Introduction to Finance BU6009

Assessment one – week 1

Instructions:

1. The assessment must be submitted before the end of the week.

2. Late submission will result in a reduction of 5% as per institutional policy. 

Question 1:

Ahmed has invested $5,000 in Al- Areen company. The firm has recently declared bankruptcy and has
$100,000 in unpaid debts. Explain the nature of payments, if any, by Ahmed in each of the following
situations.

a. Al- Areen Company is a sole proprietorship owned by Ahmed.

Ahmed is liabale for the whole debt which is equal to $100,000.
b. Al- Areen Company is a 50-50 partnership of Ahmed and Abdullah.
Ahmed and abdulla are liabale for the debt by 50-50 partnership which means that ahmed
will pay half and abdulla will pay half of the debt which equals to $50,000 each. In case
abdulla is not willing or cannot pay half of the debt then Ahmed is liabale for all the debt
which is $100,000.
c. Al- Areen Company is a corporation.
Ahmed is not liabale at all for anything. He is only liable for $5,000 share that he invested in
Al-Areen company because it has limited liability.
d. If Ahmed has nine partners in a bankrupt partnership and all of them liquidated their
possessions and runaway from Bahrain, Ahmed remained alone in Bahrain. He was unable
to escape.
Ahmed is liable for all the debt and he can get sued.

Question 2: Case Study

Ahmed is a financial analyst; he is doing what is called fundamental analysis for United investment
company which is a company that works in the field of shipping cargos all over the world. When Yousef
was analysing the company, he could not find an answer to the decline of nearly $4 per share over the
past nine months because the company’s profits had risen. He could not understand why the firm's
stock price fell as profits rose.

Then Ahmed decided to contact his cousin Aziz who was working in the company, to try to find an
answer to this mystery. His cousin indicated that he had seen documents describing the profit-sharing
plan under which all managers were partially compensated based on the company's profits. He
suggested that perhaps profit was essential to management because it directly affected their pay. Aziz
said, "That is meaningless because the stockholders own the firm. Should not manage what is best for
stockholders? That is wrong! "Ahmed replied," Well, maybe that is why the company was not concerned
with the stock price. Look, the only profits stockholders receive are cash dividends, and this firm has
never paid dividends in its 20-year history. Therefore, stockholders do not directly benefit from profits.
The only way they will benefit is to raise the stock price. "Aziz chimed in," That probably explains why
Introduction to Finance BU6009
Assessment one – week 1

Northern Governorate Municipality environmental officials are suing the firm for dumping pollutants in
the adjacent beach. Why spend money controlling pollution? It increases costs, lowers profits, and thus
lowers management's earnings! Ahmed said I got it. I know now why prices are declining and profits are
rising.

Required:

a) Explain Why the stock price is going down in spit of they are making profit (relate this to Agency
problem and the optimal goal of firms)
It is going down simpily because the managers are not taking care of the share price in the
market. they are only concerned of maximization of profit because there compensation are
linked whith the level of profit. So there is an agency problem which means there is a conflict
because the interest of the shareholders as they should take care of the share price in the
market.

b) Evaluate the company's pollution control approach. Is it ethical? Why could pollution control
expenditure be in the best interests of the company's owners, despite its negative impact on
profits?
It is not ethical. There are numerous sources of benefits for a company that wants to reduce
emissions voluntarily beyond compliance, including improved public and community relations,
lower costs, and higher production owing to better usage of resources. chemical resources and
other production inputs, enhanced employee morale, and a better reputation for the company
with customers, and the risk of a citizen lawsuit is lessened.

c) Based on the information, what specific recommendations would you offer to solve the issue?
 Mentoring management behavior.
 Structuring management compensation to make shareholders’’ interests.
 Agency costs could be incurred to ensure management acts in shareholders interests
 limiting the power of the agent.
 remove financial incentives that encourage conflicts of interest.
 Make the managers the shareholder of the company so they have the same goal as the
company.