Agency Problem:

Assume that a project costs $5 million to implement. With 20% probability, the

project will be worth $18 million. With 80% probability, the project will be worthless. For simplicity,

assume that there is no time value of money here (or, alternatively, that the discount rate is zero).

a) What is the NPV of this project, and should it be accepted or rejected based on the NPV?

$3.6 million, accept

-$1.4 million, reject

$4 million, accept

b) Now, also assume that the manager would receive a private benefit (such as memberships,

travel, prestige, perquisites, etc.) in an amount that is worth $100,000 to him/her. Assume that

the manager is not at risk to lose his/her job and owns no stock in the company. Would the

manager accept or reject the project?

Accept

Reject

Indifferent

c) What is minimum amount of manager's stock ownership to align shareholder and managerial

incentives (for this project)?

10%

7.143%

5.556%

12.25%