Kindly provide accurate answers to the following assignment
Kooldean plc was founded several years ago by the inventor of an innovative consumer product. The product has been very successful in the UK and the inventor has decided to seek a quote on the Alternative Investment Market (AIM). At present 60% of Koolclean plc's shares are held by the inventor and the remaining 40% are held by a venture capitalist who is keen for the company to list in this way so that his block of shares can be sold. The company has been managed by the inventor herself, assisted by a part-time director appointed by the venture capitalist. The part-time director will step down when the venture capitalist's block of shares is sold. The inventor is keen to appoint an experienced management team and has decided to offer a remmeration package that comprises a fairly large number of share options and a relatively small salary in order to attract a particular type of manager. Kooldean plc has published audited financial statements every year since it was incorporated. The inventor has decided to replace the company's audit firm with one that is larger and more experienced in auditing the financial statements of quoted companies. (i) Explain the advantages and disadvantages of seeking the initial funding for a new business in the form of equity from a venture capitalist rather than borrowing. [6] (ii) Explain the agency issues that are likely to arise from paying the new directors with share options rather than salaries. [8] (iii) Describe the external auditor's role in protecting Koolclean pic's shareholders' interests after it obtains its quotation. [6] [Total 20]venture capitalist's equity will also leave scope for borrowing if required, thereby providing scope for greater flexibility in seeking fresh funding. The venture capitalist is likely to seek an exit route in the medium term to release funds that can be reinvested elsewhere. That could mean that the company has to fund a major outflow at a crucial stage of its development. The other major problem is that the venture capitalist will be looking for a realistic price for the shares when they are bought out. If the company has prospered then the cost of releasing the equity may be prohibitive. Share options give the directors an incentive to maximise the share price. That may have the effect of bringing their interests into line with those of the shareholders. The directors will have an incentive to work hard and use their ingenuity in order to create wealth for the company. There are some dangers with options, though. The directors will need the share price to exceed the strike price before the options expire. That could give them an incentive to push the company's growth too quickly or even to distort the share price by manipulating the financial statements. The options also expire worthless, so the directors will have very little to lose if the options are out of the money and they decide to take a major risk. If the risk pays off then the options will be in the money and if not then the options would have been worthless anyway, but that will be of no consequence to the shareholders. The value of the options will be enhanced if the company's share price becomes more volatile. The shareholders might prefer a less volatile (i.e, less risky) investment. The auditor is appointed by the shareholders and reports to the shareholders. The external auditor has no specific duty to protect the shareholders interests. The auditor forms an opinion on the truth and fairness of the financial statements and reports that to the shareholders. If there are material concerns about the financial statements then they should be reported to the shareholders in the audit report. The purpose of the audit is to ensure that the shareholders have a credible source of accounting information that they can use to make stewardship decisions. The auditors do not claim to identify badly run or unprofitable companies. It is up to the shareholders to make such decisions for themselves, informed by the audited financial statements as they deem appropriate.venture capitalist's equity will also leave scope for borrowing if required, thereby providing scope for greater flexibility in seeking fresh funding. The venture capitalist is likely to seek an exit route in the medium term to release funds that can be reinvested elsewhere. That could mean that the company has to fund a major outflow at a crucial stage of its development. The other major problem is that the venture capitalist will be looking for a realistic price for the shares when they are bought out. If the company has prospered then the cost of releasing the equity may be prohibitive. Share options give the directors an incentive to maximise the share price. That may have the effect of bringing their interests into line with those of the shareholders. The directors will have an incentive to work hard and use their ingenuity in order to create wealth for the company. There are some dangers with options, though. The directors will need the share price to exceed the strike price before the options expire. That could give them an incentive to push the company's growth too quickly or even to distort the share price by manipulating the financial statements. The options also expire worthless, so the directors will have very little to lose if the options are out of the money and they decide to take a major risk. If the risk pays off then the options will be in the money and if not then the options would have been worthless anyway, but that will be of no consequence to the shareholders. The value of the options will be enhanced if the company's share price becomes more volatile. The shareholders might prefer a less volatile (i.e, less risky) investment. The auditor is appointed by the shareholders and reports to the shareholders. The external auditor has no specific duty to protect the shareholders interests. The auditor forms an opinion on the truth and fairness of the financial statements and reports that to the shareholders. If there are material concerns about the financial statements then they should be reported to the shareholders in the audit report. The purpose of the audit is to ensure that the shareholders have a credible source of accounting information that they can use to make stewardship decisions. The auditors do not claim to identify badly run or unprofitable companies. It is up to the shareholders to make such decisions for themselves, informed by the audited financial statements as they deem appropriate.1. (a) Agency theory presents the firm as a combination of competing interest groups, two of which are shareholders and management. REQUIRED Discuss how the firm's attitude to risk might vary depending on whether shareholders objectives or management oriented goals predominate in the firm's planning. (10 marks) (b) The directors of Gatimu Led are in the process of establishing shareholders utility function. They have approached Mr. Kilo, the principle shareholder and given him the following lotteries:- 1. 0.5 chance of receiving Sh. 0 and 0.5 chance of receiving Sh. 100,000. He is willing to pay a maximum of Sh. 45,000 for this lottery. 2. 0.4 chance of receiving Sh.45,000 and 0.6 chance of receiving Sh.100,000. He is willing to pay a maximum of Sh. 85,000 for this lottery. 3. 0.3 chance of receiving Sh. 0 and 0.7 chance of receiving Sh. 45,000. He is willing to pay a maximum of Sh. 30,000 for this lottery. Assume that utile values of 0 and 1 are assigned to a pair of wealth representing the two extremes (Sh 0 and sh. 100,000 respectively). REQUIRED Compute the utile value of Sh. 45,000, Sh. 85,000 and Sh 30,000. Construct the utility function of Mr. Kilo and state his risk attitude. (10 marks) (Total: 20 marks)
