Question

1.Which of the following forms of compensation is most likely to align the interests of managers and common stockholders:

A.A salary linked to the dividends paid by the company

B.A salary linked to the company’s profits

C.A salary linked to the level of the company’s common stock buybacks

D.A salary linked to the company’s revenues

E.A salary that is paid partly in the form of the company’s shares

2.Which of the following statements regarding agency problems and costs are correct?

1. An agency problem exists when there is a conflict of interest between a principal and an agent.
2. An agency problem exists when there is a conflict of interest between a firm’s shareholders and management
3. An agency cost occurs when management makes a decision that decreases their pay and prestige but increases the firm’s stock price.
4. An agency cost occurs when a firm’s management avoids risky projects that would increase the stock price because they are worried about keeping their jobs.

A.1 only

B.1 and 2 only

C.1, 2, and 3 only

D.1, 2, and 4 only

E.1, 2, 3, and 4

3.Your brother has offered to give you either $5,000 today or $8,000 in 10 years. Presume that your brother will honor his promise. If the interest rate is 5% per year, which option is preferable?

A.The $5,000 today is preferable.

B.The $8,000 in 10 years is preferable.

C.The offers are equally preferable.

4.Which of the following represents a financing (or capital structure) decision?

A.A decision to have dinner at the most expensive restaurant in town, charged to the company’s expense account.

B.A decision to buy a new factory to support a new line of production.

C.A decision to expand the operations to enter a new market.

D.A decision to issue $10 million worth of debt to partially finance capital expenditures.

E.A decision to invest in software to help speed the collection of accounts receivable.

5.As the winner of a breakfast cereal competition, you can choose one of the prizes listed below. If the interest rate is 12% per year, which one of the following is the most valuable prize? Ignore taxes.

A.$100,000 now.

B.$180,000 at the end of five years.

C.$11,400 every year forever.

D.$19,000 at the end of each of the next 10 years.

E.$6,500 next year and increasing thereafter by 5% a year forever.

Answer 1

1)
Employee stock options or ESOP's are one of the best products likely to align the interests of managers and common stock holders. As the employee is encouraged to perform well so that he/she gets a slice of the stock performance and be the owner of the firm, the stockholders also benefit by increased price of stock.

Answer is E) A salary that is paid partly in the form of the company’s shares

2)

An agency problem occurs whenever there is a conflict between the principal and their agents. Shareholders and management are one example of principal agent relationship. When a management avoids risky projects that has the potential to increase the shareprice but due to their worry of job losses making them not to accept the project is an agency cost.

Answer is D.1, 2, and 4 only

3)

PV of $ 5000 today = $ 5000

PV of $ 8000 in 10 years @ 5% per year = 8000/(1+5%)^10 = $ 4,911.31

Answer is A.The $5,000 today is preferable.

4)

Financing decision or capital structure decision is a decision by the management of the firm to either issue debt or equity to help finance the investment for a firm.

Answer is D) A decision to issue $10 million worth of debt to partially finance capital expenditures.

5)

So Answer is D) $19,000 at the end of each of the next 10 years.

Formulae