In most cases, goal of shareholder wealth maximization consistent with a concern for social responsibility and ethnics, by adopting policies that maximize values in the market, the firm can attract capital, provide employment, and offer benefits to its community. Nevertheless, certain socially desirable actions such as pollution control, equitable hiring practices, and fair pricing standards may at times be inconsistent with earning the highest possible profit or achieving maximum valuation in the market. For example, pollution control projects frequently offer a negative return. Under such circumstances, certain cost-increasing activities may have to be mandatory rather than voluntary, at least initially, to ensure that the burden falls equally over all business firms.
Ethics and social responsibility can take many different forms. Ethical behavior for company should be important because it creates an invaluable reputation. However, once that reputation is lost because of unethical behavior, it is very difficult to get back. Some companies are more visible than others in their pursuit of these ethical goals and most companies that do a good job in this area are profitable, save money, and are good citizens in the communities where they operate.
In other context, for example, to achieve sustainable growth and strengthen competition, the company may have to allocate more funds to replace old equipment with new more advanced equipment or to develop high end technology to gain competitive edge, this will lead to a diminution in shareholder’s wealth growth, but in the long run it is beneficial for the company’s long term prosperity and shareholder’s stake.
The NPV rule states that invest if the proposed project’s NPV is positive. Both project A and B has positive NPV, so both project are worth investing. Project A has a larger initial outlay but a larger NPV than project B, while project B has lower cost of capital 12% than project A and a higher IRR and shorter payback period. Since A and B are mutually exclusive project, IRR is not a good measure for ranking the project, because IRR is independent of the scale of the investment. Which project to commend depend on which criteria the investor value most. If the investor invests in order to gain a larger return or want to invest a project with longer duration then project A is recommended. If the investor requires the project to repay its investment in a short period of time or a lower cost of capital, B is recommended.
(a) If the salvage value of the washer is expected to be $1800 at the end of its four-year life, what are the cash flows of the project in years 1 to 4?
The net effect is an UCC increase of $4200, CCA calculations are as follows:
Year UCC CCA (30%) End of year UCC
1 $4200 $ 630 $ 3570
2 3570 1071 2499
3 2499 750 1749
4 1749 525 1224
Then the cash flow excluding the tax shield in each year is: 1600*(1-40%)=960.
Now we determine the cash flow from the project in year 1 to 4 taking CCA tax shield into account.
Year : 0 1 2 3 4
Initial investment: -6000
After tax cash flow excluding CAA: 960 960 960 960
Cash flow from the salvage value: 1800
CCA tax shield: 252 428 300 210
Total project cash flow: -4200 1212 1388 1260 1170
(b) What are the tax implications when this asset class is closed?