Goals and Governance of the Firm
Answers to Problem Sets
If the investment increases the firm’s wealth, it will increase the value of the firm’s shares. Ms. Espinoza could then sell some or all of these more valuable shares in order to provide for her retirement income.
Managers would act in shareholders’ interests because they have a legal duty to act in their interests. Managers may also receive compensation, either bonuses or stock and option payouts whose value is tied (roughly) to firm performance. Managers may fear personal reputational damage that would result from not acting in shareholders’ interests. And managers can be fired by the board of directors, which in turn is elected by shareholders. If managers still fail to act in shareholders’ interests, shareholders may sell their shares, lowering the stock price, and potentially creating the possibility of a takeover, which can again lead to changes in the board of directors and senior management.
Managers that are insulated from takeovers may be more prone to agency problems and therefore more likely to act in their own interests rather than in shareholders’. If a firm instituted a new takeover defense, we might expect to see the value of its shares decline as agency problems increase and less shareholder value maximization occurs. The counterargument is that defensive measures allow managers to negotiate for a higher purchase price in the face of a takeover bid – to the benefit of shareholder value.
The present value of the 10-year stream of cash inflows is: [pic]
NPV = –$800,000 + $886,739.66 = +$86,739.66
At the end of five years, the factory’s value will be the present value of the five remaining $170,000 cash flows:
Let St = salary in year t
b. PV(salary) x 0.05 = $38,033.13...
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