Corporate Finance Assignment Agency Problem Finance Essay

Agency jobs arise chiefly from the moral jeopardies caused by information dissymmetry between the principal and the agent ; the agent being a individual hired by the principal to run the company and has decision-making authorization. Corporate directors and CEO ‘s are by and large the agents for the house ‘s shareholders.

Agency jobs though contradictory with corporate moralss have economic effects every bit good. Agent ‘s disposition towards selfish motivation and moral jeopardy caused due to struggle of aims between the principal and agent are the primary grounds that cause bureau jobs. Abuse of bureau consequences when agents are paid inordinate compensation, which includes wage, fillips and stock options. In extra to these benefits such as travel privileges, disbursal history repasts and state nine ranks when provided can take to the agent utilizing them for selfish motivations ensuing in a decrease in the shareholder ‘s net income doing the bureau job.

Agency jobs foremost identified by Berle and Means ( 1932 ) based on their observations of modern corporations concluded that bureau jobs are inevitable between the stockholders and the director. Therefore bureau jobs are mutualist on the agents disposition to corporate moralss. In malice of the principal and the agent holding upon a duties of a market contract, hidden action or information by the agent leads to misrepresentation and this is in struggle with the shareholder ‘s involvement.

Controling the bureau job which has been of immense involvement can be done in the undermentioned ways.

Using hearers to reexamine company books.

Stock options inducements

Common monitoring among directors

Monitoring of the board

Capital market inducement

Agent ‘s values and moralss

Menace of replacing

The Agency jobs originate due to the deficiency of corporate moralss among agents. Though these jobs have economic results their roots are due to unethical behaviour by agents. These jobs are can be controlled but are inevitable unless the agents start following corporate moralss.

Question 2

Undertaking A

Undertaking B


$ 20,000,000

$ 20,000,000

Time period

3 old ages

7 old ages


$ 15,000,000

$ 17,000,000

From the inquiry we understand that Budwell & A ; Son oil company has two boring proposals. Clearly both the undertakings have a high positive NPV value and so they both can be accepted on a base entirely footing. But since the company can afford to continue with merely one proposal, we use the following techniques to do a determination.

Payback Period Technique: Harmonizing to this capital budgeting technique, the proposal which is quickest to interrupt even is preferred. Clearly among the two undertakings Project A has a quicker break-even period comparison to Project B, hence Project A is preferred

Net Present Value ( NPV ) : Harmonizing to this technique, the present value of all future hard currency flows is summed up, and if the consequence is positive i.e. present value of influxs exceeds present value of escapes so the undertaking is desirable. In this instance both the above undertakings are desirable, but the present value of undertaking B is higher than that of undertaking A and hence Project B is preferred.

Decision: The above two techniques yield beliing consequences. The Payback period method has its defect, it does non see the clip value of money and it does non take the hard currency flows after the payback period into history. The NPV technique on the other has overcomes those defects. Project A though holding a quicker payback period has a lesser NPV and this means decrease in net income. Therefore Project B is chosen over undertaking A

Question 3:

Fiscal purchase: pros and cons

Fiscal purchase is the sum of assets a house raises through adoptions and securities.It is the sum of debt of the house, hence higher the adoptions, higher will be the fiscal purchase. The companies with fiscal purchase operate on equities and other fixed return adoptions.Some advantages of fiscal purchase are listed below:

Fiscal purchase leads to an addition in return on equity.

Additions in the operating income is caused which increases the return on

equity and net incomes per portion. Leverage makes certain that the return on equity is

higher than the costs.

The stockholders profitableness will alter harmonizing to the alterations in proportion of profitableness, if the company is financed wholly by equity of stockholder. For illustration, when there is 10 percent addition in net incomes, there will be 10 percent addition in the portion value or in the stockholders dividends. The addition in the profitableness of operation when there is leveraging of the house will non increase the payments. Therefore the stockholders will acquire the extra net incomes and the value of dividends or portions will increase higher than the profitableness of the operation.

By borrowing capitals, the company acquires a liability that must be paid in little parts ( episodes ) over a period of clip. This gives us money for immediate usage, which could be used

for productive intents like using labor and puting in assets. By this money they could

besides construct up militias to run into unanticipated liabilities. Higher fiscal purchase gives us enough of

ready hard currency to construct a strong house. Leverage makes extra capital available

A company that efficaciously uses purchase by its success shows that it can cover with the unanticipated hazards related to debt. This plays a critical function while secondary funding is required. Loans will be available to them at low involvement rates. Since they are recognition worthy, loaners would swear them at give loans at attractive rates.

Some disadvantages of fiscal purchase are explained as follows

When a house uses debt, their usurers want adequate returns to compensate for the excess hazard involved when houses borrow money that must finally be paid. Interest costs can be stultifying if the house ‘s is n’t efficient plenty.

purchase involves immense costs and it is clip devouring. when return on capital employed is less than the cost of the debt after revenue enhancement, the return on equity and the prie of the house ‘s stock falls. hence holding a negative consequence on stock monetary values.leverage plants otherwise with different companies, harmonizing to the nature of the house and other factors in the concern environment. It is a tool to be dealt with cautiousness.

purchase makes investing riskier and most investors are averted to hazards.

inordinate purchase leads to failure.