Answer to Question #294493 in Management for john k

Question

A. What is an agency relationship? Also, explain how corporate governance is a

solution to the agency problem in corporate form of business organizations.

B. Ndiyepano Investments Ltd. is considering a project requiring an initial investment

of K1 billion and subsequent end of year estimated after-tax incremental operating

cash flows of K200 million, K300 million, K400 million, and K500 million.

Shareholders in Ndiyepano Investments Ltd. require a minimum of 5% return on

their investment. Evaluate the viability of this project using Net present value,

internal rate of return and Non – Discounted Payback period methods of

evaluation.

Answer 1

1. Agency relationship is that relationship where one person, party or group known as the principal allows another person, party or group known as agent to act on their behalf.

Corporate governance ensures that managers hired to operate the company prevent them from deviating so that shareholders stop improper decisions.

2.

a). N.P.V

= Initial investment - sum of cash flows each year.

$=1,000,000,000-(200,000,000+300,000,000+ 400,000,000+500,000,000)$

$= -400,000,000$

Not viable using N.P.V

b). Internal Rate of return

=Average annual income $/$ average investment.

$=350,000,000÷500,000,000$

$=0.7$

Not viable using I.R.R

c). Non discounted payback period is 3 years and 3 months.