The Agent of the Shareholders - Essay Example

Introductory Finance Name Institution Question one Year that remain before retirement – 30 years Estimated years to be spend in retirement- 27 years Household expenditure per annum- $84,000 Expenditure in years of retirement = 80% of $ 84000 = $67,200 Expected expenditure before retirement = $ (84,000×30) = $2,520, 000 Expenditure in retirement = $ (67,200×27) = $1,814,400 Required amount in retirement = expenditure less available amount = (67,200-53,000) = $14,200 $14,200 discounted for twenty seven years will be as follows: $14,200 = n (1÷1.10)27 14,200 = n ×0.07628 N = 14,200 ÷ 0.07628 N = $186, 162 This will be the amount that has to be raised in thirty years during the active service before retirement. To get the amount needed in one year will be all follows: $ (186,162 ÷30) $6,205.4 $6205.4 = n (1÷1.08)30 6205.4 = n ×0.09938 N = 6205.4 ÷ 0.09938 N = $62,441 Amount to be saved = 62,441 ÷30 = $2081.4 (Fabozzi, 2001). Question two Government bonds increased from 4% to 7%. This occurred amid fears that Greece was not capable of paying the debts owed by her. In 2009, a 10-year bond paying 4% coupon semi-annually. After six months preceding the first coupon payment, invested adjusted their interest to 7%. PB = ∑ C/ (1+i) t + Po/ (1+r) T Bond Price = C × (1-(1/ (1+I) n + M/ (1+i) n The bond is being paid semi-annually hence the maturity period will be 10×2 = 20 Coupon is 4% paid semi-annually (Solomon, 2007). Let as assume that C is $800 while Po is $1000 When the interest rate is: 800/(1+0.04)1 + 1000/(1+0.04)20 = (800 ÷1.04) + 1000/(1.04)20 = 769.2 + 456.4 = $1225.6 When the interest changes to 7% the calculations will be as follows: PB = ∑ C/ (1+i) t + Po/ (1+r) T PB = 800/ (1+0.07)1 + 1000/ (1+0.07)1 = (800÷1.07) + (1000 ÷1.0720) = 747.7+258.4 = $1006.1 It can be noted that increase in the interest rate leads to decrease in the price of the bond. When the interest is at 4% the bond value is $1225.6, when the interest increase to 7% the value decreases to $1006. The value of the bond and the interest are inversely related (Veronesi, 2010). Question three There will be increase in dividend value for three consecutive years prior to the growth. The increase will be 20% each year. Increase in dividend per share in the first year will be as follows: 100% represents $2 120% will represent (120/100) ×2 = $ 2.4 Increase in dividend per share in the second year will be as follows: 100% represents $2.4 120% will represent (120/100) ×2.4 = $2.88 Increase in dividend per share in the third year will be as follows: 100% represents $ 2.88 120% will be represented by (120/100) × $2.88 = $3.456 To calculate the new value of share keeping in mind that the dividend growth will be 5% per year, the following criterion will be followed: The factors needed in calculation of the share value are as follows: Do –Dividend = $3.456 g- Growth rate = 5% r- Required rate of return = 14% The dividend will increase by 5% per annum indefinitely. This is the growth rate of the shares. Value of stock = Do (1+g) ÷(r-g) = 3.456 (1+0.05) ÷ (0.14 – 0.05) = 3.456 (1.05) ÷ (0.09) = 3.6288 ÷ 0.09 = 40.32 = $40.32 = ($40.32 being value of the stock). The value of stock after growth of 5% of stock indefinitely will be $40.32 (Madura, 2009). Question 4 Part A The first investment will earn compound interest in a period of fifteen years. The interest rate to be applied is six percent. The length of time will be accumulative fifteen years. The workout of the solution will be as follows: Fv = p (1+r) n Future value = 2750(1.06)15 = 2750 ×2.396558193 = $6590.545 =$6590.5 The amount realized at the end of the fifteen years will be $6590.5. Part B year additional investment amount at the beginning Interest Interest amount total 1 0 900 0.09 81 981 2 1000 1981 0.09 178.29 2159.29 3 1200 3359.29 0.09 302.3361 3661.6261 4 1500 5161.6261 0.09 464.546349 5626.172449 5 1800 7426.172449 0.09 668.3555204 8094.527969 Part C Alexander can invest the 1200 at the end of the year to earn a 10 percent. The amount at the end of ten years can be calculated as provided in the table below. INVESTING 1200 AT THE END OF EACH YEAR Year Start Of The Year Interest Rate Interest Amount End Of The Year Additional Investment Total 1 0 0 0 1200 2 1200 0.1 120 1320 1200 2520 3 2520 0.1 252 2772 1200 3972 4 3972 0.1 397.2 4369.2 1200 5569.2 5 5569.2 0.1 556.92 6126.12 1200 7326.12 6 7326.12 0.1 732.612 8058.732 1200 9258.732 7 9258.732 0.1 925.8732 10184.6052 1200 11384.61 8 11384.61 0.1 1138.461 12523.071 1200 13723.07 9 13723.07 0.1 1372.307 15095.377 1200 16295.38 10 16295.38 0.1 1629.538 17924.918 1200 19124.92 At the end of the tenth year Alexander will have $ 19124.92 in his bank account. The $1200 will be invested at the end of every year for the next ten years (Lasher, 2010). Part D Alexander can invest $ 1200 at the start of the year for ten years earning the 10 percent interest rate as provided in the following table, the pattern will vary from the previous part since it is at the start of the year. The table below will show how the investment will grow over the period of ten years. The interest is calculated then added to the principal amount which is later added to the new invested $1200 at the beginning of every year. The interest is then calculated on the new amount and the new interest found. The process is repeated for the rest of the years till in the tenth year. part D Year Additional Investment Start Of The Year Interest Rate Interest Amount End Of The Year 1 0 1200 0.1 120 1320 2 1200 2520 0.1 252 2772 3 1200 3972 0.1 397.2 4369.2 4 1200 5569.2 0.1 556.92 6126.12 5 1200 7326.12 0.1 732.612 8058.732 6 1200 9258.732 0.1 925.8732 10184.6052 7 1200 11384.6052 0.1 1138.46052 12523.06572 8 1200 13723.06572 0.1 1372.306572 15095.37229 9 1200 16295.37229 0.1 1629.537229 17924.90952 10 1200 19124.90952 0.1 1912.490952 21037.40047 At the end of tenth year Alexander will have about $ 21037.40047 in his bank account. Question five Agency problem involves a conflict of interest in relationships where a single party is looked upon in representing the best interests of the other party. The problem comes about when the agent who should make decisions that serve the principal is controlled by self-interest, and the best interest of agent may be very different from the best interest of the principal. This problem is also referred to as principal-agent problem. In finance, the agency problem surfaces when a conflict of interest exists between the management of a company and the stockholders of the company. The manager being the agent of the shareholders has to maximize the wealth of the shareholder. The decisions made by the manager should always consider the welfare of the shareholders as the owners of the company (Madura, 2009). Nevertheless, in many circumstances managers would like to maximize their own individual wealth through salary. This is what led to the collapse of Enron Corporation since the managers were so worried about their own salaries that they faked wrong figures to reflect high profits in order to continue receiving high salaries. The managers were blind to the deteriorating state of the company. It is difficult to eliminate to remove the agency problem completely. Agency costs come about through the agency problem. Agency costs are incurred in an effort to eliminate the agency problem. The managers can be encouraged to act in the best interests of the shareholders by use of incentives like compensation that is performance-based. Corporate governance maintenance costs make up the agency costs (Graham, Smart, & William, 2009). The management has to be given incentives in order to treat the interests of shareholders as a priority. It is important to ensure that management to engage in honest dealings. The performance of management has to be monitored. Agency problem can interfere with the goal of profit maximization. The agency problem is brought about by the separation of ownership and management. A firm that does not have its managers being shareholders may experience agency problem from time to time. Decision makers and managers may not come up with decisions that are in support objective of maximization of shareholder wealth (Fabozzi, 2001). The managers may not be very prudent concerning approach to important issues if there is no gain on their side. They may show less energy when approaching issues and attempt to benefit themselves in regard to salary at the disadvantage of the shareholders. In finance, the principals are the shareholders whereas managers are agents since they act on behalf of owners (shareholders). The decision makers in a firm like the board of directors still act as the agents of the shareholders who are the owners. The agents do not always represent the shareholder interest in everything they engage in, and this aspect has the potential of interfering shareholder wealth maximization goal. When the management is perceived as making the wrong decisions for the shareholders this can be depicted in the market trends in terms of price of stock. The shareholders in most circumstances have no power to fire the management since the board of directors is the one that select the management team. The board is elected by the shareholders to represent their interest in the management of the firm. The agency cost or problem can be minimized by ensuring that the management is compensated well to strive to make money by securing raw deals for the company (Graham, Smart, & William, 2009). As said earlier, the managers can also be shareholders of the company so that the interest of the shareholders is considered. Executive compensation contracts are important because they assure the management of a pay package so that they can concentrate of their management duty in the interest of the shareholder. References Lasher, W. (2010). Practical Financial Management, New York: Cengage Learning. Veronesi, P. (2010). Fixed Income Securities: Valuation, Risk, and Risk Management, London: John Wiley. Fabozzi, F.K. (2001). Bond Portfolio Management. New Jersey: John Wiley and Sons. Graham, J., Smart, S.C., & William, L.M. (2009). Corporate Finance: Linking Theory to What Companies Do. New York: Cengage Learning. Madura, J. (2009). International Financial Management. New York: Cengage Learning. Solomon, J. (2007). Corporate Governance and Accountability, London: John Wiley & Sons, 2007 Read More