EChapter 2a - mmnnn PDF

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Chapter 2a Goal Alignment among Physicians An elderly physician has built up his own practice into a quite valuable business. Now that he is thinking of retiring, he wants to take on a partner to learn the business and eventually buy the practice in three years. Her compensation will be a salary plus 25% of the profits if they are below the historical average and 50% for any increase above the historical average. The eventual purchase price for the practice will be 5 times the average profits over the three years. Discuss the efficiency aspects of such a contract. Are the incentives of the buyer and seller aligned? So, let’s put the deal down: Seller’s pays a salary plus 25% bonus no matter what the profits are for the year. If the profits are above the historical average he pays a further 25% Buyer receives a salary plus 25% bonus guaranteed, and a deal to buy the business for 5x the average profits over 3 years. If the business has profits above the historical average, an incentive of 50% above salary. The combination of sales price as a function of annual profit, combined with the incentive to get the annual profit high than the historical average will cause a conflict of interest. In addition, it is inefficient to not know the final sales price of the business until the average of the forward 3 years profit can be calculated. The buyer has an incentive to keep the practice average profits lower to reduce the average over three years. The multiplier of 5 to average sales, outweighs the additional bonus of 25%. We do not know her salary compared to average profits, but it is safe to say the average profits are greater than her salary + 50%. For a case example, let’s put the salary at $100k, and the historical average profits at $500k Buyer pays seller a salary plus 25% for 3 years  $100k + $25k  $125k x 3 = $375k Bonus if > historical average profit is an extra 25%, for a 50% bonus  $150k x3 = $450k The delta is $75k, or $25k per year If historical average over the 3 years is $501k, sales price is ~$2.5M The historical average only has to be $25k below $500k for the buyer to profit by not trying to maintain the historical average profit. A better incentive might have been to set the price at 5x the prior 3 years historical average profits, and a bonus if she gets the average profits higher in the three years. This way the buyer and seller know what the final sales price will be, and there is an incentive for the buyer to grow the business while she learns from the seller before he retires.

Chapter 3a Starbucks

Starbucks is hoping to make use of its excess restaurant capacity in the evenings by experimenting with selling beer and wine. It speculates that the only additional costs are hiring more of the same sort of workers to cover the additional hours and costs of the new line of beverages. What hidden costs might emerge? Serving alcohol is different to serving coffee. There is a need to have a license in most states, and stricter rules apply. Starbucks would be liable for over serving patrons. There would be the need to retrain the workforce that are employed to serve alcohol. Some of the current staff might not be old enough to serve alcohol Having two types of employees at Starbucks would be an issue for how they compensate the staff. Most bartenders expect to be receiving a large part of their wages via tips, while baristas expect a larger salary. The alcohol trade would need significant refit of the current hardware used to serve coffee. Alcohol needs to be presented, and stored differently. There is the image issue also. Starbucks has been known for a specialized coffee shop, and to start serving alcohol would impact the brand. If the cliental changed due to the alcohol, one key hidden cost might be the damage to the current cliental reducing their visits.

Chapter 3b Dropping University Courses

Students doing poorly in courses often consider dropping the courses. Many universities will only offer a refund up to a certain date. Should this affect their drop decisions?...