CF midterm ans.docx - 1 Describe the two types of agency relationship that exist in a corporation Shareholder and managers Shareholder and creditor 2

# CF midterm ans.docx - 1 Describe the two types of agency...

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1. Describe the two types of agency relationship that exist in a corporation. - Shareholder and managers - Shareholder and creditor 2. Why does the agency problem arise in a corporation? - Difference in objectives between principal and agent or conflict of interest. - Separate of ownership and control. 3. Difference between normal and non-normal cash flow stream. - Normal cash flow stream - cost (negative CF) followed by a series of positive cash inflows. One change of signs. - Non-normal cash flow stream - Two or more change of signs. Most common: cost (negative CF), then string of positive CFs, the cost to close project. 4. Name three social responsibilities of a corporation. - To provide a safe working environment. - To avoid polluting air or water. - To produce safe products. 5. Conflict of interest exists between shareholders and managers in a corporation. Suggest ways to overcome the agency problem. - Direct intervention by shareholders. - The threat of firming. - The threat of takeover. 6. Explain the strengths and weakness of simple payback method in capital budgeting. - Strength - Easy to calculate and understand.

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Unformatted text preview: - Weakness - Ignores the time value of money. 7. Briefly explain the following: Systematic risk. - Non diversifiable. Eg. Market risk, interest rate risk, political risk. Non-systematic risk. - Diversifiable. Eg. Business risk, fundamental risk. 8. Probability Expected future return 10% (10%) 20% 2% 40% 12% 20% 20% 10% 38% (i) Expected return E(R) = (0.1)(-0.1)+(0.2)(0.02)+(0.4)(0.12)+(0.2)(0.2)+(0.1)(0.38) = 0.12 or12% (ii) Standard deviation SD = √ ( R − E ( R ) ) 2 ( P ) ……. = 12.198% 9. Briefly explain the use of coefficient of variation in risk determination. A standardize measure of dispersion above the expected value, that shows the risk per unit of return. 10. Year Project X, RM-1000 1 100 2 300 3 400 4 700 The project is risky and its WACC is 12%, calculate the modified internal rate of return (MIRR) of the project that minimizes the shareholders’ wealth? Year Project X CompCF Compounded cash flow-1000 1 100 1.4049 140.49 2 300 1.2544 376.32 3 400 1.1200 448 4 700 1.0000 700 1664.81 1000 = 1664.81 ( 1 + MIRR ) 4 MIRR = 13.59%...
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