Assignment

Problem: Marginal cost-benefit analysis and the goal of the firm

The first five questions refer to the following scenario regarding Ken Allen at Bally Gears.

Ken Allen, capital budgeting analyst for Bally Gears, Inc., has been asked to evaluate a proposal. The manager of the automotive division believes that replacing the robotics used on the heavy truck gear line will produce total benefits of $560,000 (in today's dollars) over the next 5 years. The existing robotics would produce benefits of $400,000 (also in today's dollars) over that same time period. An initial cash investment of $220,000 would be required to install the new equipment. The manager estimates that the existing robotics can be sold for $70,000.

Show how Ken will apply marginal cost-benefit analysis techniques to determine the following:

1. The marginal (added) benefits of the proposed new robotics is $______________
2. The marginal (added) cost of the proposed new robotics is $_________________
3. The net benefit of the proposed new robotics is $______________________
4. Ken Allen should recommend that the company: (Select the best answer below)

a. to not replace the existing robotics because the net profit is positive
b. replace the existing robotics because the net profit is positive

5. Other factors that should be considered before the final decision is made are: (Choose all that apply)

a. What will the energy consumption of the new robotics.
b. Make sure sunk costs are included.
c. Whether even better robotics may be available in a short while
d. Whether there will be additional training necessary with the new robotics

6. ESSAY QUESTION: What does it mean to say that managers should maximize shareholder wealth "subject to ethical constraints"? What ethical considerations might enter into decisions that result in cash flow and stock price effects that are less than they might otherwise have been?

7. ESSAY QUESTION: The Securities Exchange Act of 1934 limits, but does not prohibit, corporate insiders from trading in their own firm's shares. What ethical issues might arise when a corporate insider wants to buy or sell shares in the firm where he or she works?

8. ESSAY QUESTION: Do some reading in periodicals and/or on the Internet to find out more about the Sarbanes-Oxley Act's provisions for companies. Select one of those provisions, and indicate why you think financial statements will be more trust-worthy if company financial executives implement this provision of SOX.

9. ESSAY QUESTION: The SEC is trying to get companies to notify the investment community more quickly when a "material change" will affect their forthcoming financial results. In what sense might a financial manager be seen as "more ethical" if he or she follows this directive and issues a press release indicating that sales will not be as high as previously anticipated?

10. ESSAY QUESTION: A manager at a "Check Into Cash" business (see Focus on Ethics box on page 192) defends his business practice as simply "charging what the market will bear." "After all," says the manager, "we don't force people to come in the door." How would you respond to this ethical defense of the payday-advance business?

11. ESSAY QUESTION: Bond rating agencies have invested significant sums of money in an effort to determine which quantitative and nonquantitative factors best predict bond defaults. Furthermore, some of the raters invest time and money to meet privately with corporate personnel to get nonpublic information that is used in assigning the issue's bond rating. To recoup those costs, some bond rating agencies have tied their ratings to the purchase of additional services. Do you believe that this is an acceptable practice? Defend your position.

The next three questions refer to this news item:

Satellite-radio firm Sirius XM posted earnings and showed some signs of improvement over last year. The company expanded its subscriber base following recession driven subscriber losses in the past year. Revenues were up to a record $629.6 million and losses narrowed to $181.9 million from $217 million the previous year.

Investors perceived the news to be positive and pushed stock prices up by about five percent to 64 cents a share. Analysts believe the company's growth will slow significantly in the future but for the moment is driven by the sales of new cars that come equipped with satellite-radio service. The general consensus is that Sirius will have to become more efficient and slash costs to become profitable. In the meantime, the company continues to pursue subscribers via channels like the new Apple iPhone application released last week.

Source: Kharif, Olga, "Sirius XM: The Good and Bad Earnings News,"

12. What should be the primary goal of Sirius XM management?

A. generate efficiency.
B. maximize profits.
C. minimize costs.
D. maximize stock price.

13. Stock prices responding instantly to the release of new information illustrate which of the following concepts?

A. investor acumen.
B. profitability.
C. market efficiency.
D. none of the above.

14. Which of the following is not a form of the efficient markets hypothesis?

A. semi-strong form.
B. weak form.
C. super-strong form.
D. strong form.