Financial management

You are the CEO of a company and are considering a new project that, if accepted, would add $1 million to the value of the company’s equity. If you decide to proceed with the project, you realize that you will have to work eight extra hours each week for one year; the value to you of losing this leisure time is $51,000. Assume that your salary will not be adjusted to reflect this extra work and that the net benefit to you is your only consideration in deciding whether or not to proceed with the project.

a. What would your decision be if you owned 100% of the company’s equity?

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b. What would your decision be if you owned 1% of the company’s equity?

c. What would your decision be if you owned 3% of the company’s equity and the board of directors promised you a bonus of $25,000 if the company’s equity value was increased by $50,000 or more?

d. Suppose you owned 3% of the company’s equity and the board of directors promised you a bonus of $25,000 if the company’s equity value was increased by $50,000 or more. Assume that accepting the project no longer adds $1 million to the company’s equity value, but rather increases the equity value by $X. How high must X be for you to accept the project?

e. Evaluate your results in parts (a) to (d) in the context of the principal-agent problem.

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