23) In order to reduce agency problems, managers may be provided compensation th
ID: 2682088 • Letter: 2
Question
23) In order to reduce agency problems, managers may be provided compensation that includes:A) A fixed salary so managers' pay is not at risk, allowing managers to focus on the company's business.
B) A bonus based on the level of profit achieved during the year.
C) An option to buy the company's stock.
D) Incentive pay for achieving higher sales than last year.
Answer:
24) An investor is considering two equally risky investments. Investment A is expected to return $1,000 per year for the next 5 years. Investment B is expected to return $6,000 at the end of 5 years. Which of the following statements is most correct if both investments A and B have the same cost?
A) A risk averse investor will select investment B because it is expected to provide the most cash ($6,000 > $5,000).
B) A risk averse investor will select investment A because it provides cash earlier than investment B.
C) The investor will select investment A only if the cost is less than $1,000.
D) The investor may select investment A or investment B depending on the opportunity cost of money.
Answer:
Explanation / Answer
23) The correct option is (c)
Managers always tend to buy the stock at a cheaper or less price than the market price. They have a chance to buy the stock in the form of managerial compensation. This is just to satisfy the employees of all levels not just the higher management. Giving such type of options can satisfy employees which therefore reduces the agency problems.
Hence this is the reason why managers choose to buy the stock as a part of compensation. hence, the other 3 options are wrong.
24) The correct option is (D) because untill and unless the cost of capital is not known, we cannot select any of the investments with just the original cost. The cash flows for the two projects are also uneven. Hence, we cannot simply select the project with higher cash flows. This is the reason the other 3 options are wrong.
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