Suppose the CEO of a $750 million all-equity firm personally owns $15 million in company stock. Assume that the risk-neutral CEO makes investment decisions based strictly on the change in value (or expected change in value for risky investments) of her personal holdings, plus private benefits (if any) she gets from the investment. a) Suppose the CEO is considering a risky investment that will generate a gain with a present value of $100 million with 50% probability, but a loss of $150 million (present value) with 50% probability. Will she invest in the risky project? b) Now, suppose that the firm recapitalizes by borrowing $700 million and pays a special dividend of $700 million, and suppose that the CEO reinvests her $14 million dividend back into the recapitalized firm. (In answering this question, ignore any change in the overall value of the firm resulting from the recapitalization.) Given the same assumptions as in (i) above, will she invest in the risky project?

Suppose the CEO of a $750 million all-equity firm personally owns $15 million in company stock. Assume that the risk-neutral CEO makes investment decisions based strictly on the change in value (or expected change in value for risky investments) of her personal holdings, plus private benefits (if any) she gets from the investment. a) Suppose the CEO is considering a risky investment that will generate a gain with a present value of $100 million with 50% probability, but a loss of $150 million (present value) with 50% probability. Will she invest in the risky project? b) Now, suppose that the firm recapitalizes by borrowing $700 million and pays a special dividend of $700 million, and suppose that the CEO reinvests her $14 million dividend back into the recapitalized firm. (In answering this question, ignore any change in the overall value of the firm resulting from the recapitalization.) Given the same assumptions as in (i) above, will she invest in the risky project?

FINANCIAL ACCOUNTING

10th Edition

ISBN:9781259964947

Author:Libby

Publisher:Libby

Chapter1: Financial Statements And Business Decisions

Section: Chapter Questions

Problem 1Q

See similar textbooks

Similar questions

D3)
Is it better for a firm’s actual stock price in the market to be under, over, or equal to its intrinsicvalue? Would your answer be the same from the standpoints of stockholders in generaland a CEO who is about to exercise a million dollars in options and then retire? Explain.
Suppose you are the president of a small, publicly - traded corporation. Since you believe that your firm's stock price is temporarily depressed, all additional capital funds required during the current year will be raised using debt. In this case, the appropriate marginal cost of capital for use in capital budgeting during the current year is the after-tax cost of debt. Question 2 options: True False
If corporate managers are risk averse, does this mean that they will not take risks? If you were a corporate financial manager (NOT an individual person), would you prefer a low-risk, low-return project or a high-risk, high-return project, and why?
a) Suggest how stockholders' direct engagement with managers and management remuneration may be utilised to guarantee managers operate in the best interests of shareholders by maximising shareholder value. b) Explain the link between the Weighted Average Cost of Capital (WACC) and If you use market values to calculate the WACC and your stock price or bond prices become erratic, elaborate how this will influence your capital structure and, as a result, the firm’s investment choice.
Which of the following factors reflect pure market risk for a given corporation?a. Increased short-term interest rates.b. Fire in the corporate warehouse.c. Increased insurance costs.d. Death of the CEO.e. Increased labor costs.
You are the CFO of a profitable firm that is financially constrained. The stock market is currently going through a boom phase (assume this is a bubble). From what you have learned in this course, you know that the rational decision would be to issue new shares and use this income to pursue positive NPV projects. Before you make this decision, what is the most important variable that you would examine Assume you have information on all these variables. Select one: O a. Market Q O b. Fundamental Q O c. Elasticity of price demand for common shares O d. Cash Savings
The more you have invested in a stock, the more likely you are to be interested in monitoring the company's management to ensure they are maximizing shareholder wealth. Question 28 options: True False
a) Assume that the risk free rate of return is 6%, the market expected rate of return is 10%. The standard deviation of the market return is 4% while the covariance of return for security A and the market is 3%. Compute the required rate of return on Security A? b) The Managing Directors of three profitable listed companies discussed their companiesdividend policies at a business lunch.Company A has deliberately paid no dividends for the last five years.Company B always pays a low dividend per share (after adjusting for the general price index) and offer regular bonus issues.Company C always pays a dividend of 50% of earnings after taxation. Each Managing Director is convinced that his company policy is maximizing shareholders wealth.Required:Discuss the dividend policies used by the three companies.
Suppose the compensation committee for a corporation is preparing to hire a new CEO and debating which of two pay packages to offer. Package A includes an annual salary of $1 million plus 1000 shares of stock. Package B also has a salary of $1 million, but has 10,000 options to purchase the company at its current price of $50. a) Draw a graph showing the relationship between the CEO’s total compensation (vertical axis) and the stock price (horizontal axis) for the two pay schemes. Clearly label the two compensation methods in your graph. b) Discuss how a switch from the stock to stock option plan would alter CEO behavior. c) Discuss how a switch from the stock to stock option plan would affect the type of CEO that would be willing to accept the job.
Give typing answer with explanation and conclusion The primary operating goal of a publicly-owned firm interested in serving its stockholders should be to a. Maximize its expected EPS. b. Minimize the chances of losses. c. Maximize the stock price on a specific target date. d. Maximize its expected total corporate income. e. Maximize the stock price per share over the long run, which is the stock's intrinsic value.