TAILIEUCHUNG - Microeconomics for MBAs 35

Microeconomics for MBAs 35. The Economic Way of Thinking for Managers. Microeconomics for MBAs develops the economic way of thinking through problems that MBA students will find relevant to their career goals. Maths is kept simple and the theory is illustrated with real-life scenarios | Chapter 10 Production Costs in the Short Run and Long Run 13 the agency cost Given that agency costs will always occur with expanding firms how can the combination of debt and equity be varied to minimize the amount of costs from shirking and opportunism That question is really one dimension of a more fundamental one How can the financial structure affect the firm s costs and competitiveness In this short chapter the eye of our focus is on debt but that is only a matter of convenience of exposition given that any discussion of debt must be juxtaposed with some discussion of equity as a matter of comparison if nothing else. We could just as easily draw initial attention to equity as a means of financing growth. In fact debt and equity are simply two alternative categories of finance subject to much greater variation in form than we are able to consider here available to owners. Owners need to search for an optimum combination given the features of both. Debt and Equity as Alternative Investment Vehicles By debt of course we mean funds or the principal that must be repaid fully at some agreed-upon point in the future and on which regular interest payments must be made in the interim. The interest rate is simply the annual interest payment divided by the principal. Also we must note that in the event the firm gets into financial problems the lenders have first claim on the firm s remaining assets. By equity or stock we mean funds drawn from people who have ultimate control over the disposition of firm resources and who accept the status of residual claimants which means a return on investment which is subject to variation will be paid only after all other claims on the firm have been satisfied. That is to say the owners stockholders will not receive dividends until after all required interest payments have been met the owners are guaranteed nothing in the form of repayment of their initial investments. Obviously owners stockholders accept more risk on their investment

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