1) Assignment 1 - Answers

ASSIGNMENT 1: ECO 740: INTRODUCTION AND GOALS OF THE FIRM
PART 1
Answers
1. D
2. D
3. A
4. D
5. B
6. B
7. A
8. E
9. A
10. B
11. B
12. C
PART 2
Question 1.
In the context of the shareholder wealth-maximization model of a firm, what is
the expected impact of each of the following events on the value of the firm?
a. New foreign competitors enter the market.
Answer: New foreign competitor will increase number of competitors within the
market. As a direct response to this increase number of competitors, this will create
additional choices for consumers resulting additional supply. To cope with this new
increase of competitors, the firm will act by dropping price or by offering additional
discounts. Fall in price and also lesser revenue mean that the firms’ value will also
decrease.
b. Strict pollution control requirements are implemented by the government.
Answer: Strict pollution control requirements are very popular measures taken by
governments in ensuring more environmentally approaches will be taken by
companies in producing products. However, as more environmentally friendly
approaches will result in higher cost in production, this will lower the value of the
firm. If all firms will be equally affected by the new strict law, the cost will then be
distributed to the customers by imposing higher price.
c. A previously non-union workforce votes to unionize.
Answer: Unionisation means demand for better working condition and wages. The
first indirect consequences will be the negative impression on the firm as it may give
a bad assumption on bad working environment within the firm. A unionised firm will
directly impact the firm with the increase of cost due to demand of better wages and
benefits. This will be translated into higher expenses by the firm. Direct
consequences will reduce the value of the firm.
However, if the unionisation of the firm will result in better productivity and less
attrition, it may be able to increase the value of the firm in long term.
d. The rate of inflation increases substantially.
Answer: A simple answer will be the reduce of firms value as higher inflation will
cause the price of commodities to increase and resulting in higher cost by the firm.
However, the firm may avoid this if the higher cost will be transferred to the
consumers in order to balance the increase in cost.
e. A major technological breakthrough is achieved by the firm, reducing its

costs of production.
Answer: The major technological breakthrough will be able to improve the firm’s
status within the market. As the breakthrough will be able to directly reduce the
production cost, this will result in higher value for the firm.
Question 2.
How would each of the following actions be expected to affect shareholder
wealth?
a. RJR Nabisco sells its Del Monte division for over Monte division for over $1
billion.
Answer: The selling of the Del Monte division by RJR Nabisco was done as part of
the debt cutting initiative when Kohlber Kravis Roberts was appointed to lead the
company. This initiative was to make it possible to cut the $5.5 billion. As this is a
leveraged buyout, the company was brought in cash with borrowed and their assets
were set as collaterals. This will affect the shareholder positively as the leverage can
be used to generate shareholder’s wealth.
b. Ford Motor Company pays $2.5 billion for Jaguar.
Answer: The buying of Jaguar by Ford Motor Company was set earlier in 1989 and
finalised in 1999. When they were planning the buying of Jaguar, the shareholders
were informed that they were paying for entry position to be part of the premium and
luxury car market. During this buying, the expectation was to increase the
shareholder wealth as they were expecting for a rapid growth within the market in the
90s. However, Jaguar was sold in 2008 as they were not making promising profit
and was sold as part of sustainability strategy,
c. General Motors offers large rebate to stimulate sales of its automobiles.
Answer: Sales rebates often used by companies in promoting their products and to
increase sales. This is what is being done by General Motors. Large rebate may be
risky as it may cause lose if not enough sales made. However, with sufficient of
volume in sales of automobiles, profits will increase as well and this will help in
increasing stock price and will positively impact stockholders’ wealth
d. Rising interest rates cause the required returns of shareholders to increase.
Answer: Rising interest rate will definitely affect shareholders wealth as it will
increase cost especially with higher interest rates for loans. With additional costs, the
companies may not be able to produce more items for sale and may cause decline in
sales, resulting in reducing shareholders wealth. For companies to increase price will
backfire as the increase of interest rate will affect everyone and they will go for same
item with lower price.
e. Import restrictions are placed on the Japanese competitor of Chrysler.

Answer: Import restriction will definitely benefit local producers and companies. By
having less competitors, the local companies will be having direct access to
consumers and they will be able to be the main player with higher profits. This will
directly positively impact the shareholders weatlth.
However, with the possibility of monopoly of the market, consumers might be

affected with higher price.
f. There is a sudden drop in the expected future rate of inflation.
Answer: Drop of rate inflation will be good news for consumers. As rate of inflation is
used to measure the level of price of goods and services, a drop will result in fixed
price and even lower price. With lower rate of inflation, the purchasing power will
increase with more consumers will be able to spend more. With more spending,
profits will increase and directly result in increase of shareholders wealth.
g. A new, labor-saving machine is purchased by Wonder Bread and results in

the layoff of 300 employees.
Answer: With a new labor saving machine purchase by Wonder Bread, the cost of
labour will be able to be reduced drastically. The layoff of 300 employees will result
the saving in terms of reduction in wages and also employees’ benefits. By reducing
the cost of labour, cost of production will be reduced. With lower cost of production,
higher profit will be gained resulting in increase of shareholders’ wealth.

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ASSIGNMENT 1: ECO 740: INTRODUCTION AND GOALS OF THE FIRM

a. New foreign competitors enter the market.

b. Strict pollution control requirements are implemented by the government.

c. A previously non-union workforce votes to unionize.

e. A major technological breakthrough is achieved by the firm, reducing its

b. Ford Motor Company pays $2.5 billion for Jaguar.

c. General Motors offers large rebate to stimulate sales of its automobiles.

d. Rising interest rates cause the required returns of shareholders to increase.

e. Import restrictions are placed on the Japanese competitor of Chrysler.

However, with the possibility of monopoly of the market, consumers might be

f. There is a sudden drop in the expected future rate of inflation.

g. A new, labor-saving machine is purchased by Wonder Bread and results in

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