a. Ethical Issues in Capital Investment Decisions:

Ethics impact many aspects of investment decisions. Companies generally seek to maximize shareholder wealth while balancing secondary objectives, such as public welfare. Key ethical standards affecting companies include:

1. Health and Safety: Employees and the public should be protected from danger, which includes working conditions, adherence to employment laws, and product safety.
2. Environmental Issues: Issues such as controlling pollution, protecting wildlife, and preserving the countryside. Compliance may significantly increase the costs of capital investments.
3. Bribes and Other Payments: In some regions, investment progress may be expedited through bribes or “incentive payments.” This area is ethically challenging as gifting varies by business culture across countries.
4. Corporate Governance: Notable cases, like Enron, highlight how concealing financial conditions and investment outcomes from shareholders can pose severe ethical concerns.
5. Taxation: Companies often aim to minimize tax liabilities. Although tax evasion is illegal, there are ethical debates over tax avoidance measures, particularly in developing regions.
6. Wage Levels: Ethically, a company might consider whether paying low wages to maximize shareholder wealth is acceptable, especially in areas with low living standards.
7. Individual Manager’s Ethics: Personal motivations, such as job security, may affect managers’ decisions, impacting capital investments toward personal rather than organizational goals.

Ethical issues are increasingly significant for companies, as acting responsibly can negatively impact cash flows and NPV. However, stakeholders expect ethical behavior, with potential penalties like adverse publicity and shareholder divestment for unethical actions. This concept of ethical shareholder wealth creation is anticipated to become more relevant in Strategic Financial Management.

b. Using the Black-Scholes Option Pricing (BSOP) Model in Company Valuation:

The BSOP model is based on the idea that equity acts as a call option, offered by lenders, on the company’s underlying assets. If the company’s value drops significantly, shareholders may opt to abandon their investment, while the upside potential remains unlimited once debt interest is paid.

The BSOP model is advantageous when traditional valuation methods inadequately represent risks, or when valuing unlisted companies with uncertain growth prospects. The model requires proxies for five essential variables:

1. Underlying Asset Value: Represented by the company’s fair asset value minus current liabilities.
2. Exercise Price: Equivalent to the company’s debt, calculated as the present value of a zero-coupon bond matching current debt yield.
3. Time to Expiry: The duration before debt repayment, during which shareholders retain an option to exercise.
4. Volatility of the Underlying Asset: Measured by the volatility in the business’s asset values.
5. Risk-Free Rate: Generally the rate on risk-free investments, like short-term government bonds.