Sample MT2 PV Problem

Sample MT2 PV Problem - company. What is the main problem...

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Sample MT2 PV Problem: Six years prior, you signed a 10-year contract that now has 4 years remaining. The contract gave you the interest-free use of $350,000 as long as you worked for the company. The loan is due upon quitting prior to 10 years. However, if you stay the full 10 years, the loan does not have to be repaid. The contract states your salary will be $85,000 a year over the ten years of the contract. (Market interest rate is expected to be 8% over the life of the contract.) a) The contract gives you three distinct income components. Describe each. b) What annual salary offer from another company would be equivalent to the annual value of the remaining years of your contract? c) The main purpose of the terms of such a contract is to solve problems faced by equity financers of the
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Unformatted text preview: company. What is the main problem and how does this contract act to solve the problem? Answers: a) annual salary, interest income on the use of the loan and the annual equivalent of the loan principal to be received in 4 yrs. b) $85,000 + $28,000 + $71,919= $184,919 c) The main problem faced by equity financers is "Moral Hazard" through misuse of funds. That a major portion of compensation is from a "future" payment and the interim use of a large loan means that getting fired for inappropriate use of investor funds would impose a large loss on the employee and therefore this contract establishes a self monitoring device that lowers the monitoring costs of the owners....
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This note was uploaded on 02/22/2012 for the course MANEC 453 taught by Professor Jerrynelson during the Winter '10 term at BYU.

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