueprint to help a company to:

  1. A) match their company’s strengths and weaknesses to the environment’s opportunities and threats.
  2. B) accomplish its mission, goals, and objectives.
  3. C) identify a company’s competitive advantage and set it apart from its competition with a unique position in the market.
  4. D) All of the above

Answer:  D

Diff: 2             Page Ref: 71

AACSB:  Analytic Skills

 

5) Which of the following was not identified as a way for the typical small business to establish a competitive advantage?

  1. A) Lowering prices
  2. B) Providing higher quality goods or services
  3. C) Improving customer service
  4. D) Doing whatever the company does for its customers better than its competitors

Answer:  A

Diff: 2             Page Ref: 71

AACSB:  Reflective Thinking

 

6) ________ are a unique set of capabilities that a company develops in key operational areassuch as service, innovation, and othersthat allow it to potentially vault past its competitors.

  1. A) Core competencies
  2. B) Opportunities
  3. C) Key success factors
  4. D) Mission statements

Answer:  A

Diff: 2             Page Ref: 72

AACSB:  Reflective Thinking

 

7) The relationship between core competencies and competitive advantage is best described by which statement?

  1. A) Strengthening a company’s competitive advantage strengthens its core competencies.
  2. B) A company’s core competencies become the nucleus of its competitive advantage.
  3. C) As a company’s core competencies become stronger, its competitive advantage becomes weaker.
  4. D) There is no relationship between core competencies and competitive advantage.

Answer:  B

Diff: 3             Page Ref: 72

AACSB:  Analytic Skills

 

8) The key to entrepreneurial success over time is to build a ________ competitive advantage.

  1. A) defensible
  2. B) sustainable
  3. C) coherent
  4. D) random

Answer:  B

Diff: 3             Page Ref: 72

AACSB:  Analytic Skills

 

 

9) Which of the following is NOT a characteristic of the strategic management procedure for a small company?

  1. A) It should use a relatively short planning horizontwo years or less, typically.
  2. B) It should begin with an extensive objective-setting session.
  3. C) It should encourage the participation of employees and even outsiders to improve the reliability and creativity of the resulting plan.
  4. D) It should allow for flexibility and not be overly structured.

Answer:  B

Diff: 2             Page Ref: 74

AACSB:  Reflective Thinking

10) A clearly defined vision helps a company in which of the following ways?

  1. A) Provides direction
  2. B) Determines decisions
  3. C) Motivates people
  4. D) All of the above

Answer:  D

Diff: 1             Page Ref: 74-75

AACSB:  Reflective Thinking

 

11) A small company’s mission statement:

  1. A) establishes its purpose in writing.
  2. B) gives the business and everyone in it a sense of direction.
  3. C) defines what the company is, why it exists, and its reason for being.
  4. D) All of the above

Answer:  D

Diff: 1             Page Ref: 75

AACSB:  Reflective Thinking

 

12) When developing a company’s mission statement, an entrepreneur should remember to:

  1. A) write the statement alone without anyone else’s interference.
  2. B) omit statements about her values because they may turn some stakeholders off.
  3. C) keep it short and simple.
  4. D) All of the above

Answer:  C

Diff: 3             Page Ref: 75-76

AACSB:  Communication

 

13) Strengths and weaknesses are ________ to the organization.

  1. A) internal factors
  2. B) external factors
  3. C) internal and/or external factors
  4. D) factors not belonging

Answer:  A

Diff: 1             Page Ref: 77

AACSB:  Analytic Skills

 

14) ________ are positive internal factors that contribute toward accomplishing the company’s mission, goals, and objectives, while ________ are negative internal factors that inhibit the accomplishment of a firm’s mission, goals, and objectives.

  1. A) Strengths; weaknesses
  2. B) Weaknesses; strengths
  3. C) Opportunities; threats
  4. D) Threats; opportunities

Answer:  A

Diff: 1             Page Ref: 77

AACSB:  Analytic Skills

15) Kevin Abt noticed that people were cooking meals in their homes less often but wanted to avoid the hassle of going out to eat.  They wanted to “eat in” without cooking. Abt launched a company, Takeout Taxi, that delivers restaurant-prepared food to his customers’ homes and businesses.  Takeout Taxi is the result of a(n):

  1. A) strength.
  2. B) weakness.
  3. C) opportunity.
  4. D) threat.

Answer:  C

Diff: 2             Page Ref: 78

AACSB:  Analytic Skills

 

16) Maria Sanchez is the owner of the Main Street Café and a new restaurant opens a few blocks away.  From Maria’s perspective, this new restaurant constitutes a(n):

  1. A) strength.
  2. B) weakness.
  3. C) threat.
  4. D) opportunity.

Answer:  C

Diff: 2             Page Ref: 78

AACSB:  Reflective Thinking

 

17) Every business is characterized by a set of controllable variables that determines the relative success (or lack of it) of market participants called:

  1. A) distinctive competencies.
  2. B) key success factors.
  3. C) opportunities and threats.
  4. D) competitive edge.

Answer:  B

Diff: 1             Page Ref: 80-81

AACSB:  Analytic Skills

 

 

18) Gathering competitive intelligence, such as “dumpster diving” in a competitors trash, may raise questions regarding:

  1. A) the integrity of the data.
  2. B) the competitive profile matrix.
  3. C) a cost benefit analysis.
  4. D) ethical standards.

Answer:  D

Diff: 2             Page Ref: 83

AACSB:  Ethical Reasoning

 

19) Your ________ competitors offer the same products and services, and customers often compare prices, features, and deals from these competitors as they shop.

  1. A) significant
  2. B) direct
  3. C) indirect
  4. D) All of the above

Answer:  B

Diff: 1             Page Ref: 83

AACSB:  Analytic Skills

20) Which of the following is true about the information-gathering process in competitive analysis?

  1. A) It is an expensive process which only large companies can afford.
  2. B) It can be relatively inexpensive and easy for the small business owner to conduct.
  3. C) It is a process closely regulated by various federal laws which prohibit doing things like purchasing competitive products and analyzing them.
  4. D) It is a process that requires expert help and is relatively expensive.

Answer:  B

Diff: 3             Page Ref: 84

AACSB:  Analytic Skills

 

21) Which of the following is an effective method of collecting information about competitors?

  1. A) Ask customers and suppliers what competitors are doing.
  2. B) Talk to employees, especially sales representatives and purchasing agents, about competitors.
  3. C) Attend trade shows and collect competitors’ sales literature.
  4. D) All of the above

Answer:  D

Diff: 1             Page Ref: 84

AACSB:  Analytic Skills

 

 

22) Which of the following is not a recommended method of collecting competitive intelligence?

  1. A) Attend trade shows and collect competitors’ sales literature.
  2. B) Buy competitors’ products or services and assess their quality and features, benchmarking their products and services against yours.
  3. C) Pay competitors’ employees to become informants about their companies’ strategies, markets, and trade secrets.
  4. D) Watch for employment ads from competitors to determine the types of workers they are hiring.

Answer:  C

Diff: 2             Page Ref: 84

AACSB:  Ethical Reasoning

 

23) Purchasing rival companies’ products, taking them apart, and analyzing them is:

  1. A) called industrial espionage.
  2. B) considered illegal due to federal regulation.
  3. C) benchmarking.
  4. D) cataloging.

Answer:  C

Diff: 1             Page Ref: 84

AACSB:  Analytic Skills

For the questions below, consider the following competitive profile matrix:

 

Key Success                                                Your Business           Competitor 1                                                             Competitor 2

Factors                                                            Weighted                  Weighted

                                                                          Weighted

                        Weight  Rating     Score        Rating      Score       Rating          

                        Score

Quality           .35          4                  1.40          2                .70             1                .35

Service           .20          4                  .80             2               .40             2                .40

Convenience .15          2                  .30             4               .60             1                .15

On-Time

Delivery         .20          2                  .40             4               .80             2                .40

Location        .10          3                  .30             1               .10             2                .20

TOTAL            1.00   3.20                                2.60                             1.50

 

24) Which of the following statements is true?

  1. A) Overall, Competitor 2 is the strongest of these three companies.
  2. B) Your company’s most serious weakness is its poor quality.
  3. C) Your company’s most vulnerable point against these two competitors is in the area of on-time delivery.
  4. D) The most important of the key success factors is location.

Answer:  C

Diff: 2             Page Ref: 84-85, Table 3.2

AACSB:  Analytic Skills

 

 

25) Which company has the strongest competitive position?

  1. A) Your company
  2. B) Competitor 1
  3. C) Competitor 2
  4. D) Impossible to tell from the information given

Answer:  A

Diff: 2             Page Ref: 84-85

AACSB:  Analytic Skills

 

26) Which company has the worst location?

  1. A) Your company
  2. B) Competitor 1
  3. C) Competitor 2
  4. D) Impossible to tell from the information given

Answer:  B

Diff: 2             Page Ref: 84-85

AACSB:  Analytic Skills

 

27) In terms of quality, which company has the weakest competitive position?

  1. A) Your company
  2. B) Competitor 1
  3. C) Competitor 2
  4. D) Impossible to tell from the information given

Answer:  C

Diff: 2             Page Ref: 84-85

AACSB:  Analytic Skills

28) Which key success factor does the entrepreneur who built this table believe is most important?

  1. A) Quality
  2. B) Service and on-time delivery
  3. C) Convenience
  4. D) Location

Answer:  A

Diff: 2             Page Ref: 84-85

AACSB:  Reflective Thinking

 

29) A competitive profile matrix:

  1. A) identifies a firm’s core competencies.
  2. B) permits the small business owner to divide a mass market into smaller, more manageable segments.
  3. C) allows the small business owner to evaluate her firm against competitors on the key success factors for the industry.
  4. D) creates a road map of action for the entrepreneur in order to fulfill her company’s mission, goals, and objectives.

Answer:  C

Diff: 3             Page Ref: 84-85

AACSB:  Reflective Thinking

30) ________ are the broad, long-range attributes the small business seeks to accomplish; ________ are the more specific targets for performance.

  1. A) Goals; objectives
  2. B) Goals; strategies
  3. C) Objectives; goals
  4. D) Strategies; goals

Answer:  A

Diff: 1             Page Ref: 85

AACSB:  Reflective Thinking

 

31) Which of the following is not a characteristic of a well-written objective?

  1. A) Realistic, yet challenging
  2. B) Measurable
  3. C) General
  4. D) Timely

Answer:  C

Diff: 2             Page Ref: 85-86

AACSB:  Reflective Thinking

 

32) The focal point of any company’s strategy, whatever it may be, should be:

  1. A) its product or service.
  2. B) its competition.
  3. C) its customers.
  4. D) its strengths and weaknesses.

Answer:  C

Diff: 2             Page Ref: 87

AACSB:  Reflective Thinking

33) A ________ is a road map of the tactics and actions an entrepreneur draws up to fulfill the company’s mission, goals, and objectives.

  1. A) mission
  2. B) strategy
  3. C) competitive edge
  4. D) core competency

Answer:  B

Diff: 1             Page Ref: 87

AACSB:  Reflective Thinking

 

34)  ________ spell(s) out the “ends” an organization is to achieve; ________ define(s) the “means” for achieving the ends.

  1. A) Mission, goals, and objectives; strategy
  2. B) Key success factors; strategy
  3. C) Strategy; mission, goals, and objectives
  4. D) Strategy; vision

Answer:  A

Diff: 2             Page Ref: 85-87

AACSB:  Reflective Thinking

 

35) The relationship between a company’s mission, goals, and objectives and its strategy is best described by which of the following statements?

  1. A) Developing a company’s strategy lays the groundwork for creating its mission, goals, and objectives.
  2. B) The mission, goals, and objectives spell out the ends the company wants to achieve, and the strategy defines the means for reaching them.
  3. C) Although managers must change a company’s mission, goals, and objectives as competitive conditions change, they should avoid adjusting the company’s strategy to prevent the company from losing its focus and momentum.
  4. D) There is no real link between a company’s mission, goals, and objectives and its strategy.

Answer:  B

Diff: 3             Page Ref: 87

AACSB:  Reflective Thinking

 

36) A strategy should:

  1. A) be comprehensive and well integrated.
  2. B) focus on establishing for the firm the key success factors in the industry.
  3. C) identify how the firm will accomplish its mission, goals, and objectives.
  4. D) All of the above

Answer:  D

Diff: 2             Page Ref: 87

AACSB:  Reflective Thinking

 

37) A cost-leadership strategy:

  1. A) enables companies to concentrate on a niche within the overall market.
  2. B) is built on differences among market segments.
  3. C) works best when buyers’ primary purchase criterion is price.
  4. D) All of the above

Answer:  C

Diff: 2             Page Ref: 88

AACSB:  Reflective Thinking

38) A cost-leadership strategy works well when:

  1. A) buyers are sensitive to price changes.
  2. B) competing firms sell the same commodity products.
  3. C) a company can reap savings from economies of scale.
  4. D) All of the above

Answer:  D

Diff: 2             Page Ref: 88

AACSB:  Reflective Thinking

 

 

39) Small firms pursuing a cost-leadership strategy have an advantage in reaching customers whose primary purchase criterion is:

  1. A) quality.
  2. B) constant innovation.
  3. C) price.
  4. D) customer service.

Answer:  C

Diff: 1             Page Ref: 88

AACSB:  Reflective Thinking

 

40) Skatell’s, a small jewelry store with three locations, designs and manufactures much of its own jewelry while its competitors (many of them large department stores) sell standard, “off-the-shelf” jewelry.  As a result, Skatell’s has developed a loyal customer base of people who seek unique pieces of jewelry.  Skatell’s reputation for selling unique and custom-designed jewelry allows them to benefit from a:

  1. A) cost-leadership strategy.
  2. B) differentiation strategy.
  3. C) focus strategy.
  4. D) competitive strategy.

Answer:  A

Diff: 2             Page Ref: 88

AACSB:  Reflective Thinking

 

41) Cost-leadership may have which of the following inherent dangers?

  1. A) What is chosen to distinguish the product does not boost its performance.
  2. B) An overfocus on the physical characteristics of the product
  3. C) The identified niche is not large enough to be profitable.
  4. D) An overemphasis on costs to the elimination of other strategies

Answer:  D

Diff: 3             Page Ref: 88

AACSB:  Reflective Thinking

 

42) A differentiation strategy:

  1. A) seeks to build customer loyalty by positioning goods or services in a unique fashion.
  2. B) is built on a company’s core competence.
  3. C) must create the perception of value in the customer’s eyes.
  4. D) All of the above

Answer:  D

Diff: 2             Page Ref: 89

AACSB:  Analytic Skills

 

43) A small company following a ________ strategy seeks to build customer loyalty by positioning its goods and services in a unique fashion.

  1. A) differentiation
  2. B) cost-leadership
  3. C) focus
  4. D) niche

Answer:  A

Diff: 1             Page Ref: 89

AACSB:  Analytic Skills

 

44) A company that offers superior product quality, extra customer service, and fast delivery times is pursuing a:

  1. A) cost-leadership strategy.
  2. B) differentiation strategy.
  3. C) concentration strategy.
  4. D) strategic alliance.

Answer:  B

Diff: 2             Page Ref: 90

AACSB:  Analytic Skills

 

45) Which of the following is a danger in choosing a differentiation strategy?

  1. A) Focusing only on physical characteristics of a product or service and ignoring important psychological factors, such as status, prestige, image, and customer service
  2. B) Choosing a market that is not large enough to be profitable
  3. C) Misunderstanding the firm’s true cost drivers
  4. D) All of the above

Answer:  A

Diff: 3             Page Ref: 90

AACSB:  Reflective Thinking

 

46) The principle behind a ________ strategy is to select one or more market segments, identify customers’ special needs, and approach them with a good or service designed to excel in meeting these needs.

  1. A) cost-leadership
  2. B) differentiation
  3. C) focus
  4. D) concentration

Answer:  C

Diff: 1             Page Ref: 91

AACSB:  Reflective Thinking

 

 

47) Rather than attempting to serve the total market, the small firm pursuing a ________ strategy specializes in serving a specific target segment.

  1. A) cost-leadership
  2. B) differentiation
  3. C) focus
  4. D) head-to-head

Answer:  C

Diff: 2             Page Ref: 91

AACSB:  Reflective Thinking

48) Shere Vincente operates a travel service that specializes in arranging trips for women, giving special attention to their needs and preferences, from security and comfort to activities and events designed to appeal to her target customers.  Vincente is pursuing a ________ strategy.

  1. A) cost-leadership
  2. B) differentiation
  3. C) focus
  4. D) positioning

Answer:  C

Diff: 2             Page Ref: 91-92

AACSB:  Analytic Skills

 

49) Small companies must develop strategies that exploit all of the competitive advantages of their size by:

  1. A) responding quickly to customers’ needs.
  2. B) remaining flexible and willing to change.
  3. C) constantly innovating.
  4. D) All of the above

Answer:  D

Diff: 1             Page Ref: 11291

AACSB:  Analytic Skills

 

50) In order for the control process to work, the business owner must:

  1. A) make as few changes and modifications in the operational plans as possible.
  2. B) concentrate on competitive information.
  3. C) identify and track key performance indicators.
  4. D) maintain control and delegate as little authority and responsibility as possible.

Answer:  C

Diff: 2             Page Ref: 93

AACSB:  Analytic Skills

 

 

51) Which of the following is NOT one of the four important perspectives a balanced scorecard should look at a business from?

  1. A) Competitor perspective
  2. B) Internal business perspective
  3. C) Innovation and learning perspective
  4. D) Financial perspective

Answer:  A

Diff: 3             Page Ref: 94

AACSB:  Analytic Skills

 

52) The balanced scorecard ideally looks at a business from four important perspectives relating to:

  1. A) low-cost, differentiation, focus, and initiative.
  2. B) customers, buyers, suppliers, and substitute products.
  3. C) customers, internal factors, capital, and human resources.
  4. D) customers, internal factors, innovation, and finances.

Answer:  D

Diff: 3             Page Ref: 94

AACSB:  Reflective Thinking

53) With the growth of the Internet, globalization, and increased competition, the business environment has become more turbulent and challenging.

Answer:  TRUE

Diff: 1             Page Ref: 70

AACSB:  Use of IT

 

54) One of the biggest changes entrepreneurs face is the shift in the economy from a base of financial to intellectual capital.

Answer:  TRUE

Diff: 2             Page Ref: 70

AACSB:  Analytic Skills

 

55) The three components of intellectual capital are human, structural, and customer.

Answer:  TRUE

Diff: 2             Page Ref: 70

AACSB:  Analytic Skills

 

56) Narrower product lines, smaller customer bases, and more limited geographic areas give small companies a natural advantage over large businesses when preparing a strategic plan.

Answer:  TRUE

Diff: 2             Page Ref: 71

AACSB:  Analytic Skills

 

57) The most effective way for a small business to establish a competitive advantage is by offering lower prices.

Answer:  FALSE

Diff: 1             Page Ref: 71

AACSB:  Analytic Skills

58) Small companies’ core competencies are often the result of benefits such as agility, speed, closeness to customers, superior service, and innovative abilityall of which are size advantages that allow them to do things that their larger competitors cannot.

Answer:  TRUE

Diff: 2             Page Ref: 72

AACSB:  Analytic Skills

 

59) Large companies have a natural advantage over small firms when it comes to preparing a strategic plan.

Answer:  FALSE

Diff: 2             Page Ref: 72

AACSB:  Analytic Skills

 

60) Although developing a strategic plan is important for large companies, it is not essential to managing a small company successfully because of its limited resources.

Answer:  FALSE

Diff: 1             Page Ref: 74

AACSB:  Analytic Skills

 

61) The ideal strategic planning process for a small company should start with setting objectives.

Answer:  FALSE

Diff: 2             Page Ref: 74

AACSB:  Analytic Skills

62) The ideal strategic planning procedure for a small company should be formal and highly structured.

Answer:  FALSE

Diff: 2             Page Ref: 74

AACSB:  Analytic Skills

 

63) The most effective way to communicate the values of a company to everyone it touches is to formulate an effective mission statement.

Answer:  TRUE

Diff: 2             Page Ref: 74-75

AACSB:  Communication

 

64) The mission statement addresses the first question of any business venture: “What business am I in?”

Answer:  TRUE

Diff: 1             Page Ref: 75

AACSB:  Communication

 

65) A company’s mission statement defines what it stands for, why it exists, and its reason for being.

Answer:  TRUE

Diff: 1             Page Ref: 75

AACSB:  Communication

66) As business and competitive conditions change, so should a small company’s mission statement.

Answer:  TRUE

Diff: 2             Page Ref: 75

AACSB:  Analytic Skills

 

67) A company’s mission statement should be lengthy and use fancy jargon to impress outsiders.

Answer:  FALSE

Diff: 2             Page Ref: 76, Table 3.1

AACSB:  Communication

 

68) Conducting a SWOT analysis for her own business and for her key competitors allows an entrepreneur to gain a competitive edge by matching her company’s strengths against her competitors’ weaknesses.

Answer:  TRUE

Diff: 1             Page Ref: 77-78

AACSB:  Analytic Skills

 

69) Strengths are positive internal factors that contribute towards accomplishing the company’s mission, goals, and objectives.

Answer:  TRUE

Diff: 1             Page Ref: 77

AACSB:  Analytic Skills

70) Weaknesses are negative external forces that inhibit the firm’s ability to achieve its mission, goals, and objectives.

Answer:  FALSE

Diff: 1             Page Ref: 77

AACSB:  Analytic Skills

 

71) After a company’s strengths and weaknesses are assessed, the strategic planning process should identify opportunities and threats facing the company and should isolate the key factors for success in business.

Answer:  TRUE

Diff: 2             Page Ref: 78

AACSB:  Analytic Skills

 

72) Threats are negative external forces that inhibit a company’s ability to achieve its mission, goals, and objectives.

Answer:  TRUE

Diff: 1             Page Ref: 78

AACSB:  Analytic Skills

 

73) “Big box retailers” present an opportunity for many small business owners.

Answer:  FALSE

Diff: 2             Page Ref: 79, Hands On …

AACSB:  Analytic Skills

 

74) A firm’s strategy must focus on establishing for the firm the key success factors the entrepreneur has identified for the industry.

Answer:  TRUE

Diff: 2             Page Ref: 80-81

AACSB:  Analytic Skills

 

75) To be effective, the small business owner should limit strategic analysis to only the two or three most significant opportunities facing the firm.

Answer:  TRUE

Diff: 2             Page Ref: 80-81

AACSB:  Analytic Skills

 

76) A small business owner can collect a great deal of information about competitors through a number of low-cost competitive intelligence methods.

Answer:  TRUE

Diff: 1             Page Ref: 81-84

AACSB:  Analytic Skills

 

77) Experts estimate that 70 to 90 percent of the competitive information a company needs already resides with employees who collect it in their daily dealings with suppliers, customers, and other industry contacts.

Answer:  TRUE

Diff: 3             Page Ref: 81-82

AACSB:  Analytic Skills

78) A competitor analysis should include an analysis of direct competitors as well as significant and indirect competitors.

Answer:  TRUE

Diff: 2             Page Ref: 83

AACSB:  Analytic Skills

 

79) Significant competitors are those that offer the same products and services your company offers, and customers often compare prices, features, and deals from these competitors as they shop.

Answer:  FALSE

Diff: 2             Page Ref: 83-84

AACSB:  Analytic Skills

 

80) Conducting successful competitive intelligence on rivals’ strategies and actions may include researching their Web sites, buying their products to assess their quality, and watching for employment ads to determine the type of employees they are hiring.

Answer:  TRUE

Diff: 1             Page Ref: 84

AACSB:  Use of IT

 

 

81) Performing competitive intelligence on rivals’ strategies and actions does not mean that entrepreneurs must engage in unethical or illegal espionage activities.

Answer:  TRUE

Diff: 2             Page Ref: 84

AACSB:  Ethical Reasoning

 

82) It is unwise for entrepreneurs to monitor competitors’ strategies and actions because such activities require them to engage in illegal or unethical behavior.

Answer:  FALSE

Diff: 2             Page Ref: 84

AACSB:  Analytic Skills

 

83) One of the goals of competitive analysis is to improve a firm’s reaction time to competitor’s actions.

Answer:  TRUE

Diff: 2             Page Ref: 84-85

AACSB:  Analytic Skills

 

84) A competitive profile matrix analyzes how well a company and its rivals match the key success factors in the industry.

Answer:  TRUE

Diff: 2             Page Ref: 84-85, Table 3.2

AACSB:  Analytic Skills

 

85) Goals are the broad, long-range attributes that a business seeks to accomplish; objectives are more specific targets of performance.

Answer:  TRUE

Diff: 1             Page Ref: 85

AACSB:  Analytic Skills

86) Goals and objectives provide targets to aim for and a basis for evaluating a company’s performance.

Answer:  TRUE

Diff: 1             Page Ref: 85-86

 

87) A company’s strategy spells out the ends the business wants to achieve, and its mission, goals, and objectives define the means for reaching them.

Answer:  FALSE

Diff: 2             Page Ref: 85-86

AACSB:  Analytic Skills

 

88) “Improving the company’s cash flow” is a good example of an effective objective.

Answer:  FALSE

Diff: 3             Page Ref: 85-86

AACSB:  Analytic Skills

 

 

89) Setting seemingly impossible objectives, those outside of the likely reach of employees, helps managers to create and maintain a high motivation level.

Answer:  FALSE

Diff: 2             Page Ref: 85-86

AACSB:  Analytic Skills

 

90) “Increasing our market share from 8 percent to 10 percent by the end of the current fiscal year” is a good example of an effective objective.

Answer:  TRUE

Diff: 2             Page Ref: 85-86

AACSB:  Analytic Skills

 

91) Objectives should be as general as possible to permit flexibility in the business.

Answer:  FALSE

Diff: 2             Page Ref: 85-86

AACSB:  Analytic Skills

 

92) The strategic planning process works best when employees are actively involved with managers in setting company goals and objectives.

Answer:  TRUE

Diff: 1             Page Ref: 87

AACSB:  Analytic Skills

 

93) Before an entrepreneur can build a successful strategy, she must establish a clear mission, goals, and objectives in order to have appropriate targets at which to aim her strategy.

Answer:  TRUE

Diff: 2             Page Ref: 87

AACSB:  Analytic Skills

 

94) A strategy is a road map of action for fulfilling a firm’s mission, goals, and objectives.

Answer:  TRUE

Diff: 1             Page Ref: 87

AACSB:  Analytic Skills

95) A company pursuing a cost-leadership strategy strives to be the lowest-cost producer relative to its competitors in the industry.

Answer:  TRUE

Diff: 1             Page Ref: 88-89

AACSB:  Analytic Skills

 

96) A danger of cost-leadership is that a company may misunderstand what processes actually drive its true costs.

Answer:  TRUE

Diff: 2             Page Ref: 88

AACSB:  Analytic Skills

 

 

97) Small firms pursuing a cost-leadership strategy have an advantage in reaching customers whose primary purchase criterion is high quality.

Answer:  FALSE

Diff: 2             Page Ref: 89

 

98) The best way to build a cost-leadership competitive advantage is to focus entirely on manufacturing costs.

Answer:  FALSE

Diff: 1             Page Ref: 88-89

AACSB:  Analytic Skills

 

99) One key to building a successful differentiation strategy is to be better than competitors at some characteristic that customers value.

Answer:  TRUE

Diff: 1             Page Ref: 89

AACSB:  Analytic Skills

 

100) To be successful, a differentiation strategy must create the perception of value in the customer’s eyes.

Answer:  TRUE

Diff: 2             Page Ref: 89

AACSB:  Analytic Skills

 

101) The key to a successful differentiation strategy is to build it on a core competency, something the company is uniquely good at doing in comparison to its competitors.

Answer:  TRUE

Diff: 1             Page Ref: 89

AACSB:  Analytic Skills

 

102) A differentiation strategy frequently allows the company the opportunity to charge a higher price for its products or services.

Answer:  TRUE

Diff: 2             Page Ref: 89

AACSB:  Analytic Skills

 

103) One danger in choosing a differentiation strategy is trying to differentiate based on something that the customer does not perceive as valuable.

Answer:  TRUE

Diff: 2             Page Ref: 90

AACSB:  Analytic Skills

104) A small business following a focus strategy attempts to serve its narrow target markets more effectively and efficiently than competitors trying to appeal to the broad market.

Answer:  TRUE

Diff: 2             Page Ref: 91

AACSB:  Analytic Skills

 

 

105) A focus strategy recognizes that not all markets are homogeneous.

Answer:  TRUE

Diff: 2             Page Ref: 91

 

106) Focus strategies build on differences among market segments.

Answer:  TRUE

Diff: 2             Page Ref: 91

AACSB:  Analytic Skills

 

107) The secret to good control is identifying and tracking key performance indicators.

Answer:  TRUE

Diff: 2             Page Ref: 94

AACSB:  Analytic Skills

 

108) To evaluate the effectiveness of their strategies, some companies are developing balanced scorecards, a set of measurements unique to a company that includes both financial and operational measures and gives managers a quick, comprehensive picture of the company’s total performance.

Answer:  TRUE

Diff: 2             Page Ref: 94

AACSB:  Analytic Skills

 

109) When creating a balanced scorecard for his or her company, an entrepreneur should establish goals for each critical indicator of company performance and create meaningful measures for each one.

Answer:  TRUE

Diff: 2             Page Ref: 94

AACSB:  Analytic Skills

 

110) The focal point of the entire strategic plan and the competitive strategy chosen should be the customer.

Answer:  TRUE

Diff: 1             Page Ref: 95

AACSB:  Analytic Skills

 

111) A balanced scorecard looks at a business from four important perspectives: competitor, internal, innovation and learning, and financial.

Answer:  FALSE

Diff: 3             Page Ref: 95

AACSB:  Analytic Skills

 

112) Ideally, strategic planning is not an outcome but an ongoing process.

Answer:  TRUE

Diff: 1             Page Ref: 96

AACSB:  Reflective Thinking

 

113) What advice would you offer an entrepreneur on how to create a mission statement for his or her company?

Answer:  Tips for writing a powerful mission statement include:

  • Keep it short
  • Keep it simple
  • Get everyone in the company involved
  • Keep it current
  • Reflect your values and beliefs
  • Reflect concern for future
  • Keep tone positive and upbeat; use it to lay ethical foundation for company
  • Look at other companies’ mission statements; make sure it is appropriate for company culture
  • Use it

Diff: 2             Page Ref: 76

AACSB:  Communication

 

114) Assume that you are a consultant to a small independent hardware store in a town where a retail giant such as Wal-Mart, Kmart, or Target is about to open.  The large retailer sells many of the same items the small hardware store sells, but at lower prices.  What advice would you offer the owner concerning the hardware store’s strategy?  Explain.

Answer:  To compete successfully against a larger competitor, the small business owner must develop a true competitive advantage and utilize those core competencies that set the small business apart from the giant conglomerates like Wal-Mart.  Through the strategic management process, a concise plan could be developed.  The typical small business has fewer product lines, a better-defined customer base, and a specific geographical area.  Valuable information can be obtained through close customer contacts and a more flexible approach to meeting customer needs.

Diff: 3             Page Ref: 79-80

AACSB:  Reflective Thinking

 

115) What is strategic management?  What role does a strategic plan play in a small company?

Answer:  Strategic management involves developing a game plan to guide a company as it strives to accomplish its vision, mission, goals, and objectives and to keep it from straying off its desired course.  The strategic management process provides owners a blueprint for matching their companies’ strengths and weaknesses to the opportunities and threats in the environment.

Diff: 3             Page Ref: 87-92

AACSB:  Analytic Skills

 

116) Define each of the following terms and give an example of each:  strengths, weaknesses, opportunities, and threats.

Answer:  Strengths are positive internal factors that a company can use to accomplish its mission, goals, and objectives

Examples:

  • special skills or knowledge
  • positive public image
  • experienced sales force

Weaknesses are negative internal factors that inhibit the accomplishment of a company’s mission, goals, and objectives

Examples:

  • lack of capital
  • shortage of skilled labor
  • inferior location

Opportunities are positive external options that a firm can exploit to accomplish its mission, goals, and objectives

Examples:

  • proprietary technology
  • emergence of potentially new target market(s)
  • lower interest rates

Threats are negative external forces that inhibit a company’s ability to achieve its mission, goals, and objectives

Examples:

  • new competitors
  • adverse legislation
  • economic recession

Diff: 2             Page Ref: 77-80

AACSB:  Analytic Skills

 

 

117) Assume you own a small print shop.  Who are your competitors and why is it important for you to monitor your competitors’ activities?  Describe at least five techniques you might use to monitor competitors’ strategies and actions ethically and inexpensively.

Answer:  A recent survey identified the greatest small business challenge as competition.  Other studies suggest that monitoring rivals’ movements through competitive intelligence programs is vital to strategic activity and survival.

Specific techniques you might use include:

  • Reading industry trade publications
  • Asking customers and suppliers
  • Talking to employees
  • Attending trade shows
  • Monitor online activity
  • Buying competitors’ products (benchmarking)
  • Obtaining credit reports
  • Checking library resources
  • Using World Wide Web
  • Visiting competing businesses
  • Watching for employment ads from competitors
  • Conducting patent searches for patents filed by competitors

Diff: 3             Page Ref: 81-84

AACSB:  Analytic Skills

118) Assume you own a small shoe store.  Discuss the three different types of competition you might face and give examples of each.

Answer:  Direct competitors offer the same products and services, and customers often compare prices, features, and deals from these competitors as they shop.  Other shoe stores would be direct competitors.  Significant competitors offer some of the same products and services.  Although their product or service lines may be somewhat different, there is competition with them in several key areas.  Department stores and athletic stores would be examples of significant competitors.  Indirect competitors offer the same or similar products or services only in a small number of areas, but their target customers seldom overlap yours.  Discount stores and thrift stores may be examples of indirect competitors.

Diff: 2             Page Ref: 83-84

AACSB:  Reflective Thinking

 

 

119) What is strategy?  Describe the three basic strategies small companies can choose from: cost-leadership, differentiation, and focus.  Explain the conditions under which each works, its benefits, and its pitfalls.

Answer:  Strategy is a road map of the actions an entrepreneur draws up to a company’s mission, goals, and objectives.  This master plan covers all of the major organizational parts and ties them together.

 

Cost-leadership: Strives to be the lowest-cost producer.

Best When: Primary purchase criterion is price, and the power to set industry’s floor price and economies of scale are available.

Disadvantage: If cost drivers are unknown or other strategies are overlooked.

 

Differentiation: Seeks to build customer loyalty by positioning its product/service in a unique different fashion.

Best When: Differentiation is in the form of a “true benefit” to the customer.

Disadvantage: Trying to differentiate based on something that does not boost performance or lower cost.

 

Focus: Select one or more customer(s)/market(s) to create a niche.

Best When: Creating real value for customer by differentiation or low cost in a narrow target segment.

Disadvantages: Includes not being able to capture enough of a market share to be profitable.

Diff: 3             Page Ref: 87-92

AACSB:  Analytic Skills

120) Assume you own a small camera shop that sells and repairs cameras and equipment.  Discuss some of the methods you might select to allow you to successfully compete against the many large retailers that are nearby.

Answer:  In most cases, small business owners will not be able to select a cost-leadership strategy to meet the larger competitors who have a size advantage over them.  Therefore, this small business owner will probably have a greater chance of success utilizing a focus and/or differentiation strategy.  One option is to use a focus strategy by concentrating on a specific market segment, identifying those consumers’ special needs, wants, and interests, and approaching them with a mix of product offerings that excel in meeting those needs, wants, and interests.  Another choice may be to use a differentiation strategy that would seek to build customer loyalty by positioning his goods and services in a unique or different way than the competition.  For example, the camera shop may offer superior customer service, special product features, complete product lines, instantaneous parts availability, absolute product reliability, supreme product quality, and extensive product knowledge.  They might also offer on-site repair of camera equipment.

Diff: 3             Page Ref: 89-92

AACSB:  Reflective Thinking

 

 

Mini-Case 3-1: Finding a Competitive Advantage

 

Copreneurs Ed and Yolanda recently opened a vintage used car lot called Cherry Lane. They sell antique and collectible cars on consignment for the owners at a fee of 30 percent of the selling price. The price is further reduced by 10 percent if a particular car is not sold within the first 30 days. One of the first customers convinced Yolanda that this was the only fair thing to do, and in an effort to provide something for “the cost conscious buyer,” she provided what she thought was excellent customer service and implemented the idea.

 

Ed and Yolanda feel Cherry Lane has an ideal location. It is located adjacent to the city’s baseball stadium, alongside the freeway in the center of all the other car dealerships. Although Cherry Lane has significant foot traffic, most people never make offers to buy.

 

In an effort to increase sales, Ed and Yolanda are working on a new marketing strategy that they believe should be quite different from the “shotgun” approach they had been using over the last few months.

 

121) What is a competitive advantage?  Does Cherry Lane have one?  If so, what is it?

Answer:  A competitive advantage is an aggregation of factors that sets a company apart from its competitors and gives it a unique position in the market. No business can be everything to everyone. Developing a strategic plan allows the small business to differentiate itself from other companiesa common pitfall for many small firms. Cherry Lane has an advantage over regular car dealerships because they are well suited to concentrate on the collectible car enthusiast niche in their marketplace.

Diff: 2             Page Ref: 71-74

AACSB:  Reflective Thinking

122) As Ed and Yolanda begin the strategic planning process, what steps should they take?

Answer:  The entrepreneurs should follow these nine steps:

Step 1:   Develop a clear vision and translate it into a meaningful mission statement.

Step 2:   Assess the company’s strengths and weaknesses.

Step 3:   Scan the environment for significant opportunities and threats facing the business.

Step 4:   Identify the key factors for success in the business.

Step 5:   Analyze the competition.

Step 6:   Create company goals and objectives.

Step 7:   Formulate strategic options and select the appropriate strategies.

Step 8:   Translate strategic plans into action plans.

Step 9:   Establish accurate controls.

 

The strategic planning process does not end with these ten steps; rather, it is an ongoing process that an entrepreneur will repeat.

Diff: 2             Page Ref: 74-96

AACSB:  Reflective Thinking

 

 

123) Considering the three basic small business strategies identified in your textbook, which one would work best for Cherry Lane?  Why might that strategy be successful?

Answer:  A cost-leadership strategy would not complement the higher price image that these collectible cars usually have.

 

Some students may identify the appropriate strategy as differentiation; however, the other car dealerships are not direct competitors, nor is their market the same. The focus strategy could be used to successfully position Cherry Lane with its ability to meet the needs of a special customer basecollectible car buffs. Rather than attempting to serve the total market, the focusing firm specializes in serving a specific target segment or niche. Lowering prices with this special target market is not as important creating the perception of value in the customers’ eyes.

Diff: 3             Page Ref: 87-92

AACSB:  Reflective Thinking

Essentials of Entrepreneurship & Small Business Management, 6e (Scarborough)

Chapter 7   Buying an Existing Business

 

1) The due diligence process of analyzing and evaluating an existing business:

  1. A) may be just as time consuming as the development of a comprehensive business plan for a start-up.
  2. B) helps to determine if the company will generate sufficient cash to pay for itself and leave you with a suitable rate of return on your investment.
  3. C) helps to determine what the company’s potential for success is.
  4. D) All of the above

Answer:  D

Diff: 1             Page Ref: 190

AACSB:  Analytic Skills

 

2) When done correctly, the due diligence process will:

  1. A) reveal both the positive and negative aspects of an existing business.
  2. B) be time consuming and expensive.
  3. C) most often result in the purchase of the business.
  4. D) rarely prove to be beneficial.

Answer:  A

Diff: 1             Page Ref: 190

AACSB:  Analytic Skills

 

3) Advantages to buying an existing business that you do not have with a startup include:

  1. A) greater access to venture capital.
  2. B) the opportunity to participate in a national advertising campaign.
  3. C) inventory is in place and trade credit is established.
  4. D) easy implementation of innovations and changes from past policies.

Answer:  C

Diff: 2             Page Ref: 191-192

AACSB:  Reflective Thinking

 

4) Which of the following is a potential disadvantage of purchasing an existing business?

  1. A) The employees inherited with the business may not be suitable.
  2. B) The previous owner may have created ill will among the company’s customers.
  3. C) Equipment and facilities may be obsolete or inefficient.
  4. D) All of the above

Answer:  D

Diff: 1             Page Ref: 192-195

AACSB:  Reflective Thinking

 

 

5) When evaluating the assets of an existing business, the inventory:

  1. A) is always current and salable.
  2. B) usually appreciates over time, making the business a bargain.
  3. C) should be judged on the basis of its market value, not its book value.
  4. D) is usually stated honestly and does not need an independent audit.

Answer:  C

Diff: 2             Page Ref: 194

AACSB:  Analytic Skills

6) An entrepreneur who is considering purchasing a business is analyzing a company’s accounts receivable.  The following table summarizes her findings.

 

                        Age of Accounts   Amount      Probability of Collection

0 – 30 days                 $12,000                     .96

31 – 60 days              $  4,000                      .87

61 – 90 days              $  2,500                      .71

91 – 120 days            $  1,400                      .65

121 + days                 $     800                      .24

 

How much should this potential buyer be willing to pay for these accounts receivable?

  1. A) Nothing ; a buyer should never purchase existing accounts receivable.
  2. B) $20,700
  3. C) $17,877
  4. D) Not enough information given to determine

Answer:  C

Diff: 3             Page Ref: 194-195

AACSB:  Analytic Skills

 

7) The first step an entrepreneur should take when buying an existing business is to:

  1. A) explore financing options.
  2. B) prepare a list of potential candidates.
  3. C) analyze his or her skills, abilities, and interests in an honest self-audit.
  4. D) contact existing business owners in the area and ask if their companies are for sale.

Answer:  C

Diff: 2             Page Ref: 196

AACSB:  Reflective Thinking

 

8) When acquiring a business, the buyer should:

  1. A) conduct a self-analysis of skills, abilities, and interests.
  2. B) prepare a list of potential candidates.
  3. C) investigate potential candidates and carefully evaluate them.
  4. D) All of the above

Answer:  D

Diff: 1             Page Ref: 196-199

 

 

9) Which of the following statements concerning financing the purchase of an existing business is true?

  1. A) It is usually more difficult than securing financing for a start-up business.
  2. B) Usually, the business seller is not a good source of financing.
  3. C) The buyer should be able to make the payments on the loans out of the company’s cash flow.
  4. D) All of the above

Answer:  C

Diff: 2             Page Ref: 198

AACSB:  Analytic Skills

10) Which of the following statements concerning financing the purchase of an existing business is not true?

  1. A) The business seller usually is a good candidate for a source of financing.
  2. B) The deal should allow the buyer to make the loan payment out of the company’s cash flow.
  3. C) The buyer should wait until late in the purchase process to arrange financing to avoid processing fees in case the deal falls through.
  4. D) All of the above

Answer:  C

Diff: 2             Page Ref: 198

AACSB:  Reflective Thinking

 

11) Perhaps the ideal source of financing the purchase of an existing business is:

  1. A) a venture capitalist.
  2. B) the Small Business Administration.
  3. C) the seller of the business.
  4. D) an insurance company.

Answer:  C

Diff: 2             Page Ref: 198

 

12) To ensure a smooth transition when buying an existing business, a buyer should:

  1. A) communicate with employees to reduce their uncertainty and anxiety.
  2. B) be honest with existing employees about upcoming changes and plans for the company’s future.
  3. C) consider asking the seller to stay on and serve as a consultant until the transition is complete.
  4. D) All of the above

Answer:  D

Diff: 1             Page Ref: 199

AACSB:  Communication

 

13) The most common reasons owners of small- and medium-sized businesses give for selling their businesses are:

  1. A) need for money and low return on investment.
  2. B) boredom and burnout.
  3. C) low return on investment and burnout.
  4. D) greater opportunities working for someone else and low return on investment.

Answer:  B

Diff: 2             Page Ref: 200

AACSB:  Analytic Skills

14) Important factors to investigate regarding the business to be purchased include:

  1. A) assessing the physical assets of the business.
  2. B) reviewing accounts receivable and business records.
  3. C) reviewing contractual arrangements and assessing intangible assets.
  4. D) All of the above

Answer:  D

Diff: 1             Page Ref: 200-201

AACSB:  Analytic Skills

15) Which of the following is a criterion for a bulk transfer?

  1. A) The seller must give the buyer a signed, sworn list of existing creditors.
  2. B) The buyer and the seller must prepare a list of the property included in the sale.
  3. C) The buyer must give notice of the sale to each creditor at least ten days before he takes possession of the goods or pays for them.
  4. D) All of the above

Answer:  D

Diff: 2             Page Ref: 202

AACSB:  Analytic Skills

 

16) Laurette has entered into a contract with Jackson to purchase his retail music shop. Jackson’s lease on the existing building (which is in an excellent location) has five years remaining.  If Laurette wants the lease to be part of the business sale:

  1. A) she should include a clause in the sales contract in which Jackson agrees to assign to her his rights and obligations under that lease.
  2. B) she should notify the landlord of Jackson’s assignment of the lease agreement to her.
  3. C) A and B are correct.
  4. D) None of the above. Because Jackson does not actually own the building, he can transfer no rights to it to Laurette.

Answer:  C

Diff: 3             Page Ref: 202-203

AACSB:  Reflective Thinking

 

17) Generally, a seller of an existing business can assign any contractual right to the buyer unless:

  1. A) the contract specifically prohibits the assignment.
  2. B) the contract is personal in nature.
  3. C) A and B are correct.
  4. D) None of the above. Business sellers typically cannot assign any contractual rights to buyers.

Answer:  C

Diff: 2             Page Ref: 202-203

AACSB:  Analytic Skills

 

 

18) During the acquisition process, the potential buyer usually must sign a ________, which is an agreement to keep all conversations and information secret and legally binds the buyer from telling anyone any information the seller shares with her.

  1. A) covenant not to compete
  2. B) nondisclosure document
  3. C) letter of intent
  4. D) purchase agreement

Answer:  A

Diff: 2             Page Ref: 203

AACSB:  Analytic Skills

 

19) Which of the following is required for the covenant not to compete to be enforceable?

  1. A) Part of a business sale and reasonable in scope
  2. B) Approved by a court of law and reasonable in scope
  3. C) The assistance of an attorney and approved by a court of law
  4. D) The registration of the due-on-sale agreement

Answer:  A

Diff: 3             Page Ref: 203

AACSB:  Analytic Skills

20) The three main sources of potential legal liabilities for the buyer of an existing business include all but which of the following?

  1. A) Problems with the physical premises, such as hazardous materials
  2. B) Product liability claims
  3. C) Labor problems and disputes
  4. D) Errors and omissions

Answer:  D

Diff: 2             Page Ref: 203-204

AACSB:  Analytic Skills

 

21) A toy manufacturer is sued based on the claim of injuries caused by a product it makes.  This is an example of a:

  1. A) product liability lawsuit.
  2. B) promissory estoppel lawsuit.
  3. C) restrictive covenant lawsuit.
  4. D) contingent liability lawsuit.

Answer:  A

Diff: 1             Page Ref: 204

AACSB:  Reflective Thinking

 

 

22) When evaluating the financial position of a business he or she is considering buying, an entrepreneur should examine:

  1. A) its income statements and balance sheets from the past three to five years.
  2. B) its income tax returns for the past three to five years.
  3. C) the owner’s compensation and that of relatives.
  4. D) All of the above

Answer:  D

Diff: 2             Page Ref: 204-205

AACSB:  Analytic Skills

 

23) In a business sale, a letter of intent:

  1. A) states that the buyer and the seller have reached a sufficient meeting of the minds to justify the time and expense of negotiating a final agreement.
  2. B) should contain a clause calling for “good faith negotiations” between the parties.
  3. C) addresses such issues as price, payment terms, a deadline for closing the deal, and others.
  4. D) All of the above

Answer:  D

Diff: 1             Page Ref: 206, Figure 7.2

AACSB:  Analytic Skills

 

24) During the acquisition process, the buyer and the seller sign a ________, which spells out the parties’ final deal and represents the details of the agreement that are the result of the negotiation process.

  1. A) covenant not to compete
  2. B) nondisclosure document
  3. C) letter of intent
  4. D) purchase agreement

Answer:  D

Diff: 1             Page Ref: 206, Figure 7.2

AACSB:  Analytic Skills

25) Which of the following statements about valuing a business is true?

  1. A) The balance sheet technique is the best way to value a business.
  2. B) Business valuation is partly art and partly science.
  3. C) Buyers should rely on the seller’s industry expertise and years of experience to determine what his company is worth.
  4. D) Business valuation processes are consistently misleading regarding the future earning potential of a business.

Answer:  B

Diff: 2             Page Ref: 207

AACSB:  Reflective Thinking

 

 

26) The main reason a buyer purchases an existing business is for:

  1. A) its future income and profits for earning potential.
  2. B) its customer base and access to those customers.
  3. C) its tangible assets and the ability to liquidate those assets.
  4. D) its goodwill.

Answer:  A

Diff: 2             Page Ref: 208

AACSB:  Reflective Thinking

 

27) A method of valuing a business based on the value of the company’s net worth is the:

  1. A) balance sheet technique.
  2. B) adjusted balance sheet technique.
  3. C) earnings approach.
  4. D) opportunity cost technique.

Answer:  A

Diff: 2             Page Ref: 208

AACSB:  Analytic Skills

 

28) A valuation method that is more realistic than the balance sheet technique because it adjusts book value to reflect actual market value is the:

  1. A) excess earnings method.
  2. B) market approach.
  3. C) capitalization method.
  4. D) adjusted balance sheet method.

Answer:  D

Diff: 2             Page Ref: 208

AACSB:  Analytic Skills

 

29) Which of the following valuation methods does not consider the future income-earning potential of a business?

  1. A) Balance sheet technique
  2. B) Excess-earnings method
  3. C) Discounted future earnings approach
  4. D) Market approach

Answer:  A

Diff: 3             Page Ref: 208

AACSB:  Analytic Skills

30) When valuing inventory for a business sale, the most common methods used are:

  1. A) first-in-first-out (FIFO) and last-in-first-out (LIFO).
  2. B) first-in-first-out (FIFO) and average costing.
  3. C) cost of last purchase and replacement value of inventory.
  4. D) cost of last purchase and average costing.

Answer:  C

Diff: 2             Page Ref: 208-210

AACSB:  Analytic Skills

 

 

31) Business valuations based on balance sheet methods suffer certain disadvantages, including:

  1. A) they are extremely complex and are difficult to calculate.
  2. B) they do not consider the future earning potential of the business.
  3. C) they fail to take into account what is usually the largest asset a company owns: inventory.
  4. D) All of the above

Answer:  B

Diff: 3             Page Ref: 210

AACSB:  Analytic Skills

 

Use the following information to answer the questions below.

 

Baubles and Bells, a small business, is up for sale. The book value of its assets is $397,650, and its liabilities have a book value of $148,500. After adjusting for market value, total assets are worth $386,475, and total liabilities are $153,600. The business is considered to be a “normal risk” venture. The new owner (if he buys) plans to draw a salary of $28,000.  Estimated earnings for the upcoming year are $88,400. Complete net earnings estimates for the next five years are:

 

                        Pessimistic     Most Likely    Optimistic

      Year 1      $82,000                $88,400         $90,500

      Year 2      $85,000                $90,000         $93,000

      Year 3      $88,000                $92,500         $95,500

      Year 4      $91,000                $95,000         $97,000

      Year 5      $94,000                $97,000         $98,500

 

32) Using the adjusted balance sheet technique, what is the business worth?

  1. A) $397,650
  2. B) $386,475
  3. C) $249,150
  4. D) $232,875

Answer:  B

Diff: 3             Page Ref: 208-209

AACSB:  Analytic Skills

 

33) The valuation approach that considers the value of goodwill is the:

  1. A) balance sheet technique.
  2. B) excess earnings method.
  3. C) discounted future earnings approach.
  4. D) market approach.

Answer:  B

Diff: 1             Page Ref: 210

AACSB:  Analytic Skills

 

34) Under the excess earnings method, what is the “extra earning power” of the business?

  1. A) $86,219
  2. B) $2,181
  3. C) $11,175
  4. D) Cannot be determined from the information given

Answer:  B

Diff: 3             Page Ref: 210-211

AACSB:  Analytic Skills

 

35) Using the excess earnings method, what is the company’s “goodwill”?

  1. A) $6,543
  2. B) $33,525
  3. C) $15,267
  4. D) Cannot be determined from the information given

Answer:  A

Diff: 3             Page Ref: 210-211

AACSB:  Analytic Skills

 

36) Which of the following is considered an opportunity cost of buying an existing business?

  1. A) The salary that could be earned working for someone else and the owner’s investment in the business
  2. B) Dividends
  3. C) The market value of tangible assets
  4. D) The salary that the business has paid to previous owners

Answer:  A

Diff: 2             Page Ref: 210

AACSB:  Reflective Thinking

 

37) The amount the seller of a business receives for “goodwill” is taxed as:

  1. A) a long-term capital gain.
  2. B) regular income.
  3. C) superlative income.
  4. D) None of the above

Answer:  B

Diff: 2             Page Ref: 210-212

AACSB:  Analytic Skills

 

38) The capitalized earnings approach determines the value of a business by capitalizing its expected profits using:

  1. A) the interest rate that could be earned on a similar risk investment.
  2. B) the prime interest rate.
  3. C) the normal rate of return.
  4. D) the prevailing return of inflation.

Answer:  A

Diff: 2             Page Ref: 212-213

AACSB:  Analytic Skills

 

39) If a business buyer estimates that 20 percent is a reasonable rate of return for an existing business expected to produce a profit of $27,000, its capitalized value would be:

  1. A) $5,400.
  2. B) $32,400.
  3. C) $135,000.
  4. D) $540,000.

Answer:  C

Diff: 2             Page Ref: 213

AACSB:  Analytic Skills

 

40) In the earnings methods of business valuation, the rate of return associated with a “normal risk” business is:

  1. A) 15 percent.
  2. B) 25 percent.
  3. C) 35 percent.
  4. D) 50 percent.

Answer:  B

Diff: 2             Page Ref: 213

AACSB:  Analytic Skills

 

41) Which method of business valuation relies on three forecasts of future earnings: optimistic, pessimistic, and most likely?

  1. A) Balance sheet technique
  2. B) Excess-earnings method
  3. C) Discounted future earnings
  4. D) Market approach

Answer:  C

Diff: 2             Page Ref: 213-214

AACSB:  Analytic Skills

 

42) The ________ approach to valuing a business assumes that a dollar earned in the future is worth less than that same dollar is today.

  1. A) balance sheet
  2. B) capitalized earnings
  3. C) adjusted balance sheet
  4. D) discounted future earnings

Answer:  D

Diff: 2             Page Ref: 213-214

AACSB:  Analytic Skills

 

 

43) Which of the following valuation techniques is best suited for determining the value of service businesses?

  1. A) Discounted future earnings approach
  2. B) Balance sheet technique
  3. C) Adjusted balance sheet technique
  4. D) Excess earnings approach

Answer:  A

Diff: 2             Page Ref: 213-214

AACSB:  Analytic Skills

44) The ________ approach to valuing a business uses the price-earnings ratios of similar businesses to establish the value of a company.

  1. A) balance sheet
  2. B) capitalized earnings
  3. C) discounted future earnings
  4. D) market

Answer:  D

Diff: 2             Page Ref: 214-215

AACSB:  Analytic Skills

 

45) Which of the following is a disadvantage of the market approach to valuing a business?

  1. A) Necessary comparisons between publicly traded and privately owned companies
  2. B) Unrepresentative earnings estimates
  3. C) Difficulty in finding similar companies for comparison
  4. D) All of the above

Answer:  D

Diff: 2             Page Ref: 214-215

AACSB:  Analytic Skills

 

46) Which of the following is a drawback of the market approach of evaluation?

  1. A) It does not consider current earnings.
  2. B) It may underrepresent earnings.
  3. C) Its reliability depends on the forecasts of future earnings.
  4. D) It overemphasizes the value of goodwill.

Answer:  B

Diff: 2             Page Ref: 214-215

AACSB:  Analytic Skills

 

 

47) You are considering purchasing Babcock Office Supply.  You estimate that the company’s earnings next year will be $67,400.  You have found three similar companies whose stock is publicly traded.  Their P/E ratios are 6.8, 7.4, and 7.1. Using the market approach, you estimate Babcock Office Supply to be worth:

  1. A) $478,540.
  2. B) $9,493.
  3. C) $67,400.
  4. D) $498,760.

Answer:  A

Diff: 3             Page Ref: 214-215

AACSB:  Analytic Skills

 

48) A company’s P/E ratio is:

  1. A) the price of one share of its common stock divided by its earnings per share.
  2. B) its profits per share divided by its equity per share.
  3. C) its profits per share divided by its excess cash flow per share.
  4. D) None of the above

Answer:  A

Diff: 1             Page Ref: 215

AACSB:  Analytic Skills

49) Some business brokers differentiate between the types of buyers: ________ buyers see buying a business as a way to generate income and ________ buyers view the purchase as part of a larger picture to offer a long-term advantage.

  1. A) strategic; financial
  2. B) financial; strategic
  3. C) strategic; optimistic
  4. D) financial; passive

Answer:  B

Diff: 2             Page Ref: 215-216

AACSB:  Communication

 

50) Which of the following strategies would not be suitable for an entrepreneur who wants to surrender control of the company gradually?

  1. A) Forming a family limited partnership
  2. B) Restructuring the company
  3. C) Straight business sale
  4. D) Using a two-step sale

Answer:  C

Diff: 2             Page Ref: 216

AACSB:  Analytic Skills

 

 

51) Mitchell Schlimer, founder of the Let’s Talk Business Network, a support community for entrepreneurs, says that, initially, about ________ percent of small business owners who sell their companies to larger businesses remain with the acquiring company.

  1. A) 40
  2. B) 50
  3. C) 70
  4. D) 90

Answer:  D

Diff: 2             Page Ref: 217

AACSB:  Reflective Thinking

 

52) ________ gives owners the security of a sales contract but permits them to stay at the “helm” for several years.

  1. A) The two-step sale
  2. B) A controlled sale
  3. C) Company restructuring
  4. D) An ESOP

Answer:  A

Diff: 1             Page Ref: 219

AACSB:  Analytic Skills

 

53) A(n) ________ allows owners to “cash out” by selling their companies to their employees as gradually or as quickly as they choose.

  1. A) two-step sale
  2. B) controlled sale
  3. C) company restructuring
  4. D) ESOP

Answer:  D

Diff: 1             Page Ref: 219-220

AACSB:  Analytic Skills

54) An ESOP:

  1. A) allows an owner to transfer all or part of his company to the employees as gradually or as quickly as he chooses.
  2. B) works best in companies where pre-tax profits exceed $100,000.
  3. C) is not beneficial to companies with fewer than 15 to 20 employees.
  4. D) All of the above

Answer:  D

Diff: 2             Page Ref: 219-220

AACSB:  Analytic Skills

 

 

55) To avoid a stalled deal, a buyer should:

  1. A) take a hard line and never give an inch.
  2. B) understand that they may not be able to get what they really want.
  3. C) go into the negotiation with a list of objectives ranked in order or priority.
  4. D) be firm, focused, and unbending.

Answer:  C

Diff: 2             Page Ref: 222

AACSB:  Communication

 

56) The due diligence process in analyzing and evaluating an existing business can be just as time consuming as the development of a comprehensive business plan for a start-up.

Answer:  TRUE

Diff: 1             Page Ref: 190, 199

AACSB:  Reflective Thinking

 

57) With an existing business, the new owner can depend on employees to help him make money while he is learning the business.

Answer:  TRUE

Diff: 1             Page Ref: 191

AACSB:  Analytic Skills

 

58) For a new owner of an existing business, physical facilities and equipment costs are very similar to what would have been spent on a startup with all new facilities and equipment.

Answer:  FALSE

Diff: 2             Page Ref: 191

AACSB:  Analytic Skills

 

59) When buying a business, an entrepreneur can usually purchase equipment and fixtures at prices well below their book value.

Answer:  TRUE

Diff: 2             Page Ref: 191

AACSB:  Analytic Skills

 

60) A principal advantage of buying an existing business is the purchaser’s ability to rely on the previous owner’s experience.

Answer:  TRUE

Diff: 1             Page Ref: 192

AACSB:  Communication

61) An entrepreneur should never purchase a business that is losing money.

Answer:  FALSE

Diff: 1             Page Ref: 192-193

AACSB:  Reflective Thinking

 

 

62) A new owner of an existing business can generally introduce change and innovation almost as easily as if the company were a new business because employees and customers expect change in business practice when there is a change in ownership.

Answer:  FALSE

Diff: 2             Page Ref: 194

AACSB:  Multicultural & Diversity

 

63) Accounts receivable are rarely worth face value and should be “aged” when evaluating a company’s assets.

Answer:  TRUE

Diff: 1             Page Ref: 194

AACSB:  Analytic Skills

 

64) The reason an entrepreneur should conduct a self-audit of his or her skills, abilities, and interests is to help focus on those businesses that will best “fit.”

Answer:  TRUE

Diff: 1             Page Ref: 196

AACSB:  Reflective Thinking

 

65) The business acquisition process should begin with the search for potential companies to acquire.

Answer:  FALSE

Diff: 2             Page Ref: 196

AACSB:  Reflective Thinking

 

66) The hidden market of companies  — those companies that might be for sale and are not advertisedis one of the richest sources of top — quality businesses to purchase.

Answer:  TRUE

Diff: 1             Page Ref: 197

AACSB:  Analytic Skills

 

67) Financing the purchase of an existing business usually is easier than financing the startup of a new one.

Answer:  TRUE

Diff: 2             Page Ref: 198

AACSB:  Analytic Skills

 

68) The process of investigating the details of a company that is for sale to determine the strengths, weaknesses, opportunities and threats facing it is known as the:

  1. A) hidden market process.
  2. B) due diligence process.
  3. C) skimming process.
  4. D) business assessment process.

Answer:  B

Diff: 1             Page Ref: 199

AACSB:  Analytic Skills

69) When evaluating a business as a potential candidate for purchase, an entrepreneur should determine the real reason the current owner wants to sell.

Answer:  TRUE

Diff: 1             Page Ref: 200

 

70) The most common reasons that owners of small businesses give for selling are the intensity of competition and an inability to raise sufficient cash to continue to grow.

Answer:  FALSE

Diff: 2             Page Ref: 200-201

AACSB:  Reflective Thinking

 

71) Before purchasing an existing business, an entrepreneur should analyze both its existing and its potential customers.

Answer:  TRUE

Diff: 1             Page Ref: 201-202

AACSB:  Analytic Skills

 

72) If a business has a lien against any of its assets at the time of the sale, the buyer must assume them and is financially responsible for them.

Answer:  TRUE

Diff: 2             Page Ref: 202

AACSB:  Analytic Skills

 

73) A creditor’s claim against an asset is referred to as lien.

Answer:  TRUE

Diff: 1             Page Ref: 202

AACSB:  Analytic Skills

 

74) A prospective buyer should have an attorney thoroughly investigate all of the assets for sale in a business and their lien status before buying any business.

Answer:  TRUE

Diff: 1             Page Ref: 202

AACSB:  Analytic Skills

 

75) One way for a business buyer to avoid being surprised by liens against the assets purchased is to include a clause in the sales contract stating that any liability not shown on the balance sheet at the time of the sale remains the responsibility of the seller.

Answer:  TRUE

Diff: 2             Page Ref: 202

AACSB:  Analytic Skills

 

76) By meeting the criteria of a bulk transfer, a business buyer acquires free and clear title to the assets purchased, which are not subject to prior claims from the seller’s creditors.

Answer:  TRUE

Diff: 2             Page Ref: 202

AACSB:  Analytic Skills

 

77) When a buyer purchases an existing business, she may “inherit” liability for damages and injuries caused by products the company has manufactured or sold in the past.

Answer:  TRUE

Diff: 2             Page Ref: 203-204

AACSB:  Analytic Skills

78) A due-on-sale clause allows an entrepreneur buying a business to “assume” the seller’s loan (usually at a lower interest rate).

Answer:  FALSE

Diff: 2             Page Ref: 203

AACSB:  Analytic Skills

 

79) A due-on-sale clause requires a buyer to pay the full amount of the remaining balance on a loan or to finance the balance at prevailing interest rates.

Answer:  TRUE

Diff: 1             Page Ref: 203

AACSB:  Analytic Skills

 

80) A due-on-sale clause in a loan contract prohibits the buyer of a business from assuming a seller’s loan even though it may carry a lower interest rate.

Answer:  TRUE

Diff: 2             Page Ref: 203

AACSB:  Analytic Skills

 

81) If the corporation, rather than the business seller, signs a restrictive covenant, the seller may not be bound by its terms.

Answer:  TRUE

Diff: 2             Page Ref: 203

AACSB:  Analytic Skills

 

82) A restrictive covenant prohibits the seller of an existing business from opening a competitive business within a specific time period and geographic area of the existing one.

Answer:  TRUE

Diff: 1             Page Ref: 203

AACSB:  Analytic Skills

 

83) Ralph buys a software business from Waldo in Columbus, Ohio.  As part of the deal, Waldo signs a covenant not to compete by opening another software business anywhere in Ohio for the rest of his life.  Such a covenant would be enforceable.

Answer:  FALSE

Diff: 3             Page Ref: 203

AACSB:  Reflective Thinking

 

 

84) A business buyer can be held liable in product liability lawsuits for unsafe products that cause damage or injuries to customers even though they were made prior to the business purchase.

Answer:  TRUE

Diff: 2             Page Ref: 204

AACSB:  Analytic Skills

 

85) Potential buyers should examine income statements, balance sheets, and income tax returns for the past three to five years.

Answer:  TRUE

Diff: 2             Page Ref: 205

AACSB:  Analytic Skills

86) Many business owners show low profits in their businesses intentionally to lower their tax bills.

Answer:  TRUE

Diff: 1             Page Ref: 205

AACSB:  Analytic Skills

 

87) Because so many business owners take money from their companies’ sales without reporting it as income, a business buyer should expect to pay for undocumented, “phantom” profits when buying an existing business.

Answer:  FALSE

Diff: 2             Page Ref: 205

AACSB:  Analytic Skills

 

88) The practice of taking money from sales without reporting it as income is called sliding.

Answer:  FALSE

Diff: 1             Page Ref: 205

AACSB:  Analytic Skills

 

89) Some buyers may assume that if profits are adequate, there will be sufficient cash to pay all of the bills and fund an attractive salary for themselves, but that is not necessarily the case.

Answer:  TRUE

Diff: 2             Page Ref: 205

AACSB:  Analytic Skills

 

90) Skimming is the act of taking money from sales without reporting it as income and it is an illegal and unethical practice.

Answer:  TRUE

Diff: 2             Page Ref: 205

AACSB:  Ethical Reasoning

 

 

91) A nondisclosure document is an agreement between a business buyer and a seller that requires the buyer to maintain strict confidentiality of all records, documents, and information he receives during the parties’ negotiations.

Answer:  TRUE

Diff: 1             Page Ref: 206, Figure 7.2

AACSB:  Analytic Skills

 

92) A letter of intent is a nonbinding document stating that a business buyer and a seller have reached a sufficient “meeting of the minds” to justify the time and the expense of negotiating a final agreement.

Answer:  TRUE

Diff: 1             Page Ref: 206, Figure 7.2

AACSB:  Analytic Skills

 

93) If the owner of an existing business refuses to disclose the company’s financial records, an entrepreneur who is considering buying it should walk away from the deal.

Answer:  TRUE

Diff: 1             Page Ref: 206, Figure 7.2

AACSB:  Communication

94) Goodwill is the difference between an established successful business and one that has yet to prove itself.

Answer:  TRUE

Diff: 1             Page Ref: 207

AACSB:  Reflective Thinking

 

95) Goodwill is an intangible asset that the business buyer cannot depreciate or amortize for tax purposes.

Answer:  FALSE

Diff: 2             Page Ref: 207

AACSB:  Analytic Skills

 

96) When an entrepreneur purchases an existing business, he or she essentially is purchasing its future profit potential.

Answer:  TRUE

Diff: 2             Page Ref: 208

AACSB:  Analytic Skills

 

97) The balance sheet technique is one of the most commonly used methods of evaluating an existing business, although it oversimplifies the valuation process because it values a company only on the basis of its net worth.

Answer:  TRUE

Diff: 1             Page Ref: 208

AACSB:  Analytic Skills

 

 

98) Most small businesses have market values that exceed their book value.

Answer:  TRUE

Diff: 2             Page Ref: 208

AACSB:  Analytic Skills

 

99) The most meaningful method of determining the value of an existing business’s inventory is its book value.

Answer:  FALSE

Diff: 2             Page Ref: 208

AACSB:  Analytic Skills

 

100) Business evaluation based on balance sheet methods offers one key advantage: it considers the future earning potential of the business.

Answer:  FALSE

Diff: 1             Page Ref: 208

AACSB:  Analytic Skills

 

101) The adjusted balance sheet method of valuing a business changes the book value of net worth to reflect its actual market value.

Answer:  TRUE

Diff: 2             Page Ref: 208

AACSB:  Analytic Skills

102) Neither the balance sheet method nor the adjusted balance sheet method of valuing a business considers the future earning power of the business.

Answer:  TRUE

Diff: 2             Page Ref: 208

AACSB:  Analytic Skills

 

103) FIFO, LIFO, and average costing are three frequently used techniques, but the most common methods use the cost of last purchase and the replacement value of the inventory.

Answer:  TRUE

Diff: 2             Page Ref: 209

AACSB:  Analytic Skills

 

104) A method of valuing a business that recognizes that a buyer is purchasing the future income (earning) potential is the earnings approach.

Answer:  TRUE

Diff: 2             Page Ref: 210

AACSB:  Analytic Skills

 

105) Assessing the opportunity cost associated with the decision is not a valuable consideration when deciding to purchase a business.

Answer:  FALSE

Diff: 2             Page Ref: 210

AACSB:  Analytic Skills

 

 

106) The rate of return used to value a business is composed of the basic, risk-free return, an inflation premium, and the risk allowance for investing in the particular business.

Answer:  TRUE

Diff: 2             Page Ref: 211-212

AACSB:  Analytic Skills

 

107) Under the capitalized earnings approach to business valuation, firms with higher risk factors are more valuable than those with lower risk factors.

Answer:  FALSE

Diff: 2             Page Ref: 213

AACSB:  Analytic Skills

 

108) The discounted future earnings approach to valuing an existing business involves estimating the company’s net income for several years into the future and then discounting those future earnings back to their present value.

Answer:  TRUE

Diff: 1             Page Ref: 213

AACSB:  Analytic Skills

 

109) Under the capitalized earnings approach to business valuation, firms with lower risk factors are more valuable than those with higher risk factors.

Answer:  TRUE

Diff: 1             Page Ref: 213

AACSB:  Analytic Skills

110) Under the capitalized earnings approach to valuing an existing business, most normal-risk businesses use a rate-of-return factor ranging from 25 to 30 percent.

Answer:  TRUE

Diff: 2             Page Ref: 213

AACSB:  Analytic Skills

 

111) According to the discounted future earnings technique, a dollar earned in the future is worth more than a dollar earned today.

Answer:  FALSE

Diff: 2             Page Ref: 213

AACSB:  Analytic Skills

 

112) The reliability of the discounted future earnings approach to valuing a business depends on making accurate forecasts of future earnings and on choosing a realistic present value rate.

Answer:  TRUE

Diff: 2             Page Ref: 213

AACSB:  Analytic Skills

 

113) The best method for determining a business’s worth is the discounted future earnings approach.

Answer:  FALSE

Diff: 2             Page Ref: 213

AACSB:  Analytic Skills

114) A business buyer should build his or her own pro forma income statement from an existing firm’s accounting records and compare it to the same statement provided by the owner.

Answer:  TRUE

Diff: 1             Page Ref: 214

AACSB:  Analytic Skills

 

115) A disadvantage of the market approach to valuing a business is the difficulty of finding similar companies for comparison.

Answer:  TRUE

Diff: 2             Page Ref: 214-215

AACSB:  Analytic Skills

 

116) Next to picking the right buyer, planning the structure of a business sale is one of the most important decisions a seller can make.

Answer:  TRUE

Diff: 1             Page Ref: 215

AACSB:  Analytic Skills

 

117) Owners who do not want to sell a business outright, but want to stay around for a while or surrender control gradually can use a restructuring strategy.

Answer:  TRUE

Diff: 2             Page Ref: 216

AACSB:  Analytic Skills

118) Although selling the business outright is the cleanest exit path for an entrepreneur, it may have negative tax consequences, and it often excludes the option of “staying on” and exiting gradually.

Answer:  TRUE

Diff: 2             Page Ref: 216

AACSB:  Reflective Thinking

 

119) An earn-out is an exit strategy in which an entrepreneur can increase his or her payout by actively participating in the business to make sure the company hits specific performance targets.

Answer:  TRUE

Diff: 1             Page Ref: 217

AACSB:  Analytic Skills

 

120) A family limited partnership allows entrepreneurs to transfer their business to their children, however, the entrepreneur will forfeit all control over the business from that point forward.

Answer:  FALSE

Diff: 2             Page Ref: 218

AACSB:  Reflective Thinking

 

121) In the global marketplace, companies from Canada and Great Britain lead the world in acquiring U.S. companies, but China is moving up the list.

Answer:  TRUE

Diff: 2             Page Ref: 219

AACSB:  Multicultural & Diversity

122) To use an ESOP successfully, a company should have pre-tax profits of at least $100,000 and a payroll exceeding $500,000 a year.

Answer:  TRUE

Diff: 3             Page Ref: 219

AACSB:  Analytic Skills

 

123) Price is what the business is actually worth; value is what the buyer agrees to pay.

Answer:  FALSE

Diff: 2             Page Ref: 222

AACSB:  Communication

124) Briefly describe the advantages and the disadvantages of buying an existing business.

Answer:  The advantages of buying an existing business may include:

  • increased likelihood of success
  • established customer base
  • supplier relationships
  • set up business system
  • equipment installed and productive capacity is known
  • inventory in place and financing in place
  • location established
  • employees established
  • previous owner experience base
  • easier financing
  • may be a bargain

 

Disadvantages of buying an existing business may include:

  • the business may be losing money
  • previous owner may have created ill will
  • employees inherited with the business may not be suitable
  • business location may have become unsatisfactory
  • equipment and facilities may be obsolete or inefficient
  • change and innovation are difficult to implement
  • inventory may be outdated or obsolete
  • accounts receivable may be worth less than face value
  • business may be overpriced

Diff: 3             Page Ref: 191-195

AACSB:  Reflective Thinking

 

 

125) Briefly discuss the five steps in acquiring a business.

Answer:

  1. Analyze your skills, abilities, and interests to determine what kind(s) of businesses you should consider. Think about what you expect to get out of a business, what size company you want to buy, what location you prefer, etc.
  2. Prepare a list of potential candidates. Search not only the obvious sources, but also the hidden market of companies that may be for sale but are not advertised as such.  This might include business brokers, bankers, accountants, industry contacts, networking, trade associations, etc.
  3. Investigate and evaluate the best one. Consider the strengths and weaknesses of the candidates, their profitability, customer base, physical condition, competition, etc.
  4. Explore financing options. Consider approaching the seller for financial assistance.  Also, consider traditional sources.
  5. Ensure a smooth transition. Communicate openly with employees.  Consider asking the seller to serve as a consultant until the transition is complete.

Diff: 3             Page Ref: 196-199

AACSB:  Reflective Thinking

126) Your friend Susan is considering purchasing an existing business.  How would you explain to her what due diligence is, why it is important, and the critical areas of it?

Answer:  The due diligence process in analyzing and evaluating an existing business may be just as time consuming as the development of a comprehensive business plan for a start-up company.  It is also just as crucial.  It is important to verify all the facts and figures provided to you by the seller.  It is also important in determining the potential for success.

 

The five critical areas include:

  1. Why does the owner really want to sell the business? His stated reason may not be the real one.  Is he trying to hide anything from you?
  2. What is the physical condition of the business? Carefully evaluate the assets to determine their value.  Consider the location and physical facility’s appearance.
  3. What is the potential for the company’s products or services? Complete a thorough market analysis to develop an accurate and realistic sales forecast.  Evaluate industry trends.
  4. What legal aspects should you consider? Liens, bulk transfers, contract assignments, covenants not to compete, ongoing legal liabilities, and product liability lawsuits should all be considered.
  5. Is the business financially sound? Remember that any investment in a company should produce a reasonable salary for her, an attractive return on the money she invests, and enough to cover the amount she must borrow to make the purchase.  Carefully review past sales, operating expenses, and profits, as well as the assets used to generate those profits. Analyze income statements, balance sheets, and income tax returns for the past three to five      years, as well as cash flow documents.

Diff: 3             Page Ref: 199-205

AACSB:  Reflective Thinking

 

 

127) Explain the steps in the acquisition process.

Answer:  The acquisition process involves these seven steps as seen in Figure 7.2:

  1. Identify and approach candidate
  2. Sign nondisclosure document
  3. Sign letter of intent
  4. Buyer’s due diligence investigation
  5. Draft purchase agreement
  6. Close the final deal
  7. Begin the transition

Diff: 2             Page Ref: 206, Figure 7.2

AACSB:  Analytic Skills

 

128) What is “goodwill”?  Give an example of goodwill.  Is it possible to inherit “ill will” from an existing business?

Answer:  Goodwill is an intangible asset.  It is based on the company’s reputation and ability to attract customers.   Expect student’s to provide an example of goodwill based on this definition.  Yes, it is possible to inherit ill will.  Customers are not always aware when a business changes hands, nor are previous poor business practices easily forgiven.

Diff: 2             Page Ref: 207

AACSB:  Reflective Thinking

129) Is there a “best method” for determining the value of a business?  Why?  How should a prospective buyer go about establishing the value of a business?

Answer:  No, there is no “best” business valuation method.  Valuation is partly an art and partly a science.  Establishing a reasonable price for a privately held business is difficult due to a wide variety of factors that influence its value: The nature of the business itself, its position in the market or industry, the outlook for the market or industry, the company’s financial status, its earning capacity, any intangible assets it may own (such as patents, trademarks, copyrights), the value of other similar publicly held companies, and many other factors.  The wisest approach is to compute a company’s value using several techniques and then to choose the one that makes the most sense.

Diff: 2             Page Ref: 207-215

AACSB:  Reflective Thinking

 

 

130) Briefly summarize the mechanics of each of the methods for valuing an existing business: balance sheet technique, adjusted balance sheet technique, excess earnings method, capitalized earnings method, discounted future earnings method, and the market approach.

Answer:

  • Balance sheet technique: Book value of net worth = Total assets — Total liabilities
  • Adjusted balance sheet technique: Net worth adjusted to reflect market value
  • Earnings approach: Net worth + Intangible value
  • Capitalized earnings: Net income — Owner’s salary divided by ROR similar risk investment
  • Discounted future earnings: Weighted average of 5 years use optimistic + 4 (most likely) + pessimistic divided by 6
  • Market approach: Uses price/earnings ratios of similar businessesonce an average P/E ratio is found from as many businesses as possibleit is then multiplied by the private company’s estimated earnings

Diff: 3             Page Ref: 208-215

AACSB:  Analytic Skills

 

131) Explain five strategies business owners can use to exit their businesses.  Cite a specific advantage of each.

Answer:

  • Straight business sale – facilitating a quick, clean and straight forward exit from the business
  • Forming a family limited partnership – able to keep control while transitioning ownership to family members
  • Sell a controlling interest – facilitating a gradual transition to new owners
  • Restructure company – replacing the existing business while taking on new investors
  • Sell to an International Buyer – appealing to a broader pool of potential buyers
  • Use a two-step method sale – security of a sales contract with a planned transition from leadership
  • Establish an employee stock option plan (ESOP) – transitioning ownership to employees

Diff: 3             Page Ref: 216-220

AACSB:  Reflective Thinking

 

132) Explain what the buyer and the seller of a business are each looking for in the negotiation process.

Answer:  The seller is looking to:

  • get the highest price possible for the business.
  • sever all responsibility for the company’s liabilities.
  • avoid unreasonable contract terms that might limit his future opportunities.
  • maximize the cash he gets from the deal.
  • minimize the tax burden from the sale.
  • make sure the buyer will be able to make all future payments.

 

The buyer seeks to:

  • get the business at the lowest possible price.
  • negotiate favorable payment terms, preferably over time.
  • get assurances that he is buying the business he thinks he is getting.
  • avoid putting the seller in a position to open a competing business.
  • minimize the amount of cash paid up front.

Diff: 2             Page Ref: 222

AACSB:  Communication

 

133) Identify five questions that influence the negotiation process between a business buyer and a seller?

Answer:

  • How strong is the seller’s desire to sell?
  • Will the seller help with financing?
  • What terms does the buyer suggest? Which terms are most important to him?
  • Is it urgent that the seller close the deal quickly?
  • What deal structure best suits your needs?
  • What are the consequences for both parties?
  • Will the seller sign a restrictive covenant?
  • Is the seller willing to stay on with the company for a time as a consultant?
  • What general economic conditions exist in the industry at the time of the sale?

Diff: 3             Page Ref: 222-223

AACSB:  Communication

 

Mini-Case 7-1: What’s It Worth?

 

Lauren Holcombe has wanted to open her own clothing store since she was in high school. Her career interest and dynamic personality enabled her to get a part-time job at a small women’s clothing shop in her hometown after school. When Lauren enrolled in the state university to major in retail management, she got a part-time job in the ladies’ clothing section of a prestigious department store in the city. Lauren’s supervisor was impressed with her business acumen and her congenial personality. “Lauren is one of the best workers we’ve ever had in this department. She’s very bright, quite attractive, and very outgoing. Lauren is eager to learn anything she can about the business; she’s always asking questions!”

 

During Lauren’s senior year in college, her Aunt Bessie died and left her an inheritance totaling nearly $300,000. “I’ll miss dear old Aunt Bessie, but have I got plans for my inheritance! Now, I’ll be able to run my own clothing store just like I’ve always dreamed.” Lauren immediately began planning to launch her business venture, but progress was slow. During a trip to her hometown over the Christmas break, Lauren discovered that a well-established ladies’ clothing shop was up for sale. The shop was well known and quite successful, but the owner, Kathleen Todd, was quitting to retire in Tahiti. Lauren contacted Ms. Todd to discuss the sale of the business.

 

Ms. Todd hired a company to conduct an independent appraisal of the business, which concluded that tangible assets were $230,000 and assumable liabilities were $18,000. The appraisal estimated net profit for the next year to be $73,000 before deducting any managerial salaries. Lauren expects to draw $20,000 in salary since she believes this is the salary she could expect when working for someone else. Lauren estimates that a reasonable rate of return on an investment of similar risk is 25 percent. Ms. Todd has set a value of $85,000 for intangibles such as goodwill, and is asking $297,000 for the business.

 

134) Using the capitalized earnings method, calculate the value of the business.

Answer:  Value  =

 

=   = $215,200

Diff: 3             Page Ref: 213

AACSB:  Analytic Skills

 

 

135) Based on the excess earnings approach, what do you expect the business to be worth?

Answer:  Tangible net worth ($230,000 – $18,000)      $212,000

 

Opportunity cost:

Salary                                                 $20,000

Investment ($212,000 x .25)          $53,000

Total opportunity costs                  $73,000

 

Estimated net profit                        $73,800

Extra earning power ($73,800 – 73,000) $800

 

Value of intangibles (3 x $800)                 $2,400

 

      Total Value                                              $214,400

Diff: 3             Page Ref: 213-214

AACSB:  Analytic Skills

136) Given the following earnings estimates, compute the value of the business using the discounted future earnings technique.

Answer:  Number of Years Pessimistic   Most Likely   Optimistic

               into the Future

1                      $62,000          $73,800         $75,000

2                      $65,000          $75,000         $77,000

3                      $68,000          $77,000         $79,000

4                      $71,000          $79,000         $80,000

5                      $73,000          $80,000         $82,000

 

                                              Average              PV                PV of

                                             Earnings    x    Factor  =          Earnings

Year 1             $72,033         .8000              $57,626

Year 2             $73,667         .6400              $47,147

Year 3             $75,833         .5120              $38,826

Year 4             $77,833         .4096              $31,880

Year 5             $79,167         .3277              $25,941

                        Total                                                         $201,429

 

Estimate of cash flow stream beyond 6 years:

79,167  x   = $316,668

 

$316,688 x .2621 = $83,013

                  Total Value = $284,433

Diff: 3             Page Ref: 210-214

AACSB:  Reflective Thinking

 

 

137) Is Ms. Todd’s asking price reasonable?  How much should Lauren offer Ms. Todd at the beginning of the negotiation process?

Answer:  P/E Ratios 3.98

3.64

3.56

Total               11.18

 

Average = 11.18 / 3 = 3.37

 

Value = $73,800 x 3.73 = $275,274

 

Ms. Todd’s asking price of $297,000 seems to be high.  Lauren should offer Ms. Todd a price below the $297,000 to allow some room for bargaining.

Diff: 3             Page Ref: 214

AACSB:  Analytic Skills

Mini-Case 7-2:  Building Supply

 

You have recently decided to purchase a local building supply store. The business has passed the initial screening test and you are ready to begin discussing prices with the present owner. An independent appraisal has calculated the tangible net worth of the business to be $175,000. You determine the rate of return on an investment of similar risk to be 25 percent. You plan to draw a salary of $19,000. Your CPA estimates the net profit of the business (before your salary is deducted) to be $75,000. The present owner has selected a goodwill value of $65,000, and is asking $240,000 for the business.

 

138) Based on the balance sheet method, what do you calculate the business to be worth?

Answer:  Value = $175,000

Diff: 3             Page Ref: 208

AACSB:  Analytic Skills

 

139) Based on the capitalized earnings method, what do you calculate the business to be worth?

Answer:  Value =  = $224.000

Diff: 3             Page Ref: 213

AACSB:  Analytic Skills

 

 

140) Based on the excess earnings approach, what do you calculate the business to be worth?

Answer:  Adjustable tangible net worth $175,000

 

Opportunity cost:

Salary $19.000

Investment ($175,000 x .25)       $43,750

Total opportunity costs               $62,750

 

Estimated net profit                     $73,800

Extra earning power

($75,000 — 62,750)                      $12,250

 

Value of intangibles:($12,250 x 3*)   $36,750

or

($12,250 x 4*)                    $49,000

 

Total Value at 3 years profit                $211,750

 

            – or –

 

Total Value at 4 years of profit          $224,000

 

*Students may use a years-of-profit figure of 3 or 4 years

Diff: 3             Page Ref: 213-214

AACSB:  Analytic Skills

141) You have found two similar businesses whose stock is publicly traded on the OTC market.  Their price-earnings ratios are 3.19 and 2.91.  Using these two firms as a benchmark, what do you estimate the business to be worth using the market approach?

Answer:  Average P/E ratio = 3.05

 

Value = $75,000 x 3.05 = $228,750

Diff: 3             Page Ref: 214-215

AACSB:  Analytic Skills

 

 

142) Given the following earnings estimates, compute the value of the business.

Answer:  Number of Years Pessimistic Most Likely  Optimistic

               into the Future

1                      $62,000          $75,800         $80,000

2                      $68,000          $78,000         $82,000

3                      $72,000          $82,000         $85,000

4                      $78,000          $86,000         $89,000

5                      $85,000          $89,000         $91,000

 

                                              Average              PV                PV of

                                             Earnings    x    Factor  =          Earnings

Year 1             $73,667         .8000              $58,933

Year 2             $77,000         .6400              $49,280

Year 3             $80,833         .5120              $41,378

Year 4             $85,167         .4096              $34,884

Year 5             $88,667         .3277              $29,054

                        Total                                                         $213,539

Estimate of cash flow stream beyond 6 years:

$88,667 x 1/.25 = $354,667

$354,667 x .2621 = $92,974

      Total value = $213,539 + 92,974 = $306,513

Diff: 3             Page Ref: 213-214

AACSB:  Analytic Skills

 

143)  How much would you offer the present owner at the beginning of the negotiation process?

Answer:  Students’ responses will be different, but their initial offer price should be below the asking price of $240,000.

Diff: 3             Page Ref: 213-214

AACSB:  Analytic Skills