Agency Costs of Equity - HAAS SCHOOL OF BUSINESS UNIVERSITY...

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H AAS S CHOOL OF B USINESS U NIVERSITY OF C ALIFORNIA AT B ERKELEY UGBA 103 A VINASH V ERMA A GENCY C OSTS OF E QUITY Consider an owner-manager who owns 100% of an all-equity firm. The firm is currently valued at $1 million. However, an additional investment of $2 million is needed for expansion, which can be raised either as debt at an interest rate of 12%, or as equity. The annual cash flows that the expanded firm will generate depend, among other things, on how hard the owner-manager works. If she works an average of 6 hours a day, the cash flow that accrues annually to the firm is $300,000. On the other hand, if she works 10 hours a day, the annual cash flow increases to $400,000. Let us now examine what kind of incentives she would have under the two proposed financing alternatives. Suppose $2 million is raised as [perpetual] debt. The annual interest payment will be $2, , * . $240, 000 000 012 000 = . The table below works out the owner-manager’s total remuneration. Further, if we assume 250 working days in a year, we can also figure out her hourly
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This note was uploaded on 02/12/2012 for the course UGBA 101A taught by Professor Mccullough during the Spring '08 term at University of California, Berkeley.

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Agency Costs of Equity - HAAS SCHOOL OF BUSINESS UNIVERSITY...

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