Agency problems are said to be inherent in the corporate form of an organization

Agency problems are said to be inherent in the corporate form of an organization

Agency problems are said to be inherent in
Subject: Business    / Finance   
Question
1. Agency problems are said to be inherent in the corporate form of an organization. Why
do you think this is the case?
Do you think agency problems arise in a sole proprietorship or a partnership?
What steps would you take to reduce agency problems in a so-called typical corporation?

2. Why is it necessary for a firm to maintain a reasonable level of liquid assets?
Do you think some industries require higher or lower levels of liquid assets than others?
What factors might affect a firm’s liquidity requirements?

3. It has been said that anyone with a pencil can calculate financial ratios, but it takes a
brain to interpret them. What should financial analysts keep in mind when evaluating the
financial statements of any firm?

4. The notion that money has time value is based on the existence of a non–zero opportunity
rate (i.e., a rate of return at which it is possible to invest). Why is the opportunity rate so
important?
Construct an example that shows, with an opportunity rate of 0%, that the value of $1
received today will be $1 in the future.

5. Imagine you are the treasurer of a small manufacturing firm. Your firm is planning to go
public (i.e., sell stock to investors for the first time). One unresolved question concerns
the market’s required return on the stock. Given what you have learned, how do you
think the required return will affect the market value of your firm’s stock?
How would you go about estimating this rate?

6. What is the stand-alone principle?
Why is it important to the analysis of capital projects?

7. What is a sunk cost?
Why is it important to understand this concept when analyzing capital projects?

8. What is operating leverage?
How is it measured?
Why is it important to the analysis of capital expenditure projects?

9. You are discussing stock valuation techniques with your broker. You mention that your
Finance professor stated that “a stock that will never pay a dividend is valueless.” Your
broker says this is not true because

• you can always sell the stock to someone else (thus, a capital gain is possible)
• a share of stock represents a share of ownership in something tangible (i.e., the
issuing firm).

Argue for or against your broker’s position.

10. In discussing asset pricing, your textbook suggests that an investor will be indifferent
between two bonds with equal yield to maturity, as long as they are of equivalent risk.
Can you think of any real-world factors that might make an investor prefer one of these
bonds over the other?

11. Compare discounted cash flow (DCF) and non-discounted cash flow capital budgeting
techniques. If you were to evaluate a project, which one of these techniques would you
use?

12. Given our goals of firm value and shareholder wealth maximization, we have stressed the
importance of NPV. Yet many financial decision makers at well-known firms continue to
use less desirable measures (such as payback period) rather than more desirable measures
(such as payback period and AAR, in addition to the NPV and IRR).
Why do you think this is the case?

13. According to your textbook, “an investment should be accepted if the net present value is
positive and rejected if it is negative” (p. 239). What does an NPV of zero mean?
If you were a financial decision maker facing a project with NPV of zero (or close to
zero) what would you do?
Can you think of any other factors that might influence your decision?

14. What are the four methods of calculating operating cash flow?
Under what circumstances is each method appropriate?

15. Briefly describe each of the three methods of performing the “what if” analysis described
in your textbook. What is the financial analyst’s main goal when conducting each
analysis?
Under what circumstances would each method be appropriate?

16. Define the three forms of market efficiency. Why should a financial decision maker, such
as a corporate treasurer or CFO, be concerned with market efficiency?

17. We routinely assume that investors are “risk-averse return-seekers” (i.e., they like returns
and dislike risk). If so, why do we contend that only systematic risk is important?
Alternatively, why is total risk, on its own, not important to investors?

18. According to the CAPM, the expected return on a risky asset depends on three
components. Describe each component, and explain the role of each one in determining
expected return.

19. Why should financial decision makers obtain a good estimate of a firm’s cost of capital?
What are the consequences of using a discount rate that is higher or lower than a firm’s
true required return?