1.4.2 Risk and Liability — Practice Questions

Seven original multiple-choice questions on risk and liability: risk and reward, limited and unlimited liability, types of business ownership and personal guarantees.

7 questions Edexcel B A-Level Multiple choice Model answers included

Not read the notes yet? Start with the 1.4.2 Risk and Liability revision notes.

1. 1. An entrepreneur can either open a branch of an established sandwich franchise or launch an untested meal-kit delivery business, which is much more likely to fail. Taking the risk into account, the meal-kit business is worth choosing only if the profit it aims to make is

   Applied reasoning

   Select one answer

   A Above zero in its first year.

   B Equal to the franchise's.

   C Higher than the franchise's.

   D Lower than the franchise's.
   Show model answer

   Answer: C (Higher than the franchise's.). Profit is the reward for taking risk. The riskier the venture, the higher the profit needed to make it worth trying. The meal-kit business has a greater chance of failing, so it is only worth choosing if it aims to earn more than the safer franchise.

   Why the other options are wrong

   • A — Making a profit in the first year says nothing about the extra risk. The comparison that matters is with the safer option the entrepreneur gives up.
   • B — With equal profit in prospect, the entrepreneur would be taking more risk for no extra reward. The safer franchise would be the better choice.
   • D — This has the trade-off the wrong way round. Taking on more risk calls for a higher reward, not a lower one.

2. 2. Table 1 shows four business owners. Each business fails owing more than it owns, and none of the owners has given a personal guarantee.
   Using Table 1, the owners who could lose personal assets beyond what they put into the business, such as their home, are

   Data interpretation

   Table 1: Four business owners

   	The owner's position
   Owner 1	Runs a mobile coffee van as a sole trader
   Owner 2	Holds shares in a private limited company, owned by one family, that makes candles
   Owner 3	Is one of two partners in a partnership that runs a garden-design business
   Owner 4	Holds shares in a public limited company listed on a stock exchange

   Select one answer

   A Owner 1 only.

   B Owners 1 and 3.

   C Owners 2 and 4.

   D Owners 1, 2 and 3.
   Show model answer

   Answer: B (Owners 1 and 3.). Sole traders and partners have unlimited liability: the law treats owner and business as the same thing, so creditors can take the owner's own savings, car or house. That is Owner 1 and Owner 3.
   Shareholders in a private or public limited company have limited liability: they lose the value of their shares, and the company's debts are not theirs to pay. That is Owners 2 and 4.

   Why the other options are wrong

   • A — This misses Owner 3. A partnership has unlimited liability just as a sole trader does, so each partner can be made to pay the business's debts from their own assets.
   • C — This is the wrong way round. Owners 2 and 4 are shareholders in limited companies, the two owners whose personal assets are protected.
   • D — A private limited company is often small and owned by family, but it is still a company and a separate legal entity, so Owner 2 has limited liability.

3. 3. Two partners run a software business. To grow, they want to raise £2 million from outside investors who will take no part in running it. Forming a limited company would help most, because these investors

   Applied reasoning

   Select one answer

   A Could lose no more than they paid for their shares.

   B Would be guaranteed a share of the profit each year.

   C Would earn a fixed rate of interest on their money.

   D Would share responsibility for all the firm's debts.
   Show model answer

   Answer: A (Could lose no more than they paid for their shares.). With limited liability, the most an investor can lose is what they paid for their shares. That makes people willing to buy shares in a business they do not run, so a company can raise far more outside finance than a partnership. This is why a business that wants large amounts of outside finance becomes a company.

   Why the other options are wrong

   • B — Shareholders expect a share of the profit as dividends, but nothing guarantees one. A company that makes a loss may pay no dividend at all.
   • C — A fixed rate of interest is what a lender earns. Share capital carries no interest; shareholders are part owners, not lenders.
   • D — This describes unlimited liability, which is what the investors would be avoiding. If they had to share responsibility for all the debts, few would invest in a business they do not run.

4. 4. A private limited company closes owing a supplier £12,000 that it cannot pay. Its two shareholders each paid £5,000 for their shares, and neither gave a personal guarantee. The most that either shareholder loses is

   Calculation

   Select one answer

   A £0

   B £5,000

   C £6,000

   D £11,000
   Show model answer

   Answer: B (£5,000). A company is a separate legal entity, so the £12,000 is the company's debt, not the shareholders'. With limited liability, each shareholder can lose no more than the money they put in: the £5,000 paid for their shares, which are now worthless. The supplier bears the rest of the loss.

   Why the other options are wrong

   • A — Limited liability caps the owners' losses; it does not remove them. Each shareholder still loses the £5,000 they paid for shares in a company that has failed.
   • C — This splits the £12,000 debt between the two shareholders, as if they had to pay it. The debt belongs to the company, and limited liability means they do not.
   • D — This adds an equal share of the debt (£6,000) to the £5,000 paid for shares, as if each shareholder had to cover half the company's debts. The debt belongs to the company; shareholders lose their shares and nothing more.

5. 5. A packaging supplier normally gives its customers 60 days to pay. A newly formed private limited company asks for the same terms, and the supplier offers it only 14 days. The best explanation is that limited liability

   Definition in context

   Select one answer

   A Caps the company's debts at the value of its shares.

   B Lets the company stop trading without paying any debts.

   C Moves risk from the company's owners to its creditors.

   D Requires the company to keep its accounts private.
   Show model answer

   Answer: C (Moves risk from the company's owners to its creditors.). Limited liability caps what the owners can lose. If the company fails, the people it owes may get back only part of what they are owed, because they cannot claim from the owners. So the risk moves to lenders and suppliers, and a supplier may give a new company less time to pay to limit how much it could lose.

   Why the other options are wrong

   • A — Limited liability caps what the owners can lose, not what the company can owe. A company can run up debts far larger than its share capital.
   • B — A company must still pay its debts while it trades, and if it fails its assets go to the people it owes. What limited liability protects is the owners' personal assets.
   • D — This is the wrong way round. A limited company must file its accounts at Companies House, where anyone can read them. That actually helps a supplier judge how safe it is.

6. 6. A bank will lend £60,000 to a new private limited company only if its sole director signs a personal guarantee. The company later fails without repaying the loan. Because of the guarantee, the director

   Definition in context

   Select one answer

   A Can be asked to repay the loan from personal assets.

   B Has lost limited liability for all the company's debts.

   C Loses only the money paid for the company's shares.

   D Owes nothing, as the debt belongs to the company.
   Show model answer

   Answer: A (Can be asked to repay the loan from personal assets.). A personal guarantee is a promise to repay from the owner's own money. It gets round limited liability for this one loan: if the company cannot repay, the bank can turn to the director, whose savings or home may be at risk. Banks often ask for one from a small company with few assets.

   Why the other options are wrong

   • B — The guarantee covers only the loan it was signed for. The company's other debts, such as those to suppliers, are still covered by limited liability.
   • C — Without the guarantee, this would be right. The guarantee adds a personal promise to repay the £60,000, so the director can lose more than the share capital.
   • D — The debt does belong to the company, but the director has promised to pay it if the company cannot. That promise is the whole point of the guarantee.

7. 7. Someone starting a weekend dog-walking business, with almost no equipment and no borrowing, chooses to be a sole trader rather than form a company. The most likely reason is that being a sole trader

   Applied reasoning

   Select one answer

   A Gives the owner limited liability for any debts.

   B Lets the owner sell shares to raise finance.

   C Makes banks more willing to lend to the business.

   D Starts at once and keeps its accounts private.
   Show model answer

   Answer: D (Starts at once and keeps its accounts private.). A sole trader can start straight away, with no forms to file, and keeps the accounts private. The cost is unlimited liability, but a business with almost no equipment and no borrowing has few debts to put the owner's own assets at risk, so the simpler set-up wins.

   Why the other options are wrong

   • A — A sole trader has unlimited liability. Limited liability comes only from forming a company.
   • B — Only a company can raise share capital. A sole trader has no shares to sell.
   • C — Banks lend more readily to an established company. Being a sole trader does not make a bank more willing to lend.