Question 1

Which of the following capital expenditure may not appear in capital budget? I) Investment in a new plant
II) Investment in a new machine
III) Investment in training employees
A) I only
B) II only
C) III only
D) I and II only

Accepted Answer

A capital budget typically includes long-term investments in tangible assets such as plants, equipment, and machinery. Investment in training employees, which is an intangible asset, may not be included in the capital budget as it is not a physical asset that generates revenue directly.

Question 2

The following capital expenditure(s) are (is) included in the capital budget:
A) Investment in information technology
B) Investment in research and development
C) Investment in training and personal development
D) Investment in a new office building

Accepted Answer

D

Question 3

The following are agency problems associated with capital budgeting except:
A) Reduced effort
B) Maximizing the value of the firm to the shareholders
C) Empire building
D) Perks

Accepted Answer

All of the choices except B are agency problems that can arise in capital budgeting. B is actually the goal of capital budgeting, as it aims to maximize the value of the firm to shareholders by selecting projects that provide the most value.

Question 4

Agency costs can be thought of as the loss in the value of a firm resulting from the following actions by managers:
I. reduced effort
II. perks or private benefits
III. empire building
IV. entrenching investments
V. avoiding risks
A) I, II and V only
B) I, II, and IV only
C) I, II, III and IV only
D) I, II, III, IV and V

Accepted Answer

All of the actions listed can result in agency costs. Reduced effort by managers can lead to decreased productivity and lower profits, perks or private benefits can reduce the funds available for reinvestment or distribution to shareholders, empire building can result in inefficient allocation of resources and lower overall performance, entrenching investments can tie up funds in unproductive assets or projects, and avoiding risks excessively may result in missed opportunities and suboptimal decisions.

Question 5

The ultimate responsibility for monitoring a firm rests with:
I. Shareholders;
II. Board of Directors;
III. Independent accountants;
IV. Lenders
A) I only
B) I and II only
C) I, II, and III only
D) I, II, III and IV

Accepted Answer

The answer of The ultimate responsibility for monitoring a firm...

Question 6

In the principal-agent framework, the ultimate principal is:
I. Managers; II) Board of directors;
III. Shareholders;
IV. Government
A) I and II only
B) IV only
C) III only
D) I, II and IV only

Accepted Answer

In the principal-agent framework, the ultimate principal is the entity or group that owns the company, which is the shareholders. While managers and the board of directors may have decision-making power, they ultimately answer to the shareholders who own the company. The government may have some regulatory influence, but they are not considered the ultimate principal.

Question 7

The following are agency problems associated with capital budgeting except:
I. reduced effort
II. perks or private benefits
III. empire building
IV. entrenching investments
V. avoiding risks
A) I, II and V only
B) I, II, and IV only
C) I, II, III and IV only
D) I, II, III, IV and V

Accepted Answer

The agency problems associated with capital budgeting are reduced effort, perks or private benefits, empire building, entrenching investments, and avoiding risks. Therefore, option D is the correct answer as it includes all of the agency problems associated with capital budgeting.

Question 8

In large public companies monitoring is delegated to:
I. Shareholders;
II. Board of Directors;
III. Independent accountants;
IV. Lenders
A) I only
B) II only
C) I, II, and III only
D) I, II, III and IV

Accepted Answer

The answer of In large public companies monitoring is delegated...

Question 9

Free-rider problem in the case of monitoring results in:
I. ineffective monitoring by the shareholders
II. monitoring being delegated
III. no monitoring by a large number of small individual investors
A) I only
B) II only
C) III only
D) I, II and III

Accepted Answer

The free-rider problem occurs when individuals who benefit from a public good (in this case, effective monitoring) do not contribute to its production. Ineffective monitoring by the shareholders may occur because some shareholders may feel that their individual contribution to monitoring will not make a difference, and therefore they choose to free-ride on the efforts of others. Delegation of monitoring to a third party (such as a board of directors or an external audit firm) may also create a free-rider problem if shareholders expect others to oversee the monitors. Finally, a large number of small individual investors may not have enough influence to affect monitoring decisions, leading them to free-ride on the efforts of larger shareholders. Therefore, all three options (I, II, and III) correspond to the free-rider problem.

Question 10

Calculate the economic value added (EVA) for the firm. (Cost of capital is 10%)
A) $100
B) $50
C) $120
D) None of the above

Accepted Answer

The answer of Calculate the economic value added (EVA) for...

Question 11

CEO compensation is the highest in (the):
A) U.S.A.
B) India
C) U.K.
D) Germany

Accepted Answer

The United States has the highest CEO compensation compared to other countries. In 2018, the average CEO salary in the United States was $14.5 million, which is much higher than the United Kingdom ($7.7 million), Germany ($4.9 million), and India ($2.2 million).

Question 12

When stock options are given to managers as incentives, typically the exercise price of these options is set equal to the firm's:
A) stock price on the day the options are granted.
B) expected stock price in one year from the day the options are granted.
C) expected stock price on the expiration date of the options.
D) none of the above.

Accepted Answer

The exercise price of stock options given to managers is typically set equal to the current stock price on the day the options are granted. This means that the managers would only make a profit if the stock price increases above the exercise price, providing an incentive for them to work towards increasing the company's value. Setting the exercise price at a future expected price or expiration date would not provide the same level of motivation for the managers.

Question 13

Monitoring is done by:
I. Shareholders;
II. Board of Directors;
III. Independent accountants;
IV. Lenders
A) I only
B) I and II only
C) I, II, and III only
D) I, II, III and IV

Accepted Answer

All listed parties (shareholders, board of directors, independent accountants, and lenders) have roles in monitoring a company's activities and performance.

Question 14

Because monitoring is not perfect, managers compensation plans must be designed provide them incentives to:
A) put in a lot of effort
B) work long hours
C) take actions that make employees happy
D) maximize the value of the firm to the shareholders

Accepted Answer

The main goal of a manager should be to maximize the value of the firm to the shareholders. This aligns the manager's interests with those of the company's owners and promotes long-term success. While effort and employee satisfaction are important, they may not necessarily lead to the best outcomes for the company if they do not directly contribute to increasing shareholder value. Working long hours may also lead to burnout and a decrease in performance.

Question 15

The following are agency problems in capital budgeting except:
A) Empire building
B) Entrenching investment
C) Avoiding risks
D) Accepting all the positive NPV projects

Accepted Answer

Accepting all the positive NPV projects is not an agency problem; it aligns with the goal of maximizing shareholder value.

Question 16

Agency costs can be reduced by monitoring:
I. managers' efforts
II. managers' actions
III. by intervening when managers veer off course
A) I only
B) I and II only
C) I, II and III only
D) III only

Accepted Answer

Agency costs can be reduced by monitoring managers' efforts and actions as well as intervening when managers veer off course. Therefore, all three options (I, II, and III) are effective ways to reduce agency costs.

Question 17

Managers on a fixed salary are subjected to following temptations all the time:
I. reduced effort
II. perks or private benefits
III. empire building
IV. entrenching investments
V. avoiding risks
A) I, II and V only
B) I, II, and IV only
C) I, II, III and IV only
D) I, II, III, IV and V

Accepted Answer

Managers on a fixed salary may be tempted to engage in reduced effort to avoid extra stress and work. They may also be tempted to seek private benefits or perks, such as company cars or free travel. In addition, they may work on empire building to create a name for themselves and justify their positions. They may invest heavily in entrenching themselves within the organization to make it hard to replace them. Finally, they may avoid taking risks in order to maintain the status quo and ensure job security. Thus, all five temptations are possible for managers on a fixed salary, making option D the correct answer.

Question 18

The following actions by the managers may result in over-investment problem:
I. entrenching investments
II. empire building
III. investing beyond the point where NPV falls zero
A) I only
B) II only
C) I and II only
D) I, II, and III

Accepted Answer

All three actions listed contribute to over-investment problem. Entrenching investments refers to the tendency of managers to maintain or increase investment in a project even if it is no longer profitable or necessary. Empire building refers to managers expanding their divisions or departments for their own benefit, rather than for the benefit of the company. Investing beyond the point where NPV falls zero means that additional investments will not generate any additional cash flows, which leads to a decline in the company's overall profit. All of these actions can result in over-investment, which can lead to a reduction in the company's overall profitability.

Question 19

Generally, mangers' compensation is based on:
A) the effort they put in
B) the number of hours they work
C) verifiable results
D) none of the above

Accepted Answer

Managers' compensation is usually based on the verifiable results they achieve, such as meeting financial targets, increasing market share, or improving customer satisfaction. This approach incentivizes managers to focus on achieving tangible outcomes rather than just putting in effort or working long hours.

Question 20

If the cost of capital is 10%, what is the net return on investment?
A) 10%
B) 5%
C) 12%
D) None of the above

Accepted Answer

The answer of If the cost of capital is 10%,...

Quiz 12: Agency Problems, Compensation, and Performance Measurement

Which of the following capital expenditure may not appear in capital budget? I) Investment in a new plant II) Investment in a new machine III) Investment in training employees

The following capital expenditure(s) are (is) included in the capital budget:

The following are agency problems associated with capital budgeting except:

Agency costs can be thought of as the loss in the value of a firm resulting from the following actions by managers: I. reduced effort II. perks or private benefits III. empire building IV. entrenching investments V. avoiding risks

The ultimate responsibility for monitoring a firm rests with: I. Shareholders; II. Board of Directors; III. Independent accountants; IV. Lenders

In the principal-agent framework, the ultimate principal is: I. Managers; II) Board of directors; III. Shareholders; IV. Government

The following are agency problems associated with capital budgeting except: I. reduced effort II. perks or private benefits III. empire building IV. entrenching investments V. avoiding risks

In large public companies monitoring is delegated to: I. Shareholders; II. Board of Directors; III. Independent accountants; IV. Lenders

Free-rider problem in the case of monitoring results in: I. ineffective monitoring by the shareholders II. monitoring being delegated III. no monitoring by a large number of small individual investors

Calculate the economic value added (EVA) for the firm. (Cost of capital is 10%)

CEO compensation is the highest in (the) :

When stock options are given to managers as incentives, typically the exercise price of these options is set equal to the firm's:

Monitoring is done by: I. Shareholders; II. Board of Directors; III. Independent accountants; IV. Lenders

Because monitoring is not perfect, managers compensation plans must be designed provide them incentives to:

The following are agency problems in capital budgeting except:

Agency costs can be reduced by monitoring: I. managers' efforts II. managers' actions III. by intervening when managers veer off course

Managers on a fixed salary are subjected to following temptations all the time: I. reduced effort II. perks or private benefits III. empire building IV. entrenching investments V. avoiding risks

The following actions by the managers may result in over-investment problem: I. entrenching investments II. empire building III. investing beyond the point where NPV falls zero

Generally, mangers' compensation is based on:

If the cost of capital is 10%, what is the net return on investment?