Agency Cost, Financial Manager Roles, and Loan Amortisation

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Reflective Discussion Questions
Part A:
Agency cost is regarded as an internal cost that is paid by an agent to the principal in the
event of occurrence of situations such as conflict of interest between the shareholders and the
business managers. As such, the expense incurred in resolving the disagreement between the
agent and principal are referred to as agency costs. The three legal from of business and their
corresponding agency cost is as follows:
 Sole Proprietorship: This type of business form is a type of enterprise that is owned and
managed by the owner and as such there is no legal distinction between the business
corporation and the owner. It is referred to as simplest form of business under which a
business operates and theretofore there is no agency cost involved in such type of
business. This is due to absence of any principal and agent in such form of business and
therefore there is no agency cost.
 Partnership: Partnership is regarded as a formal agreement between two or more parties
to manage and operate a business. The partners share the resources and the significant
profit and loss realized as per the terms of partnership. There is limited liability on one
partner to another and therefore there is less probability of occurrence of agency cots.
 Corporation: It is a company or group of people possessing the authority to act as a single
entity and have a definite legal structure. Therefore, there is presence of a separate
principal, that is, owners or shareholders and agent, that is, business leader or manager
holding the responsibility of maximizing the benefit of principal. Therefore, there is a
high chance of occurrence of conflict of interest and associated agency costs (Gitman,
Juchau and Flanagan, 2007).
Part B:
The agency costs related with the different roles of a financial manager are explained as follows:
 Capital Budgeting: The difference in opinion can occur in relation to the use of a capital
budgeting technique such as NPV, IRR, pay-back period or any other to evaluate the
potential feasibility of a project planned to be undertaken by the company.

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 Financing decision: The expense incurred due to conflict of interest between the
shareholders and managers in regards to maintain an appropriate capital structure. The
differences in opinion can occur whether to obtain finance by the use of debt and equity
for promoting the future growth of the company.
 Working Capital Management: This refers to discrepancies occurring between owners
and managers in relation to maintaining a balance between current assets and current
liabilities (Parrino, 2012).
Part C:
The two ways through which agency cost can be reduced are as follows:
 Through changing the ownership structure: When the major ownership of the company
vest with the shareholders than it is easy to minimize the agency cost. This method is not
effective as managerial decision making process vest with the board of directors even if
the ownership changes.
 Establishing the independent Board: The independent board of directors (Outsiders) can
make effective decision that is favorable for all the stakeholders of the company. This
method is effective as independent board of director can make decisions that favor the
shareholders of company without given effect to what management is saying.

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Case Study 1:
Part A:
20 % of the Drive away value of car that is paid from the personal deposit: $20000 * 20% =
$4000
Loan to be taken: $ 16000 and fee of bank A: $400 and bank B: $100
Amount borrowed if loan is taken from the Bank A: $16000 +$400 = $16400
Amount borrowed if loan is taken from bank B: $ 16000 +$100 = $16100
Part B:
Loan payment calculator:
Particulars Bank A Bank B
Loan Amount $ 16,400.00 $ 16,100.00
Interest Rate 6.70% 7.00%
Compounded Quarterly Semi Annually
Interest Rate per period 1.68% 3.50%
Number of payments in a year 4 2
Total number of period 8 4
Payment per period $ 2,207.51 $ 4,383.24
Payment in Year $ 8,830.05 $ 8,766.49