Question 1

When firms award stock options to managers as incentives, they typically set the exercise price of these options equal to the firm's

Accepted Answer

The exercise price of stock options is typically set equal to the stock price on the day the options are granted, in order to provide an incentive for the manager to increase the stock price and generate a profit from exercising the options in the future. Setting the exercise price higher than the current stock price would make it less likely that the options would be exercised, while setting it lower would provide less of an incentive for the manager to work toward increasing the stock price.

Question 2

The following capital expenditures are typically included in a firm's capital budget:

Accepted Answer

D

Question 3

CEO compensation is generally highest in

Accepted Answer

CEO compensation is generally highest in the United States, where there is a culture of rewarding top executives with substantial compensation packages. This is often attributed to the country's focus on individual achievement and capitalism.

Question 4

Generally, firms should attempt to base mangers' compensation on

Accepted Answer

Basing managers' compensation on verifiable results aligns their interests with those of the firm and encourages performance. The number of years of managerial experience or the number of hours worked may not necessarily reflect a manager's effectiveness or contribution to the firm. Perks consumed are not a suitable basis for compensation.

Question 5

Agency costs can be thought of as the loss in the value of a firm resulting from the following actions by managers:

Accepted Answer

Agency costs arise from conflicts of interest between managers and shareholders. Managers may engage in actions like reduced effort, seeking perks or private benefits, empire building, making entrenching investments to secure their position, and avoiding risks that could potentially benefit shareholders but threaten their job security, all of which can reduce the firm's value.

Question 6

In large public companies, monitoring is the primary responsibility of the

Accepted Answer

The answer of In large public companies, monitoring is the...

Question 7

Since monitoring is not perfect, compensation plans should primarily provide managers incentives to

Accepted Answer

Compensation plans should primarily incentivize managers to maximize the value of the firm to the shareholders, as this aligns with the overall goal of the organization. While putting thought into their work, working long hours, and making stakeholders happy are important to a certain extent, they are not the primary objective of a compensation plan.

Question 8

Managers on a fixed salary often fall victim to the following temptations:

Accepted Answer

Managers on a fixed salary might be less motivated to exert high effort since their compensation does not directly depend on the company's performance. They might indulge in needless spending on perks or private benefits, engage in empire building to increase their power within the company, make entrenching investments to secure their position, and avoid risks that could potentially harm their job security but might be beneficial for the company in the long run.

Question 9

The following actions by managers are examples of overinvestment:

Accepted Answer

Overinvestment occurs when managers invest in projects that do not maximize shareholder value. This includes entrenching investments, empire building, and investing beyond the point where the net present value (NPV) falls to zero, as these actions do not contribute positively to the firm's value.

Question 10

A firm has an average investment of $1,000 during the year. During the same time, the firm generates after-tax earnings of $150. Calculate the economic value added (EVA)for the firm. (The cost of capital is 10 percent.)

Accepted Answer

Economic Value Added (EVA) is calculated as the net operating profit after taxes (NOPAT) minus the opportunity cost of capital. Here, NOPAT is $150, and the opportunity cost of capital is 10% of $1,000, which is $100. Therefore, EVA = $150 - $100 = $50.

Question 11

The free-rider problem, when referring to monitoring of the firms' performance, often results in

Accepted Answer

The free-rider problem occurs when some shareholders choose not to monitor the firm's performance, relying on other shareholders to do the monitoring. This often leads to ineffective monitoring by shareholders, who may delegate their monitoring responsibility to boards of directors. Additionally, small individual investors may not have the resources or incentives to monitor the firm's performance, leading to a lack of monitoring from this group as well. Therefore, the best answer is D, which includes all of these outcomes.

Question 12

The ultimate responsibility for monitoring a firm rests with the

Accepted Answer

The answer of The ultimate responsibility for monitoring a firm...

Question 13

The following are agency problems associated with capital budgeting except

Accepted Answer

The other choices are agency problems associated with capital budgeting. However, maximizing firm value is the goal of capital budgeting and not an agency problem.

Question 14

In the principal-agent framework, the ultimate principals are
I.managers;
II.board of directors;
III.shareholders;
IV.governments

Accepted Answer

In the principal-agent framework, the ultimate principals refer to those who own the company, namely the shareholders. The other answer options, such as managers, board of directors, and governments, may be considered intermediaries between the shareholders and the agents (employees). However, they are not the ultimate principals who have the final say in the decision-making and control of the company. Therefore, choice C) III only is the best answer.

Question 15

Agency costs can be reduced by

Accepted Answer

Monitoring managers' efforts and actions and intervening when necessary are all effective ways to reduce agency costs. By monitoring both efforts and actions, the principal can ensure that the manager is working hard and making decisions that align with the principal's interests. If the manager veers off-course, intervention can correct the problem before it becomes costly. Therefore, (C) is the best choice. Monitoring managers' efforts only (A) is incomplete as it does not address actions, and (D) is not comprehensive enough as it only addresses intervention without sufficient monitoring.

Question 16

Monitoring is typically done by

Accepted Answer

Monitoring in a corporate setting involves various stakeholders to ensure that the company is managed effectively and in accordance with laws and regulations. Shareholders, the board of directors, and independent accountants play direct roles in monitoring the company's activities. Lenders also have a vested interest in monitoring the company to protect their investments and often impose covenants that require the company to meet certain financial metrics, which necessitates monitoring.

Question 17

Which of the following capital expenditures may not appear in a firm's capital budget?

Accepted Answer

Investment in training employees is not a capital expenditure, but rather an operating expense. A firm's capital budget typically only includes expenditures related to physical assets, such as factories, machinery, and buildings.

Question 18

The following are agency problems associated with capital budgeting:

Accepted Answer

The answer of The following are agency problems associated with...

Question 19

The following are agency problems in capital budgeting except

Accepted Answer

Accepting all positive NPV projects is not an agency problem; it aligns with the goal of maximizing shareholder value.

Question 20

A firm has an average investment of $1,000 during the year. During the same time, the firm generates after-tax earnings of $150.
If the cost of capital is 10 percent, what is the net return on investment?

Accepted Answer

The net return on investment is calculated by dividing the after-tax earnings by the average investment and then subtracting the cost of capital. In this case, ($150 / $1,000) - 10% = 15% - 10% = 5%.

Quiz 12: Agency Problems and Investment