Question

(A)

i) Define the agency problem and explain how it contributes towards agency costs? How can the agency problem and agency costs be reduced by a properly constructed corporate governance structure?

ii) Explain the differences between financial markets and financial institutions?

(B)

i) ABC Corporation received pretax profits of RM1.2 million, an average tax rate of 34 percent, and it paid preferred stock dividends of RM50,000. There were 100,000 shares outstanding and no interest expense. What was ABC Corporation's earnings per share?

ii) A firm has projected sales in May, June, and July of RM100, RM200, and RM300, respectively. The firm makes 20 percent of sales for cash and collects the balance one month following the sale. What is the firm's total cash receipts in July?

Answer 1

(A) (i) In the general context, the conflict of interest between the company's management and its stakeholder is known as agency problem. It is also known as problem of agent and principal where principal are the shareholder's of the business and agent are the management in order to act to maximize the interests of the shareholders. Agents take crucial business decisions on behalf of the principal due to these difference agency costs arises. Both of them i.e. agents and principal try to fulfill and maximize their self interest as the result agency costs increases due to conflict of interests between the management and shareholder's of the organization.

One of the major solutions to reduce the agency costs arising due to conflict of interests between the management and shareholders (owners) of the company is to provide incentives schemes and Performance based benefits to the management of the company to promote and act in order to maximize shareholders wealth. Providing incentives will motivate the management to act for the interest of the shareholders and will ultimately result in reduction of agency costs.

(ii) Financial markets refers to the marketplace where different financial instruments such as Equities, debentures, commodities and currencies are traded between the buyers and sellers of such financial instruments. Financial market act as the common platform for both buyers and sellers of the financial instruments. Whereas financial institutions provide sources of funds such as equity financing and debt financing. They are the providers of funds and capital in order to meet working capital requirements and business expansion purposes such as banks and NBFCs

(B) (i) Profits pre tax is equal to RM 1.2 million

Tax rate is 34% i.e. RM 408000

Profits after tax rate = 1.2 million -408000 which is equal to RM 792000

50,000 dividend paid to preference shares should be deducted i.e. 792000- 50000 = RM 742000

There were 100,000 outstanding shares therefore EPS = 742,000/100,000 = 7.42 Earning per share

(ii) 20 % of sales are cash and rest 80% of them are credit sales

May sales= RM 100 out of which RM 20 were cash sales and RM 80 were credit sales

June sales = RM 200 + RM 80 out of which RM 40 were cash sales of June, RM 80 were collected for May month and RM 160 were credit sales

For July month RM 300 sales + RM 160 sales from June month out of which RM 60 were cash sales, RM 160 collected from June month and rest RM 240 were credit sales

Hence total cash receipts in July will be RM 60+ RM 160 = RM 220 collected in cash in the month of July