Goal Alignment at a Small Manufacturing Concern

The owners of a small manufacturing concern have hired a vice president to run the company with the expectation that he will buy the company after five years. Compensation of the new vice president is a flat salary plus 75% of the first $150,000 profit, and then 10% of profit over $150,000. Purchase price for the company is set at 4.5 times earnings (profit), computed as average annual profitability over the next five years.

a.Plot the annual compensation of the vice president as a function of annual profit.

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b.Assume the company will be worth $10 million in five years. Plot the profit of buying the company as a function of annual profit.

1-2 Goal Alignment at a Small Manufacturing Concern (cont.)

Does this contract align the incentives of the new vice president with the profitability goals of the owners?

1-3 Goal Alignment at a Small Manufacturing Concern (cont.)

Redesign the contract to better align the incentives of the new vice president with the profitability goals of the owners.

1-4 Goal Alignment at New York City Schools

A total of 1,800 New York City teachers who lost their jobs earlier this year have yet to apply for another job despite the fact that there are 1,200 openings. Why not?

1-5 Goal Alignment between Airlines and Flight Crews

Planes frequently push back from the gate on time, but then wait 2 feet away from the gate until it is time to queue up for take-off. This increases fuel consumption, and increases the time that passengers must sit in a cramped plane awaiting take-off. Why does this happen?

Chapter 2 Questions

2-1 Airline Delays

How will commercial airlines respond to the threat of new $27,500 fines for keeping passengers on the tarmac for more than three hours? What inefficiency will this create?

2-2 Selling Used Cars

I recently sold my used car. If no new production occurred for this transaction, how could it have created value?

2-3 Flood Insurance

The U.S. government subsidizes flood insurance because those who want to buy it live in the flood plain and cannot get it at reasonable rates. What inefficiency does this subsidy create?

2-4 France’s Labor Unions Force Early Closing Times

In 2013, France’s labor unions won a case against Sephora to prevent the retailer from staying open late and forcing its workers to work “antisocial hours.” The cosmetics store does about 20% of its business after 9 P.M., and the 50 sales staff who work the late shift are paid an hourly rate that is 25% higher than the day shift. Many of them were students or part-time workers, who were put out of work by these new laws. Identify the inefficiency, and figure out a way to profit from it.

2-5 Kraft and Cadbury

When Kraft recently bid $16.7 billion for Cadbury, Cadbury’s market value rose, but Kraft’s market value fell by more. What does this tell you about the value-creating potential of the deal?

Chapter 3 Questions

3-1 Concert Opportunity Cost

You won a free ticket to see a Bruce Springsteen concert (assume the ticket has no resale value). U2 has a concert the same night, and this represents your next-best alternative activity. Tickets to the U2 concert cost $80, and on any particular day, you would be willing to pay up to $100 to see this band. Assume that there are no additional costs of seeing either show. Based on the information presented here, what is the opportunity cost of seeing Bruce Springsteen?

3-2 Concert Opportunity Cost 2

You were able to purchase two tickets to an upcoming concert for $100 apiece when the concert was first announced three months ago. Recently, you saw that Stub Hub was listing similar seats for $225 apiece. What does it cost you to attend the concert?

3-3 Housing Bubble

Because of the housing bubble, many houses are now selling for much less than their selling price just two to three years ago. There is evidence that homeowners with virtually identical houses tend to ask for more if they paid more for the house. What fallacy are they making?

3-4 Opportunity Cost

The expression “3/10, net 45” means that the customers receive a 3% discount if they pay within 10 days; otherwise, they must pay in full within 45 days. What would the seller’s cost of capital have to be in order for the discount to be cost justified? (Hint: Opportunity Cost)

3-5 Starbucks

Starbucks is hoping to make use of its excess restaurant capacity in the evenings by experimenting with selling beer and wine. It speculates that the only additional costs are hiring more of the same sort of workers to cover the additional hours and costs of the new line of beverages. What hidden costs might emerge?

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