Question Two

] a) Agency problem arises when the agents pursues their own interest rather than the interest of the principal. Discuss the causes of conflicts between shareholders and auditors and the solutions to the conflict.

b) Sunrises Ltd. dealing in readymade garments, is planning to expand its business operations in order to cater to the international market. For this purpose, the company needs additional KES. 8000, 000 for replacing machines with modern machinery of higher production capacity. It involves committing the finance on a long-term basis. These decisions are very crucial for any business since they affect its earning capacity in the long run. The company wishes to raise the required funds by issuing debentures. The debt can be issued at an estimated cost of 10%. The EBIT for the previous year of the company was KES. 800,000 and the total capital investment was KES. 10,000,000. Instead of issuing 10% Debenture the Company can issue Equity Shares for raising the fund.

The financial manager of the company would normally opt for a source that is the cheapest.

i) Identify and explain the long-term finance decision being contemplated.

ii) Examine the main factors affecting each of the decisions contemplated above. [