ABMF4024 BUSINESS FINANCE
October 9, 2010
Question 1 Shareholder wealth is defined by the market value (the price the stock is trading for on the stock market) of the shareholders common stock holdings, its a function of all future return. The manager must consider the long run impact and not just focus on the short run. For example, if the company ignore the long run impact (e.g. R%D), then in the future the firm cannot produce new product and get lower earning. Therefore long term goal g oal is important. *Short run focus on earnings and dividend; Long run focus on R&D
Question 2 Due to separation of ownership and interest, managers tend to pursue other goal. For example managers may maximize their personal utility (welfare). Therefore management provides the manager with the job survival (job security) to ensure that the managers being motivate to increase the firm value.
Question 3 Earnings per share are not a consistently good measurement of a firms performance, because it does not specify the timing or duration du ration of expected returns. It also does not consider risk and does not allow for the effect of dividend policy on the market price of the stock, which this is all stockholder will consider on.
Question 4 The major factors that determine the value of stock are projected cash flows to shareholders, timing of the cash flow stream, and riskiness of the cash flows. The firms stock price will directly affected by the expected cash flows, flows, if the cash inflows are expected to be higher or the cash outflows is expected to be lower, the higher the firms stock price will be. The value of an investment made by the firm is depends on the timing of cash flow, flow, the shorter the period of return is better, because we can earn interest on money we received today. Investor will seek for investments that have hig her return than a risk-less asset; it is because the concept of high of high risk higher returns.
Question 5 To ensure that the shareholders and manager interest are aligned, we can use motivational tools: I.
Reasonable cooperation package the managerial compensation plans are based on the companys performance, this will encourage manager to put more effort on the firms performance. Others than that, the manager will also offered with the executive stock option.
II.
Direct intervention by shareholder shareholders can intervene directly with managers by talking with managers and make m ake suggestion about how the business should be run.
III.
Threat of firing
those managers who underperform or their action affect the firms value,
management may fire them.
ABMF4024 BUSINESS FINANCE
IV.
Threat of takeover
October 9, 2010
when the stock underworked this may give chance to corporate raiders to
take over the firm. If such attempt by corporate raiders success, the managers will be replace.
Question 6 Agencies is defined by one or more individuals, called principals, hire another individual or called agent to perform some services and delegate decision making authority to the agent. For example, I wish to purchase a house, so I seek for a person with professional knowledge to help me take care of all the step and procedure. I am the principal and that person is an agent. Agency cost is a type of internal cost that must be paid to an agent acting on behalf of a principal. It usually arises due to conflicts of interest between shar eholder and management.
Question 7 a) It is not an appropriate goal. This is because one should not consider market shares as a goal itself. Furthermore, the important goal is shareholders maximization wealth. b) It is not an appropriate goal, because if the firm selling product prices lower than competitor, they cannot maximize their market value. c)
It is not an appropriate goal, because the firm will only consider it to maximize shareholders wealth which concern on amount of risk and timing of cash flow.
Question 8 a) Fixed salary compensation which is independent of firms success. b) Salary linked to profit ties to the employees compensation and result of firms success. However, profit itself subject to different accounting rules and cannot be reliable measure of firms success. c)
Salary that is paid partly in the form of the companys shares here, the managers earn only after they maximized shareholders wealth. At the point, it is most likely align to managers shareholders interest.
Question 9 Different companies have different risk based on the business operation. For example, firm operate in biotechnology have high investment in R&D, hence it h as relatively high risk and their stock price will high as well. Other factors: heavy use of debt financing vs. equity financing, and stock price instability.
Question 10 A firms intrinsic value is an estimate of of a stocks true value based on accurate risk and return data. It can be estimated but not not measured precisely. A stocks current price is its market pricethe value based on perceived but but possibly incorrect information information as seen by the marginal investor. From these definitions, you can see that a stocks true long-run value is more closely related to its intrinsic value rather than its current price.
ABMF4024 BUSINESS FINANCE
October 9, 2010
Question 11 The primary goal of the corporation is to maximize the stockholders wealth, which transfers to maximizing the price of the firms stock. a) REFERE TO NOTE! b) REFERE TO NOTE!
