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Managerial Economics 2021

2022

Revision Questions II

These questions are for practice and to help you review the course.  They are not intended as hints about the contents of this year’s examination

1. It has been said that small businesses are at the mercy of their bank and have no choice but to accept increases in interest rates and other charges imposed by the bank.  Competition is not effective because other banks are very reluctant to make loans to small businesses who are transferring from another bank. Why might this be?

2.  The risk neutral shareholders of a company have to decide on an investment project.  It is known that the project will yield cash flows of 80 100 or 150 with a probability of  each. The project requires an initial investment of 80 of which 90% is financed by debt.  Assume

that all cash flows are discounted at the risk free rate of 10%.  The interest rate for debt is also 10%.

(a) What is the project’s net present value?

(b) What do shareholders earn and what is the payoff for debt holders? How will each group of capital providers judge the project?

(c) After the debt-holders have agreed to finance the project a new investment opportunity arises.  The new project has cash flows of 10,  140,  150 with a probability of   each. What will the shareholders do now?  How does the situation look from the perspective of the debt holders?

(d) What problem does this example illustrate? Explain.

(e)  Suppose the new project is known about before the debt-holders agree to provide finance. How would this affect the outcome?

3. In much of Europe family firms are common.  These are firms where a controlling block of shares is owned by the members of a wealthy family. what are the advantages and disadvan- tages of this method of organisation?

4. Vertical Relations

(a) You are in charge of a company. Widgets are an important input into your production. How would you decide whether to produce widgets in-house or to buy them from an independent company?

(b) If you order goods on-line some firms will deliver the goods themselves e.g supermarkets, while other firms will use independent delivery companies.  What are the key factors determining the choice.