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Problem 5-3

(a) The risk-indifferent manager would accept Investments X and Y because


these have higher returns than the 12% required return and the risk does not
matter.

(b) The risk-averse manager would accept Investment X because it provides the
highest return and has the lowest amount of risk. Investment X offers an increase
in return for taking on more risk than what the firm currently earns.

(c) The risk-seeking manager would accept Investments Y and Z because he or


she is willing to take greater risk without an increase in return.

(d) Traditionally, financial managers are risk-averse and would choose


Investment X, since it provides the required increase in return for an increase in
risk.

Problem 10-3

(a) Project X Project Y

PVn = PMT × (PVIFA15%,5 yrs.) PVn = PMT × (PVIFA15%,5 yrs.)

PVn = $10,000 × (3.352) PVn = $15,000 × (3.352)

PVn = $33,520 PVn = $50,280

NPV = PVn − Initial investment NPV = PVn − Initial investment

NPV = $33,520 − $30,000 NPV = $50,280 − $40,000

NPV = $3,520 NPV = $10,280

Calculator solution: $3,521.55 Calculator solution: $10,282.33

Both projects should be accepted because NPV is >0.


Assessing the Goal of Sports Products, Inc.

(a) Maximization of shareholder wealth, which means maximization of share


price, should be the primary goal of the firm. Unlike profit maximization, this goal
considers timing, cash flows, and risk.

It also reflects the worth of the owners’ investment in the firm at any time. It is the
value they can realize should they decide to sell their shares.

(b) Yes, there appears to be an agency problem. Although compensation for


management is tied to profits, it is not directly linked to share price. In addition,
management’s actions with regard to pollution controls suggest a profit
maximization focus, which would maximize their earnings, rather than an attempt
to maximize share price.

(c) The firm’s approach to pollution control seems to be questionable ethically.


While it is unclear whether their acts were intentional or accidental, it is clear that
they are violating the law—an illegal act potentially leading to litigation costs—
and as a result are damaging the environment, an immoral and unfair act that
has potential negative consequences for society in general. Clearly, Sports
Products has not only broken the law but also established poor standards of
conduct and moral judgment.

(d) From the information given there appears to be a weak corporate governance
system. The fact that management is able to measure and reward their
performance on profits indicates that no one is watching out for the shareholders.
Loren and Dale’s concerns indicate that employees apparently have an interest
in the long-run success of the firm. Allowing the continuation of pollution
violations is also apparently escaping the interest and control ability of others
who should be monitoring the firm.