Corporate Valuation and Agency Relationships Within any type of business environ

Question

Corporate Valuation and Agency Relationships

Within any type of business environment businesses are always looking at corporate valuation and financial planning to grow in both good and bad economic times.

Define the terms capital intensity and self-supporting growth rate. Explain how a decline in capital intensity would affect the AFN if all other things are held constant?

What is an agency relationship?

When you first begin business operations as a sole proprietor and you are the only employee with only your funds invested within the business operations, would any agency conflicts exist with your company or business? Please explain you answer or response to this question?

Explanation / Answer

Capital Intensity: Capital intensity is the amount of fixed or real capital present in relation to other factors of production, especially labor. At the level of either a production process or the aggregate economy, it may be estimated by the capital to labor ratio, such as from the points along a capital/labor isoquant. It represents the dollars of assets required per dollar of sales. The higher the capital intensity ratio, the more new money will be required to support an additional dollar of sales. Thus, a decline in capital intensity would decrease the AFN, other things remaining constant.

Self-Supporting growth rate is the maximum growth rate the firm could achieve if it had no access to external capital.

“Agency Relationship” is a fiduciary and consensual relationship between two persons where one person acts on behalf of the other person and where the agent can form legal relationships on behalf of the principal. It may be a business or personal relationship. It allows the principal the ability, if you will, to be more than one place at a time, thereby expanding their potential business opportunities.

In other words, one person (the agent) agrees to do something for another party (the principal), subject to the control of the other party, and the other party (the principal) also agrees to the agreement.

It simultaneously means the principal is bound (normally) by what the agent does, since the agent is acts as if the principal were there him/herself.

A potential agency conflict arises whenever the manager of a firm owns less than 100 percent of the firm's common stock. If a firm is a sole proprietorship managed by the owner, the owner-manager will undertake actions to maximize his or her own welfare. The owner-manager will probably measure utility by personal wealth, but may trade off other considerations, such as leisure and perquisites, against personal wealth. If the owner-manager forgoes a portion of his or her ownership by selling some of the firm's stock to outside investors, a potential conflict of interest, called an agency conflict, arises. For example, the owner-manager may prefer a more leisurely lifestyle and not work as vigorously to maximize shareholder wealth, because less of the wealth will now accrue to the owner-manager. In addition, the owner-manager may decide to consume more perquisites, because some of the cost of the consumption of benefits will now be borne by the outside shareholders.

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