Problem2.1 When making a decision, an item of information needs to satisfy two criteria in order to
be relevant and worthy of taking into account. What are these two criteria?
2.2 Why is profit maximisation considered incomplete as the definition of what most busi-
nesses seek to achieve?
2.3 Is exploitation of customers by a monopoly supplier, who charges very high prices,
consistent with the objective of maximising shareholders’ wealth? Explain your
response.
2.4 A business has £1 million at its disposal and managers feel that this could either be
invested in new production facilities or be paid to shareholders as a dividend. What
does the separation theorem suggest that the business should do? Can the business
both pay the dividend and make the investment? Explain.
2.5 Explain why, according to the separation theorem, the financing method (equity or loan)
does not affect shareholders’ wealth.
2.6 Why, in practice, would borrowing by the business to raise cash to pay a dividend not
be economically equivalent to borrowing by the individual shareholders to provide
themselves with cash?
(Note that the answer to this question is not really provided in the chapter. A combina-
tion of background knowledge and common sense should enable you to come up with
some relevant points, however.)Review questions
Suggested answers to
Review questions
in Appendix 3.
(This problem is a basic-level one.)2.1 Talco Ltd undertakes research work. It also manufactures engineering products. It is
currently engaged on a research project which, when completed, will be sold for
£250,000. So far, costs totalling £200,000 have been incurred by Talco on the project.
This is more than was budgeted to bring the project to the present stage and, as a
result, the question arises as to whether it would be better to complete the project or
abandon it immediately.
It is estimated that the following will be necessary to complete the project:
1 Material, already bought at a cost of £40,000 (not included in the £200,000 men-
tioned above) and currently held in inventories (stock). This is toxic material for which
Talco has no other use. It has no market value, but it will, if the project is abandoned,
have to be disposed of at a cost of £8,000.
2 Labour, which will cost a further £25,000. This labour is skilled and in demand else-
where in the business. If the project is abandoned, the labour will be used to make
and sell 2,000 units of a standard product. This product will be sold for £25 each
with a material cost of £12 each.PROBLEM
A sample answer to this
problem appears in
Appendix 4.
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