1 AGENCY PROBLEMS Who owns a corporation Describe the proces

1. AGENCY PROBLEMS

Who owns a corporation? Describe the process whereby the owners control the firm’s management. Describe the main reason why an agency relationship exists in the corporate form of organization. In this context, describe the types of problems that can arise.

2. ENTERPRISE VALUE

A firm’s enterprise value is equal to the market value of its debt and equity, less the firm’s holdings of cash and cash equivalents. This figure is particularly of interest to potential purchasers of the firm. Why?

3. CURRENT RATIO

Explain what it means for a firm to have a current ratio of .50. Would the firm be better off with a current ratio of 1.50? What if it were 15.0? Explain your answers.

4. SALES FORECASTS

Why do you think most long term financial planning begins with sales forecasts? Stated differently, why are future sales the key input?

Solution

QUESTION 1

ANSWER: The shareholders of the company own the business. The process in which owners control the firm management happens through the election of the board of directors in the firm. The shareholders of the business elect their representatives who are the board members and they control the firm\'s management.

The main reason for the agency problem is because managers of the firm act in a manner such that their growth occurs and not that of the firm. The managers of the firm will focus on increase their own compensation (salary) rather than acting in the favour of investors which leads to the agency problem.

The types of problems that can arise are:

1. Managers acting to increase their own salary within the company

2. Managers may not want to give dividends and shareholders may want dividends

3. The Managers may see that a particular merger as attractive whereas shareholders do not.

4. The managers may not solve the operational issues as fast as the shareholders want.

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