The first thing that needs to understand is what the maximization of shareholder wealth is. The shareholders of the company want to enhance the value of the shares to the highest level possible .The high stock means that the value of the company also increased. More clearly, "when business managers try to maximize the wealth of their firm, they are actually trying to increase their stock price. As the stock price increases, the individual who holds the stock wealth increases. As the stock price goes up, the value of the firm increases and the net worth of the individual who owns the stock increases".
In the most situations, the goal of maximization shareholder wealth does not conflict with the social responsibility for the firm. Actually, sponsorship of sporting events or charitable activities without making profit is one of many ways to expand the good company's imagining. The logo and company's name are mentioned as well as shown throughout the program will make participants show more their attention. That makes the company's brand is known more. When a company can show their good side, the ways to make maximization of shareholder wealth will not be difficult.
For example, Omo is a famous brand of washing powder and it is very popular in Vietnam. However, not natural Omo was such a widely-used. Annual, Omo spends a huge amount for charity, helping poor households by supporting clean clothes. Besides, they made the advertising saying about the quality of washing powder, which is great in washing cleanly; at the same time they call for users to buy their products as a contribution to the household poverty. Naturally, they can sell a large number of their products. Of course they still keep the promise of charity, but can confirm that the company's brand and reputation has increased a lot. It is the foundation for the later period, people buy these products in order to use. Shares will increase and there are more investment activities to make profit.
So, the projects, such as, sponsorship of sporting events of the opera, charity or other entertainment do not contradict the goal of the maximization of shareholder wealth.
Question 2:
There are two most-used measures for evaluating an investment project are the net present value (NPV) and the internal rate of return (IRR). These 2 methods belong to Capital-budgeting. However, they have some differences and also advantages.
NPV is "a capital-budgeting decision criterion defined as the present value of the free cash flows after tax less the project's initial outlay". It can be expressed as:
NPV = - IO
Where FCFt = the annual free cash flow in the time period t
k= the appropriate discount rate
IO = the initial cash outlay
n = the project's expected life
The advantage of NPV is showing "a direct measure of the dollar contribution to the stockholders"
"Whenever the project's NPV is greater than or equal to zero, we will accept the project; whenever the project's NPV is negative, we will reject project".
NPV ≥ 0.0: Accept the project
NPV < 0.0: Reject the project
While IRR is "a capital-budgeting decision criterion that reflects the rate of return a project earns. Mathematically, it is the discount rate that equates the present value of the inflows with the present value of outflows". Mathematically, IRR is shown as:
IO =
Where FCFt = the annual free cash flow in time period t
IO = the initial cash outlay
n = the project's expected life
IRR = the project's internal rate of return
"The IRR method shows the return on the original money invested". If the IRR is greater than or equal to the required rate of return, the project will be accepted. If the IRR is less than the required rate of return, the project will be rejected.
IRR ≥ the required rate of return: Accept
IRR < the required rate of return: Reject
Following the question, to make a project which is accepted or rejected by 2 methods, it should be:
If NPV ≥ 0, and IRR ≥ the required rate of return, we will accept the project
If NPV < 0, and IRR < the required rate of return, the project will be rejected for sure
However, the NPV and IRR method still have difference which makes conflict when using them. For example:
"Assume once again that Newco needs to purchase a new machine for its manufacturing plant. Newco has narrowed it down to two machines that meet its criteria (Machine A and Machine B), and now it has to choose one of the machines to purchase. Further, Newco has assumed the following analysis on which to base its decision:
Year
0
1
2
Cash-flow Machine A
-5,000
3,000
3,000
Discounted cash-flow
-5,000
2,768
2,553
Cumulative cash-flow
-5,000
-2,232
321
Cash-flow Machine B
-10,000
5,800
6,000
Discounted cash-flow
-10,000
5,350
5,106
Cumulative cash-flow
-10,000
-4,650
456
The NPV for each machine is:
NPVA = -$5,000+ $2,768 + $2.553 = $321
NPVB = -$10,000 + $5,350 + $5,106 = $456
According to the NPV analysis, Machine B is the best choice for Newco to purchase.
"The next step is to determine the IRR for each machine using our financial calculator. The IRR for Machine A is equal to 13%, whereas the IRR for Machine B is equal to 11%.
According to the IRR analysis alone, Machine A is the most appropriate choice for Newco to purchase".
As it can be seen, NPV and IRR methods produce conflicting. "This is most likely due to the timing of the cash flows for each project as well as the size difference between the two projects"
