Problem Set1

1. To attract Walt Snore to job of CEO of Good Sleep Inc. Walt is given the following (a) a signing bonus of $500,000 (b) a bonus of $200,000 in any year that company profits raise by at least 2% over the previous year and (c) 1000 shares per annum of the stock, which he might not sell for 5 years.  Which of these components is most likely to address the principle-agent problem?  Which is least likely? Why?
Most Likely:______________

Least Likely:_____________

Reason: _________________________________________________________

__________________________________________________________________

2. Good Sleep Inc. is considering the buy a new mattress assembler which allows the construction of multiple firmness levels in same mattress.  Good Sleep anticipates the following 4-year earnings stream from the sale of this mattress.

Years in the Future    Anticipated Profit (‘000’s)
1                                      50
2                                      40
3                                      30
4                                      20

If the discount rate is 5% and the machine costs $130 (000), payable at once, what is the net present value of machine?  Is it a good buy?  (prepare out the net earnings stream to generate your answer)

Net Present Value_______________________________________

Good purchase?:________

3. Fred Smith owns a British Consul, a security that pays the equal of $1000 U.S. every year on September 15, forever.  Fred has recently considered selling the security.  The current interest rate is 10%

a. What is the minimum sales price he must be offered to should consider selling the Consul, after Sept. 15?

________________________________

b. Joe Miller offers to purchase the Consul, but wants to buy it on Sept. 14. Should Fred change his price in (a)?  If so, why and what price must he charge?

____________________________________________________

____________________________________________________

4. Joe Holiday operated a business renting beach umbrellas this past summer.  He operated the concession for 3 months.  Joe knew that rain was frequent along this stretch of beach, but he was luck and enjoyed 60 rentable days this season.  On each rentable day Joe rented 40 umbrellas per day at $10 per rental.  He ran the concession by himself, but had to pay Beachcomber Enterprises $10,000 for the concession (the use of the umbrellas and for the beachfront rental location).  Suppose Joe could have earned $10,000 working construction.

a. What were Joe’s Accounting Profits for undertaking business? What were his Economic Profits?

Accounting profits: ______________________________________________

Economic profits: _ ____________________________________________

Did Joe realize positive economic profits from venture?  If so, to what were these profits attributable?

Positive economic profits? ( Y / N )

Justification: _______________________________________________________
 
5. Assume that as a lottery prize you win a trip worth $5000.  You are uninterested in trip, however under the terms of prize you can collect the $5,000 in cash, however only if you do not redeem the trip for 3 years.  If the interest rate is 4%, the present value of the prize is

a) $4,445
b) $4,807
c) $5,200
d) $5,624

6. Assume that you own a small portfolio of stock. Your holdings are from mature firms who have a long history of paying a $1000 dividend every year on February 1. You anticipate this pattern to continue indefinitely.  If the interest rate is 5%, what is minimum amount you would require to consider selling this portfolio on February 2?

a) $952.82
b) $1050
c) $20,000
d) $21,000

7. After receiving good reviews for her work at a series of the art shows, Jean Rodin considers quitting her job as a management consultant to pursue full time her hobby of sculpting.  Jean figures which she can sell $90,000 worth her art each year. She found a studio which she can rent for $2,000 per month and know that materials will cost her $10,000 per year.  She now earns $70,000 per year.  If her computations are correct, Jean’s annual economic profits from the venture will be.

a) $56,000
b) $20,000
c) $10,000
d) $14,000

8. Consider again the circumstances in problem 7 above.  What differentiation would it make in Jean’s computations of economic and accounting profits if rather than having to find a studio, she owns a space that she could rent for $2,000 per month if she did not use it herself?

a) Both accounting and economic profits would increase
b) Economic profits would increase but accounting profits would remain unchanged
c) Accounting profits would increase, but economic profit would remain unchanged
d) Neither economic nor accounting profits would change.