FIN 301 HW
Chapter 1 (Odds 1-17)
1. Define shareholder wealth. Explain how it is measured
Shareholder wealth is represented by the market price of a firm’s common stock. It is measured by the market value of the shareholders’ common stock holdings
2. Which type of corporation is more likely to be a shareholder wealth maximizer -one with wide ownership and no owners directly involved in the firms management or one that is closely held. A closely held corporation
3. It has been argued that shareholder wealth maximization is not a realistic normative goal for the firm, given the social responsibility activities that the firm is “expected” to engage in (such as contributing to the arts, education, etc.). Explain why these social responsibility activities are not inconsistent with shareholder wealth maximization. By increasing shareholder wealth, the net worth of the shareholders increase. This would allow them to contribute to their own social responsible activities because they will have additional funds to invest in their own communities.
4. Explain what is meant by agency relationships and agency costs Agency relationships occur when one or more of the principals hire an agent to perform a service on behalf of the principals. Agency costs are costs incurred by the owners of a firm when others manage the firm.
5. What is the source of potential agency conflicts between owners and bondholders? Who is the agent and who is the principal in this relationship? Bondholders do not have any decision-making abilities. They also assume the risk if default because they are a creditor. Bondholders are the agent and the owners are the principals.
6. Explain the relationship between financial management and (a) microeconomics and (b) macroeconomics Financial management relies heavily on related fields and disciplines such as accounting and economics. Microeconomics deals with the economic decisions of individuals, households and firms. Macroeconomics looks at the economy as a whole.
7. Metropolitan Life Insurance Company, Swiss Bank Corporation, and several other holders of RJR Nabisco bonds filed suit against the company to prevent it from completing the leveraged buyout acquisition from Kohlberg Kravis Roberts. Why do you think the bond-holders wanted to block this transaction? What argument can you make for and against the bondholders’ case? The bond-holders suffer because they don’t have an opportunity to share in the higher returns earned by the company taking over after the transaction has increased the risk. The unexpected increase in the financial risk caused the value of the bonds to decline. An argument for the bondholders is their rights were violated that are supposed to be protected under the bond covenants. An argument against the bondholders is they accepted the default risk by becoming a creditor.
8. Under pressure from outside investors including corporate raider Carl Icahn, USX Corporation, the parent corporation for U.S. Steel and Marathon Oil, announced a plan to split its stock into separate steel and energy issues. The market response to this action was immediately positive, with the stock price of USX increasing $2.37 to close at $31.25 on the day of the announcement. Why do you think this action by USX was so well received by the stock market? The company is doing well and the stock price is expensive for investors to acquire ownership. By splitting the number of shares and the price now being half of what it was the liquidity is increased. This promotes trade which in turn promotes an increase in price.
9. How can the adherence to high standards of ethical business practice contribute to the goal of shareholder wealth maximization? This would increase the company’s reputation and make it more valuable. If a business is found to be doing unethical business we can conclude that most people and other companies wouldn’t want to be associated with that making the company less valuable...
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