Question

Based solely on Corporate Finance, and using correct terminology, discuss why a decrease in the corporate tax rate could lead to poorer projects being accepted by companies.

( Please write a little more if possibly)

Answer 1

A higher corporate tax rate ensures that only those projects are being selected which generates higher after tax return on funds invested, while choosing the best option, lot of poor projects are turned down because of their low return. However, when the tax rate will be reduced, poor projects with low return will show a higher after tax return on funds invested than before. This would mean that even poorer projects, which were earlier turn down by the management due to inadequate return on funds invested can look more desirable and therefore firm will end up investing their money within the same. Though, a lower tax rate will help companies and businesses in huge way, but it will hurt company in disguise by wrong selection of projects which were not as good earlier. A reduced tax rate can help businesses in various ways like saving in taxes, leads to higher EPS, therefore higher valuation in market, lower taxes will lead to a rise in the overall GDP of the nation, increase in jobs etc.

          Hence, it can be said that though a reduced tax rate would benefit business and economy very much, but it will hurt businesses in disguise by wrong selection of projects which did not generate adequate after tax return earlier, but now they can, not due to operational efficiency but due to lower corporate tax rate.