Master of

Business Administration
Managerial Economics
GSM5000

Assignment 1
Prepared By:
Wan Nur Farhah binti Wan Leeh (PBS1311097)
Muhammad Muza Muhayen (PBS1311194)
Mohd Zarulsyafiq Mustafa (PBS1312142)
Cheah Wei Keng (PBS1311103)
Badlina Iziyani binti Badrol Hisham (PBS1311098)

Prepared For:
Pensyarah Prof. Dr. Mohd Shahwahid Haji Othman
Due Dates:
04th October 2013

Q1. In the context of the shareholder wealth-maximization model of a firm, what is the
expected impact of each of the following events on the value of the firm? Explain why.

The goal of shareholder wealth-maximization model is to maximize the net present value of the
expected future cash flow for the equity owners (shareholder). It implies a long term business goal
whereby the amount, timing and risk of the firms expected future profits being the determinants of the
value of the firm. This relationship can be represented by the following equation:
V0 . (Shares Outstanding)

[1]

Where V0 = current value of a share of stock (the stock price)

t = economic profits expected in future period (1 to )
ke = required rate of return
Real Option Value = cost savings or revenue expansions
Equation 1 clearly shows that the NPV takes into account the timing of future profits as in having a
dollar in future worth less than a dollar received instantaneously. The value is said to be discounted at
the required rate of return, ke. The level of risks are one of the factor determining the NPV i.e. the
higher the risk, the higher is the required rate of return, k e, used to discount the future cash flows and
therefore the lower the NPV.

In occurrence of the following events, the expected impacts are as follow:

a. New foreign competitors enter the market.
The entry of new foreign competitors means that there will be no monopoly in the market. The existing
company is expected to lose its competitive advantage in terms of market dominance while
consumers or customers enjoy the benefits due to having alternative suppliers. This may lead to a
negative impact on the existing firms progress in making profit hence the value of the firm is expected
to decrease. In order to retain their market dominance, company is forced to lowering their prices and
forced to share their customers. Based on the supply and demand relationship, as the sales quantity
shifts to the left, the price is expected to decrease causing the NPV to decrease.
b. Strict pollution control requirements are enacted.
A stringent environmental policy updates would increase the cost of production of a company as it is
required to allocate funds for staff trainings and to cover the costs for implementing new control
measures in order to comply with the strict pollution control requirements. In worst-case scenario, a
firm could also be penalized by a more substantial amount if it decides to ignore the requirement and
not adhering to the requirements. The loss of revenue would be the result of the lower rate of
productivity and therefore the firms value decreases. The increase in price is expected to counter the
drop in quantity demanded which may result in almost constant profit. However due to increase in
cost of production, the NPV would therefore be reduced.

c. A previously non-union workforce votes to unionize.

In such a situation, a company would gain less benefit from the workforce unionization as it would
create potential threats such as union strike that will disrupt business operations. It would influence
the firms stock price in ways beyond the managers control such as the possibility of having greater
demands for an increased wage of the workers and therefore reducing the equity owners profit and
the value of the firm. Care should always be taken to handle such incidents and therefore company
would have to invest additional amount for business continuity plans or management. Thus extra cost
incurred would further reduce the NPV and consequently the shareholders wealth.

d. The rate of inflation increases substantially.

The increase of rate of inflation reflects a reduction in purchasing power. Consumers will react to the
price increase by lowering their expenditure and causes loss of economic profits to the company. Net
profit is calculated as the total revenue deducted by the total cost of production. Since price of goods
are higher, this may increase the cost of production i.e. increase in raw material or supply goods for
manufacturing the products. This in turn will lead to negative impact on the profit generated. In
addition, the demand curve is a negative relationship. Therefore when price of goods increase,
quantity demanded will decrease. As a result, the value of the firm is expected to decrease due to
having less profit as a result of lower sales quantity.

e. A major technological breakthrough is achieved by the firm, reducing its cost of production.
Based on the innovation theory of profit, a successful innovation would reward in better generation of
profit. As the technological breakthrough reduces its cost of production, the company is expected to
gain more profit and forced other competitors to compete or alternatively tend to easily adopt the new
technology. The firm gains the upper hand and therefore the value of the firm increases as a result of
the growth in the shareholders wealth maximization.

Reference:
th

Economics for Managers, 12 Edition (Canada: South-Western CEngage Learning, 2011), pp. 8
19.

Chapter 2
Problem 1:

The Managerial Challenge example in the Chapter discussed the rationale for a checked
baggage charge on airlines. As a result of the new surcharge, what would you expect to
happen to the number of checked bags, as well as the average weight of checked bags? Why?

Both number of checked baggage and average weight will expected to drop. Airline industry is
industry that its elasticity fall under elastic region which mean it is very sensitive with price increased.
Although new surcharge is not direct charges on air-ticket fee but it will still impact overall sales due to
baggage fee is cost of complementary, especially if you are sportsmen who do skiing. Such
equipment only can be bring along if it is checked baggage. Therefore, demand curve for airline
traveller will shift to left and demand will drop respectively because of over price increased and
ultimately will causing number of checked baggage drop.
Number of checked baggage and average weight will be influenced by its replacement on board
baggage. Customer will try to make use of on board baggage to avoid paying extra for checked
baggage surcharge.
Although number of checked baggage will expected to drop but it also foresee there will be regain
after short amount of period due to airline industry is fixed cost industry which also means that other
airline operator will face similar issue and expected to resolve similar issue with similar way.

Effect in Demand Curve

The study focuses on the effect of the Deep Water Horizon oil spill in the Gulf of Mexico to the local
wages. A calamity such as aforementioned is assumed to cause the demand curve in the oil cleanup
market to shift to the right, as illustrated in figure 1. This shift will cause an increase of quantity of
workers in the oil cleanup market from Q1 to Q2, and wage to increase from p1 to p2.
Legend

Wage for Unskilled Workers

P1: old wage rate
P2: new wage rate
Q1: old qty of labor
Q2: new qty of labour

Figure 1 shows demand and supply of the oil cleanup wage rate which is denoted by Price p

Effect in Supply Curve

In the case of the oil spill, the event has automatically disqualifies Deep Water Horizon from
conformance to Contamination Control Standards. The sudden rise of need to re-compliance will
cause the Supply Curve to shift to the left. Adding this effect to figure 1, we deduce figure 2.
Wage for Unskilled Worker

Legend
P1: original wage rate

P2

P2: final wage rate

P1

Figure 2 shows the Supply curve shifts to left and demand curve shifts to the right for the
labour in the oil cleanup market

Summary of Demand and Supply graph for Unskilled Labour Wages

After deducing that the demand shifts to the right due to spike in demand for these unskilled workers
and supply shifts to the left due to extra cost to re-comply to legislation(s), the price of wage for
unskilled worker increased from p1 to p2. The illustration suggests that quantity may record only
marginal increase.

Effect on Local Wages

Skilled Labour can be treated as a substitute service over the un-Skilled Labour. Assuming that all is
constant, below is the illustrated example of the effect to the local skilled labours supply and demand.

Demand and supply for skilled Labour

Figure 3 shows a shift to the left of demand curve for the skilled labour services

Supply is deduced to decrease, causing the curve to shift to the left. The increase of wage in the
unskilled labour service as illustrated in figure 2 affect the supply of skilled Labour inversely because
they are substitutes to each other.

Anticipation of increase in Imported Labours

Yes, we do think that there will be an increase in workers migrating there to assist with the cleanup.
This may be done in order to revive the Skilled Labour Services which sees a decrease in overall
quantity. Lower expectations of salary by the migrating labour may be able to set a lower equilibrium
price for the demand and supply for the oil cleanup market.