7/31/2019 Answer of Integrative Case 1 (Track Software,Ltd)

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a. (1) Upon what financial goal does Stanley seem to be focusing? Is it the correct goal? Why orwhy not?

Stanley seems to be focusing on profit maximization, in another word the EPS performance. It is

not the correct goal, as profits do not necessarily result in cash flows available to the

stockholders, only when earnings increases are accompanied by increased future cash flows

would a higher stock price be expected, therefore the stockholders wealth would be

maximized.

(2) Could a potential agency problem exist in this firm? Explain.

There is a potential agency problem exist in this firm. First of all,he owns only 40% of the firm,

but he manages actively all aspects of its activities and the other stockholders are not active in

management

of the firm, so he is an agent of the other owners. Secondly he is reluctant to take more than

moderate risk, which might jeopardize his goal of profit maximization and reduce his personal

wealth, so there

is a conflict between owner wealth maximization and his personal goals.Scri Bd:

(a)Upon what financial goal does Stanley seem to be focusing? Is it the correct go al?Why

or Why not?

T h e f i n a n c i a l g o a l t h a t S t a n l e y s e e m s t o b e f o c u s i n g o n i s m a x i m i z i n g

t h e profitability of Track Software Inc. which is apparent in years 1997 to 2003 increases in n e t

p r o f i t f r o m ( $ 5 0 , 0 0 0 ) t o $ 4 8 , 0 0 0 r e s p e c t i v e l y . H i s f i n a n c i a l g o a l o f

p r o f i t maximization was also evident in his hesitance to hire a software developer because this

would result in a salary cash outflow of $80,000 per year and lower the Earnings Per Share

(EPS) in years to come.

Par:

(1)Stanley is focusing on maximizing profit, as shown by the increase in net profits over thep e r i o d

1 9 9 7 t o 2 0 0 3 . H i s d i l e m m a a b o u t a d d i n g t h e s o f t w a r e d e s i g n e r , w h i c h

w ou ld d e p r e s s e a r n i n g s f o r t h e n e a r t e r m , a l s o d e m o n s t r a t e s h i s

e m p h a s i s o n t h i s g o a l . M a x i m i z i n g w e a l t h s h o u l d b e t h e c o r r e c t g o a l

f o r a f i n a n c i a l m a n a g e r . W e a l t h m a xi mi za t io n t a ke s a l o ng - t er m

pe rs pe ct iv e an d al so co ns id er s r i sk an d ca sh f l ow s. Profits maximization does not

integrate these three factors (cash flow, timing, risk) in thedecision process

(2) An agency problem exists when managers place personal goals ahead of corporate goals.Sinc e

Stanley owns 40% of the outstanding equity, it is unlikely that an agency problem would

arise at Track Software

Another Scri:

7/31/2019 Answer of Integrative Case 1 (Track Software,Ltd)

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A. Maximization of shareholder wealth, which means maximization of share price,should be theprimary goal of the firm. Unlike profit maximization, this goalconsiders timing, cash flows, and

risk. It also reflects the worth of the owners'investment in the firm at any time. It is the value they

can realize should theydecide to sell their shares.

B. Yes, there appears to be an agency problem. Although compensation for management is tied toprofits, it is not directly linked to share price. In addition,management's actions with regard to

pollution controls suggest a profitmaximization focus, which would maximize their earnings,

rather than an attemptto maximize share price