2. Agency Costs Tom Scott is the owner, president, and primary salesperson for S
ID: 2665122 • Letter: 2
Question
2. Agency Costs Tom Scott is the owner, president, and primary salesperson for Scott Manu-facturing. Because of this, the companyâ??s profits are driven by the amount of work Tom does.
If he works 40 hours each week, the companyâ??s EBIT will be $450,000 per year, and if he works
a 50-hour week, the companyâ??s EBIT will be $550,000 per year. The company is currently worth $2.7 million. The company needs a cash infusion of $1.5 million, and it can issue equity or issue
debt with an interest rate of 9 percent. Assume there are no corporate taxes.
a. What are the cash flows to Tom under each scenario?
b. Under which form of financing is Tom likely to work harder?
c. What specific new costs will occur with each form of financing?
Explanation / Answer
a) Cash Flows
Scenario 1 Scenario 2
40 hours 50 hours
Cash inflows $550,000 per year $450,000 per year
Overall cash inflow estimation is $1.5 million
b)
Tom likely to work harder on issue of equity because If the company want to issue equity they have to follow the following steps
Equity issuance can involve a private sale, in which the transaction between investors and the firm takes place directly, or publicly, in which case the firm has to register the securities with the authorities and the sale takes place in an organized market, open to any registered investor, a process more akin to an auction. Two common types of public equity issuance are initial public offerings (IPOs) and seasoned equity offerings (SEOs). This is one of the ways firms finance themselves, that is, they obtain funds from investors in order to engage in business.
If you are planning to issue stock, there are a number of important steps that should be undertaken, including the following:
Board Approval The Board of Directors of the company should approve the offer and sale of the stock, any agreements for the sale, and the filing of any needed governmental documents. This can be accomplished through resolutions adopted at a Board meeting or by written unanimous consent.
Shareholder Approval Approval of the shareholders may also be necessary, especially if the Articles of Incorporation of the company are being amended. Amendment of the Articles will typically require approval by the holders of the majority of the outstanding shares, either by resolutions adopted at a meeting or by written consent.
Review the Company Charter. The company’s charter (Articles of Incorporation or Certificate of Incorporation) should be reviewed to ensure that you have enough shares authorized to allow the new issuance.
Review Compliance with Securities Laws. Before an offer or sale of stock can be made, you need to ensure that the proper steps have been taken to comply with the federal securities laws and the securities laws of the states where the offers or sales of stock are made.
c)
Four costs of issuing equity: underwriting fees, share price discounts, delays in registration, and asymmetric-information related stock-price declines. And very important is Flotation Costs. (The Costs of Issuing Securities)
For debt they not have specific costs and for debt we have to pay interest on taken loan
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.