WEEK 9 ASSIGNMENTDealing with Risk, Asymmetric Information, an.docx

WEEK 9 ASSIGNMENT
Dealing with Risk, Asymmetric Information, and Incentives
INTRODUCTION
Choice of a company
Continue research on Southwest Airlines, or
Select another company, or
Select the company you work for
Size of paper
Six to eight (6–8) pages
QUESTION 1
Evaluate a company’s recent (within the last year) actions
dealing with risk and uncertainty. (10 %)
Difference between risk and uncertainty
Risk is how we characterize uncertainty about values that vary.
Risk is modeled using random variables multiplied by their
probabilities.
Uncertainty refers to the distribution of the random variables.
Which probabilities should be assigned to the various values the
random variables can take?
QUESTION 1
Evaluate a company’s recent (within the last year) actions
dealing with risk and uncertainty. (10 %)
When you’re uncertain about the costs or beneﬁts of a decision,
replace numbers with random variables and compute expected
costs and benefits.

Analyze common types of uncertainty and risk your company
faces. For example:
Uncertainty in pricing
Uncertainty in dealing with suppliers and distributers
…
QUESTION 2
Offer advice for improving risk management. (15 %)
By modeling uncertainty, you can:
Learn to make better decisions
Identify the source(s) of risk in a decisions
Compute the value of collecting more information.
Difference-in-difference estimators are a good way to gather
information about the beneﬁts and costs of a decision.
The ﬁrst difference is before versus after the decision or event.
The second difference is the difference between a control and
an experimental group.
If you are facing a decision in which one of your alternatives
would work well in one state of the world, and you are
uncertain about which state of the world you are in, think about
how to minimize expected error costs.
QUESTION 2
Offer advice for improving risk management. (15 %)
Uncertainty is unavoidable. To cope with uncertainty, gather
more or better information.
Best Buy has used dispersed sets of non-experts to predict
future variables, such as a holiday sales rate.
Google uses internal prediction markets to generate demand and
usage forecasting.

The US Marines advise:
Because we can never eliminate uncertainty, we must learn to
fight effectively despite it. We can do this by developing
simple, flexible plans; planning for likely contingencies;
developing standing operating procedures; and fostering
initiative among subordinates.
QUESTION 3
Examine an adverse selection problem your company is facing
and recommend how it should minimize its negative impact on
transactions. (15 %)
Define adverse selection
Adverse selection is a problem that arises from information
asymmetry—anticipate it, and, if you can, ﬁgure out how to
consummate the unconsummated wealth-creating transaction
(for example, how to make low-risk customers pay for health
insurance).
Screening is an uninformed party’s effort to learn the
information that the more informed party has.
Signaling is an informed party’s effort to communicate her
information to the less informed party.
QUESTION 3
Examine an adverse selection problem your company is facing
and recommend how it should minimize its negative impact on
transactions. (15 %)
Lessons
Anticipate adverse selection and protect yourself against it.
Using screening or signaling helps overcome the adverse
selection problem so that low-risk individuals can be transacted
with profitably.

Gather enough information to distinguish high-risk from low-
risk consumers.
Direct and indirect methods
Information may be gathered indirectly by offering consumers a
menu of choices, and consumers reveal information about their
risks by the choices they make.
QUESTION 4
Determine the ways your company is dealing with the moral
hazard problem and suggest best practices used in the industry
to deal with it. (15 %)
Moral hazard refers to the reduced incentive to exercise care
once you purchase insurance.
What is the difference between adverse selection and moral
hazard?
Adverse selection arises from hidden information about the type
of individual you’re dealing with.
Moral hazard arises from hidden actions.
The cost of managing both problems can be reduced by reducing
uncertainty (gathering more information).
QUESTION 4
Solution

s to the problem of moral hazard center on efforts to eliminate
the information asymmetry
monitoring
changing the incentives
QUESTION 4
Example: Moral hazard in lending.
This is a problem for both the lender and the borrower. If the
bank anticipates moral hazard they will be less willing to lend,
or demand a higher interest rate.
This incentive conﬂict is only made worse when the borrower
can put other people’s money at risk.
Borrowers take bigger risks with other people’s money than
they would with their own.
To control this, lenders must ﬁnd ways to better align the
incentives of borrowers with the goals of lenders.
Banks sometimes do this by requiring borrowers to put some of
their own money at risk.
This is why banks are much more willing to lend to borrowers
who put a great deal of their own money at risk, but it also
leads to the complaint that banks lend money only to those who

don’t need it.
QUESTION 5
Identify a principal-agent problem in your company and
evaluate the tools it uses to align incentives and improve
profitability. (15 %)
Principals want agents to work for their best interests, but
agents typically have different goals than do principals. This is
called incentive conﬂict.
In a well-run organization, decision makers have
the information necessary to make good decisions and
the incentive to do so.
If you decentralize decision-making authority, you should
strengthen incentive compensation schemes.
If you centralize decision-making authority, you should make
sure to transfer specific knowledge (information) to the decision
makers.
QUESTION 5
Identify a principal-agent problem in your company and

To analyze principal–agent conflicts, focus on three questions:
Who is making the bad decisions?
Does the employee have enough information to make good
decisions?
Does the employee have the incentive (performance evaluation
+ reward system) to make good decisions?
Alternatives for controlling principal–agent conflicts center on
one of the following:
Reassigning decision rights (to someone with better incentives
or information)
Transferring information
Changing incentives (performance evaluation and reward
system)
QUESTION 6
Examine the organizational structure of your company and
suggests ways it can be changed to improve the overall
Organizational options
Functional (U-form): A functionally organized firm is one in
which various divisions perform separate tasks, such as
production and sales.

M-Form: An M-form ﬁrm is one whose divisions perform all the
tasks necessary to serve customers of a particular product or in
a particular region.
QUESTION 6
Companies with functional divisions share functional expertise
within a division and can more easily evaluate and reward
division employees. However, change is costly, and senior
management must coordinate the activities of the various
divisions to ensure they work towards a common goal.
Process teams are built around a multi-function task and are
evaluated based on the success of the task.
QUESTION 6

Three possible solutions for incentive conflicts
Change the division that does the decision making,
Change the flow of information, or
Change a division’s evaluation and compensation schemes
Profit center
The benefit of a profit center is that they are easy to evaluate
(and manage); the cost is that they are concerned only with
their own division profit.
A cost center
It is rewarded for reducing the cost of producing a specified
output.
You can get rid of the conflict by turning one division into a
cost center.
QUESTION 6
In a multi-divisional company, transactions between divisions
can create incentive conflicts.
To understand the source of conflicts that arise between
divisions, personify the divisions and consider each to be a
rational actor. Then ask the same three questions

Which division is making the bad decision?
Does the division have enough info. to make a good decision
Does it have the incentive to do so?
The problems of corporate budgeting and how to fix it
ACADEMIC RESOURCES
Use at least five (5) quality academic resources in this
assignment.
5 %
Note: One of your references should have been published within
the last 6 months.
Note: Wikipedia does not qualify as an academic resource.
FORMATTING REQUIREMENTS
Be typed, double spaced, using Times New Roman font (size
12), with one-inch margins on all sides; citations and references
must follow APA or school-specific format. Check with your
professor for any additional instructions.
Include a cover page containing the title of the assignment, the
student’s name, the professor’s name, the course title, and the
date. The cover page and the reference page are not included in
the required assignment page length.

5 %
Running head: FINANCIAL MATRICS CAFÉ GRILL5
Financial Metrics Café Grill
Crystal Messer

The proforma financial models have anticipated outcomes of a
transaction. Café Grill proforma balance sheet gives a summary
of the projected future of the business after all the transactions
based on the current financial status. Café Grill short total
assets, both short term, and long term equate to total liabilities
in the future, and hence the future balance sheet is realistic. The
next business profitability and risks are given out in the
proforma balance sheet. Solvency and liquidity of the business
dare calculated in risk analysis. Café Grill has enough cash to
meet all its obligations as portrayed in the balance sheet. Its
assets equate to the liabilities. The business solvency depicts
whether the company can be able to recover from losses. The
proforma balance sheet also looks into the future profitability
analysis in profitability ratios such as return on equity. (ROE).

The proforma income statement of Café Grill consists of
expenses and revenues alongside the resulting net loss or
income over a certain period from the company’s activities. The
proforma income statement of the business clearly shows the
management and investors whether the firm will make money or
not in the future. The future income statement has got a revenue
section that has inflows of cash as well as cash outflows. The
next net income is calculated by subtracting total expenses from
total revenue. Among the proforma expenses are; COGS (cost of
goods sold). This gives a future value of Café Grill’s direct
costs associated with the production and selling of goods. Other
costs such as expenses in development and research of products
are also included. Expected depreciation costs with respect to
the company’s fixed assets are also part of the proforma income
statement. The proforma non-operating expenses and revenues
include primary business losses such as foreign exchange rates
whereas revenues include patent income. A proforma analysis
on earnings per share, EPS is also calculated from the income
statement to give out the shareholders expected a profit for the
targeted period. The net income section in the proforma income
statement is critical as it represents the firm’s expected
profitability attributable to its shareholders. It determines the
production schedule. It also gives a sales projection as well as
computing other expenses.
The proforma cash flow gives out the expected amount of cash

outflows and inflows of the business. The proforma cash flow
statement illustrates Café Grill anticipated net cash flow over
the specified period. The cash balance on the proforma cash
statement shows improvement, and hence, the business will be
profitable. The proforma cash flow is composed of; operational
cash flows. This gives the expected cash receivership as a result
of Café Grill internal business activities. The cash earnings will
be net positive maintaining the company’s solvency. Investment
cash flows are also included in the proforma cash flow
statement of Café Grill. It estimates the amount of cash that will
be received from long-life assets and other investments.
Proforma financing cash flows will give the anticipated cash
receivership from equity and debt, or the cash paid out as share
repurchases and as dividends.
Café Grill expected rate of return is calculated from the
proforma cash flow statement as well as the net present value.
The two gives out a positive value; hence, the business is worth.
There are no problems with Café Grill’s proforma liquidity as
shown by the proforma cash budget. The company will have
enough cash and hence no probability of collapsing or going
bankrupt. Also, from the proforma cash budget, income
generated by accrual accounting of the firm is of quality. Café
Grill’s financial products risks are also anticipated to be low
based on the proforma cash budget.
Both the tangible and intangible costs of the business do not

exceed the gross income of the company; hence, the funding
source is well implemented.
A business would be worthwhile if it has a good return on
equity ratio (ROE). Return on equity ratio would measure the
effectiveness of the industry in using its equity to generate
income. Dividing the net profit with the equity gives this ratio
by the company’s equity. A return on equity ratio of about 15-
20% would make the enterprise worth as it gives the ability of
the management to generate income from the available equity.
(Saleem, 2011).
Operating margin will also provide a functional analysis of
whether the business is worthwhile. The ratio is calculated by
dividing the operating income with the company’s revenue. If
the industry happens to have a small ratio, then it is less
profitable and vice versa. If the operating margin of the
business is zero, then the company is not earning anything from
its sales. (Saleem, 2011).
Moreover, I would check on the business’s profit margin as the
operating margin ratio won’t be sufficient as a standalone. The
profit margin will measure the amount of profit the company
earns from its sales. The ratio is calculated by dividing profit by
sales. Both gross and net profit margins would be vital in
evaluating the profitability of the venture. Return on assets ratio
(ROA) would be crucial in measuring how the assets are being
effectively utilized to generate profit. The ratio would be made

by dividing the net income by the total assets. If the ratio is
high, then the business is effectively utilizing its assets to
generate profits. (Penman, 2007).
In conclusion, basic earning power ratio (BEP) of the business
is also considered. The ratio would be calculated by dividing
the business EBIT by its total number of assets. Generation of
income form the assets is effective if the ratio is high. EBIT
sums in all the income earned by the company in calculating the
BEP ratio and hence showing how the company makes money.
Comparison of tax situations with the business is done using
BEP ratio (Saleem, 2011).
References
Nissim D, Penman SH. (2001). Ratio analysis and equity
valuation: From research to practice. Review of accounting
studies.
Penman SH. (2007). Financial statement analysis and security
valuation.
Saleem Q, Rehman RU. (2011). Impacts of liquidity ratios on
profitability.

Table of Contents
1. Financial Start Up Needs2
a. Analysis2
b. Rationale3
2. Financing Options3
3. Financial Ratios4
1. Financial Start Up Needsa. Analysis
Start-up needs
Quantity
Total based on month
Amount
Cash at hand
200,000
30
6000,000
Set of cooking tools and Equipment’s
Total needed is 4 as each cost 300,000
0
12,00,000
Purchase of chicken and other needed raw material

5 kg per day and each kg is 1000 of chicken and 10,000 for
other material
150000+300000
450,000
Rent cost
250,000 monthly
250000
250000
Water and cold drink dispenser
100,000 per dispenser of water and cold drink. Total needed in
quantity is 2
400,000
400,000
Air conditioners
5 as each has a cost of 100,000
500000
500000
Tables and chairs
15 sets as each costs 150000
2250,000
2250,000
Standby generator

200000
0
200,000
Utility expenses (electricity bills, fuel etc)
100,000 per day
30
30,00,000
Labour cost
Total 20 working staff and each would be paid 50000, and for
executives 7 managers it needs to pay 120000
30000000+840000
30840000
Total
42090,000b. Rationale
Café grill would require cash at hand of Rs. 200000 to meet day
to day operations and financial needs. And it also requires a set
of cooking tools and equipment in order to cook fries, burgers,
broasts and other needed stuff for cooking. Not only this it
would also require chicken and other raw material needed to
cook chicken and other stuff and it will also incur the cost of
rent as we will not go for the purchase of land and building
because it will incur an excessive cost as paying aren’t in a
month would be simple enough. Café grill would also need to

have water, and cold drink dispensers in order to serve drinks,
water and ice cream to customers. Since it also needs to have an
air conditioner in order to create a smooth and comfortable
environment for customers as because its competitors offer all
these facilities along with it will also need a standby generator
in case of electricity breakdown occurs so that our customers
don’t get dissatisfied with the environment we provide. Lastly,
it will incur some utility expenses such as electricity bills of
light, machines and needed equipment and incurrence of fuel
charges for generator.
2. Financing Options
There are many ways through which company can generate the
amount of money to cater its business needs as café grill can
also go for the joint stock company, loans from bank, peers or
friends, a sole proprietorship in case if he has his own saving
hence in my opinion and partnership. The best financing option
for café grill would be going for partnership among all of its
partners as it can obtain money by a partnership of 5 partners
among each other. As one of the options can be that each
partner must invest an equal amount of money in the business
and also invest sufficient expertise and time needed to run this
restaurant business. Since another option can be active partners
who may invest less amount of money and provide expertise and
knowledge in the business and sleeping partner must invest a
huge amount of investment and pay a very little time to manage

the day to day operations. And approaching through this type
of financing would be finding credible partners who may invest
a certain sum of money as these credible partners can be one of
your friends, relatives or colleagues.3. Financial Ratios
Although there are many direct ways to measure the
performance of the business as we can measure it by evaluating
the number of assets café grill have, low amount of liabilities it
has and etc. but the two most important rations in order to
measure the performance of the business is Return on Equity
ratio (ROE) and current assets (CA) ratio as firstly current
assets ratio means that the amount of currents assets it has in
comparison to its liabilities. In other words, A high proportion
shows a greater degree of protection, which expands flexibility
for the company And also high ratio indicates that company can
have good financial efficiency of using its assets efficiently to
create revenue and its capability to deal with those advantages
whereas return on equity refers to measuring the financial
efficiency that tells us how much company generate profits
relative to its stockholder investment as A rising ROE
recommends that an organization is expanding its capacity to
produce profits without requiring as much capital. It
additionally demonstrates how well an organization
administrates its investors' capital. Hence with these two ratios,
we can measure the company performance of how it is
performing.

Crystal Messer
FIN 317
Table of Contents
1.Brief2
i.Location2
ii.Type of customers2
iii.Competitors2
2.Why this type of business interests you?2
3.Why do you believe it would be successful3

Cafe Grill
Brief
This business is from the food and beverage industry. Café grill
would be a fast-food restaurant chain like Mc Donald, Burger
King, KFC, and other fast-food restaurants. And the type of
business I am planning to start would be a partnership as it
doesn’t require paying income taxes as each partner would have
to pay tax based on personal income and it would have
increased pool of knowledge, capital, and expertise.
Location
The location of the business Warner Robins, Georgia, USA.
Since this would be the best location as would be the best fit
because people would love to try something new when coming
to Mc Donald’s and most of the restaurants and because the area
of your food business will affect about as much as the menu. If
your restaurant is at an inappropriate spot, you won’t attract
customers you will require so as to remain in business.

Type of customers
The type of customers of café grill would be fast food lovers
such as youngsters(these are the people who would love to
spend most of their pocket money with friends ) , children(
because they don’t prefer homemade food every time) and
office going people( who don’t have time to make food would
prefer to drive-thru).
Competitors
The main competitors of café grill would be Mc Donald’s, KFC,
Burger King, Subway, Dunkin Donuts, Pizza hut, Wendy’s and
Taco Bell as they all are direct competitors of café grill as
because they have an almost similar target market and also
selling nearly similar food.
Why this type of business interests you?
As an entrepreneur, I love to do creative and innovative things
and I have an interest in cooking and trying new recipes so it is
the passion and creativity that lures me to open a restaurant.
Not only this but I am also a sociable person so restaurant
business falls into the hospitability category business so I love
to meet new people (greeting customers and solving their
problems). In Addition to this, I possess strong stamina for
working long hours and solving uncertain problems.
Why do you believe it would be successful?
The reason behind taking restaurant business is that eatery

business is one of the most beneficial business in view of its
developing demand as nowadays people want to dine out more
in comparison to cooking meal at home and as per market
research more than twice a week people like to dine out and try
to taste new and tasty food and spend some quality time with
their family and peers as because routine is hectic there so they
find this solution as more appropriate as eating food while
having good time with family.
3 | Page
Sheet1Pro forma balance sheet as at 31st december 2019Café
GrilAssets Liabilities Cash at hand 6000000rent3000000Sales
20000000labor costs 27350000Gnerator 400000Tables and
chairs 2250000Air conditioners 500000cooking tools
1200000Total 3035000030350000Proforma income statement
Cash receipts january february
mrchapriljunejulyaugustseptmberoctobernovemberdecember500
00006000000600000080000001000000010000000120000001200
0000150000001600000018000000Total118000000cash
payments january february
marchaprilmayjunejulyaugustseptemberoctobernovemberdecemb

er200000020000003000000200000040000005000000500000050
000006000000600000070000008000000Total
55000000Proforma cash budget Total cash receipts
=receipts118000000Toital cash payments55000000
1
2
3
4
5
6
7
8
9
A
B
C
D
E
Pro forma balance sheet as at 31st december 2019
Café Gril
Assets
Cash at hand
6000000
Sales

20000000
Gnerator
400000
Tables and chairs
2250000
Unacceptable Below 70% F
Fair 70-79% C
Proficient 80-89% B
Exemplary 90-100% A
1. Evaluate a company’s recent (with in the last year) actions
dealing with risk and uncertainty.
Points Range: 0 (0%) - 21.68 (6.99%)
Did not submit or did not address the subject.
Points Range: 21.7 (7%) - 24.78 (7.99%)
Partially evaluated a company’s recent (within the last year)
actions dealing with risk and uncertainty. Offered advice for
improving risk management.
Points Range: 24.8 (8%) - 27.88 (8.99%)
Satisfactorily evaluated a company’s recent (within the last
year) actions dealing with risk and uncertainty. Offered advice
for improving risk management.
Points Range: 27.9 (9%) - 31 (10%)
Thoroughly evaluated a company’s recent (within the last year)

actions dealing with risk and uncertainty. Offered advice for
improving risk management.
2 Offer advice for improving risk management.
Points Range: 0 (0%) - 32.52 (10.49%)
Points Range: 32.55 (10.5%) - 37.17 (11.99%)
Partially offered advice for improving risk management.
Points Range: 37.2 (12%) - 41.82 (13.49%)
Satisfactorily offered advice for improving risk management
Points Range: 41.85 (13.5%) - 46.5 (15%)
Thoroughly offered advice for improving risk management
3. Examine an adverse selection problem your company is
facing and recommend how it should minimize its negative
impact on transactions.
Points Range: 0 (0%) - 32.52 (10.49%)
Points Range: 32.55 (10.5%) - 37.17 (11.99%)
Partially examined an adverse selection problem your company
is facing and recommended how it should minimize its negative
impact on transactions.
Points Range: 37.2 (12%) - 41.82 (13.49%)
Satisfactorily examined an adverse selection problem your
company is facing and recommended how it should minimize its
negative impact on transactions.
Points Range: 41.85 (13.5%) - 46.5 (15%)

Thoroughly examined an adverse selection problem your
company is facing and recommended how it should minimize its
negative impact on transactions.
4. Determine the ways your company is dealing with the moral
to deal with it.
Points Range: 0 (0%) - 32.52 (10.49%)
Points Range: 32.55 (10.5%) - 37.17 (11.99%)
Partially determined the ways your company is dealing with the
moral hazard problem and suggested best practices used in the
industry to deal with it.
Points Range: 37.2 (12%) - 41.82 (13.49%)
Satisfactorily determined the ways your company is dealing
with the moral hazard problem and suggested best practices
used in the industry to deal with it.
Points Range: 41.85 (13.5%) - 46.5 (15%)
Thoroughly determined the ways your company is dealing with
the moral hazard problem and suggested best practices used in
the industry to deal with it.
5. Identify a principal-agent problem in your company and
profitability.
Points Range: 0 (0%) - 32.52 (10.49%)

Points Range: 32.55 (10.5%) - 37.17 (11.99%)
Partially identified a principal-agent problem in your company
and evaluated the tools it uses to align incentives and improve
profitability.
Points Range: 37.2 (12%) - 41.82 (13.49%)
Satisfactorily identified a principal-agent problem in your
company and evaluated the tools it uses to align incentives and
improve profitability.
Points Range: 41.85 (13.5%) - 46.5 (15%)
Thoroughly identified a principal-agent problem in your
company and evaluated the tools it uses to align incentives and
improve profitability.
6. Examine the organizational structure of your company and
profitability.
Points Range: 0 (0%) - 43.36 (13.99%)
Points Range: 43.4 (14%) - 49.56 (15.99%)
Partially examined the organizational structure of your company
and suggested ways it can be changed to improve the overall
profitability.
Points Range: 49.6 (16%) - 55.76 (17.99%)
Satisfactorily examined the organizational structure of your
company and suggested ways it can be changed to improve the
overall profitability.

Points Range: 55.8 (18%) - 62 (20%)
Thoroughly examined the organizational structure of your
company and suggested ways it can be changed to improve the
overall profitability.
7. Use of at least 5 academic quality references, and one that
has been published in the last 6 months.
Points Range: 0 (0%) - 10.84 (3.5%)
Did not submit or did not include citations or references in
work.
Points Range: 10.85 (3.5%) - 12.39 (4%)
Used enough references; however, not all were of academic
quality, and one has been published in the last 6 months.
Points Range: 12.4 (4%) - 13.94 (4.5%)
Did not use enough references; however, all were of high
quality and citations/references were appropriately done, and
one has been published in the last 6 months.
Points Range: 13.95 (4.5%) - 15.5 (5%)
Used 5 or more academic quality references and citations were
appropriately done, and one has been published in the last 6
months.
8. Clarity, writing mechanics, and formatting requirements
Points Range: 0 (0%) - 10.84 (3.5%)
Student did not submit the assignment or there are so many
errors that work is confusing to read. APA citation not
attempted.

Points Range: 10.85 (3.5%) - 12.39 (4%)
Several errors (5-6) in grammar, formatting and APA citation.
Points Range: 12.4 (4%) - 13.94 (4.5%)
A few errors (3–4) in grammar, formatting, and APA citation,
but not so much that the reader is confused.
Points Range: 13.95 (4.5%) - 15.5 (5%)
Minimal (0-2) errors in grammar, formatting and APA citation.

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