Question # 1.

”The success and failure of a corporation depends on the relationship between its
owners and managers.” How much do you agree with this statement? How would the conflicts
between owners and managers, if happened, affect the value of a corporation? Suggest some
ways to mitigate against these possible conflicts. (04 Marks)

Success of a corporation certainly depends on relationship between its owners and managers, as
we all know in a corporation management is separate from its owners. Management should work
for the best interest of shareholders or owners however managers often make decisions that are
of their interest. Managers often choose projects or make decision that drives personal benefits
and are not contributing towards success of the company, this is the result of separate
management than shareholders. In such stances management is not goal aligned towards value
maximization of the corporation and agency conflict occurs.

To cope up with agency conflict and unaligned management owners often needs to bear two
types of costs, managers often choose projects that benefits them (short term) or boost their
performance and incentives and forgo the potential projects that will contribute to value
maximization. This is called implicit (opportunity cost). Moreover, sometimes
owners/shareholders may need to rely on third party involvement for monitoring, specifically
internal and external auditors which is explicit cost. Be it explicit or implicit cost it will ultimately
affect the value of the firm as any other unwanted expense. Firms should establish and follow
effective corporate governance system as their operating manual to mitigate such conflicts.

Question # 2. The Balance Sheet and Income Statement of XYZ Corporation is appended below:

Balance Sheet ($ in Millions) Income Statement ($ in

Assets 2020 Liabilities and2020 Millions)
Owners' Equity   2020  
Current Assets   Current Liabilities   Sales 2026  
Cash 339 Accounts Payable 678 Cost of Goods Sold 1525  
Accounts Receivable 678 Notes Payable 678 Taxable Income 501  
Inventory 1016 Total Current 1356 Taxes 153  
Liabilities Net Income 348  
Total Current Assets 2033 Long-Term Liabilities   Dividends 119  
    Long-Term Debt 847 Addition to Retained Earnings 229  
Fixed Assets   Total Long-Term847
Liabilities
Net Fixed Assests 1355 Owners' Equity  
    Common Stock ($1 Par) 508
    Retained Earnings 677
    Total Owners' Equity 1185
Total Assets 3388 Total Liab. and 3388
Owners' Equity

Required:
Use the balance sheet and income statement above to perform (calculate):
(a) DuPont analyses and identify the strengths or weaknesses where the company should
focus to improve Return on Equity (ROE). (2.5 Marks)

(b) External financing needed (EFN) given that the company’s fixed assets are being utilized at
full capacity and forecasted growth rate in sales is 20%. (1.5 Marks)
Question # 3. A cement manufacturing company is considering replacing an old machine with a
new one. The net investment is $105,625 and incremental net annual cash inflows are $29,250
per year for the next five years of the new machine. The average annual net income is $8,125 per
year for next five years. The machine has no salvage value. Calculate the following. (05 Marks)

Required:

(a) Average Accounting Return, Payback Period, Internal rate of return, and Net present value
assuming a 14 percent cost of capital.

Average accounting return:

AVG.NETINCOME/AVG.INTIAL COST
=8,125/21,125
=0.38 OR 38%
 Payback Period
Period CF Balance
(105625)

1 29250 (76375)

2 29250 (47125)

3 29250 (17875)

17875/29250= 0.611

Therefore Payback Period is 3+ 0.611

3.611 years

$105,625 = $29250/(1+.12) + $29250/(1+.12)2 + $29250/(1+.12)3 + $29250/(1+.12)4 +

$29250/(1+.12)5
Therefore IRR= 11.9%

NPV: -ICO + EPV OF CF

= -105625+ 100417.618
NPV= -5207.382

(b) If the cement manufacturing company has a target accounting rate of return of 35
percent, a maximum payback of four years, and a 14 percent cost of capital, should the
firm undertake the project? Provide your reasoning for acceptance or rejection of the
project.
Firm shouldn’t undertake the project as the cost of capital is higher than IRR. 14% >
11.9%. Although the projects payback period is within 4 years Firm shouldn’t undertake
the project as the cost of capital is higher than IRR. 14% > 11.9%

Question # 4. Why do companies need to go public? Is the traditional IPO process relevant in
today’s business environment? (02 Marks)

An initial public offering is the process of offering shares of a private corporation to the public in a
new stock issuance. The traditional IPO process is not that relevant in today’s business
environment as there has been a significant decline in companies going public since 2000. Once a
company goes public, its finances and almost everything about it, including its business
operations, is open to government and public scrutiny. Following are the reasons why companies
need to go public.
1) For the purpose of raising additional capital in order to pay back debt or to expand existing
business by selling shares to the public.

2) Going public is a great way for companies to market themselves especially for companies that
are not widely known, an IPO provides a huge amount of publicity and attract new investors,
partners, and customers.
3) When a company goes public and the market for its stock is set up, the company's stock can be
looked at as ‘currency’. Most private companies’ stock is not highly valued, so it is much easier
to acquire other companies using stock once they’re public. It is sometimes looked at more
favorably than cash due to long-term tax implications when acquiring a business.