Assignment 1 solutions

Assignment 1 solutions - when the shareholders wealth is...

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ECON*3560DE Summer 2007 Theory of Finance Assignment 1 Due: June 17, 2007 Total number of marks: [100] 1. [5] Discuss which of the following forms of compensation is most likely to align the interests of managers and shareholders? a) A fixed salary b) A salary linked to company profits c) A salary that is paid partly in the form of the company’s shares d) An option to buy the company’s shares at an attractive price A fixed salary means that compensation is (at least in the short run) independent of the firm’s success. A salary linked to profits ties the employee’s compensation to this measure of the success of the firm. However, profits are not a wholly reliable way to measure the success of the firm. The text points out that profits are subject to differing accounting rules, and reflect only the current year’s situation rather than the long-run prospects of the firm. A salary that is paid partly in the form of shares means that the manager earns the most
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Unformatted text preview: when the shareholders wealth is maximized. This is therefore most likely to align the interests of managers and shareholders. Stock options create great incentives for managers to contribute to the firms success. In some cases, however, stock options can lead to agency problems. For example, a manager with many options might be tempted to take on a very risky project, reasoning that if the project succeeds the payoff will be huge, while if it fails, the losses are limited to the lost value of the options. Shareholders, in contrast, bear the losses as well as the gains on the project, and might be less willing to assume the risk. 2. [5] What is the overall change in net working capital resulting from the following changes? $300 increase in inventories, $150 increase in accounts payable, $120 decrease in accounts receivable, $60 decrease in other current assets, $150 decrease in other current liabilities....
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Assignment 1 solutions - when the shareholders wealth is...

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