Essay - Wacc 1) We Will Assume that the Old Machine is...


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WACC

1) We will assume that the old machine is fully depreciated. This makes the tax burden on the disposal as $34,000. The depreciati***** expense on the new machine will reduce the ***** burden, and ***** cost savings are assumed to translate directly to profit, which will increase the tax burden. The net effect is an increase in tax burden from the ***** mach*****e of $37,400 per year, which subtracts from the cost *****, giving a net ********** cash flow of $432,600. ***** net present value of the new machine therefore becomes $1,715,925.02. The present cash flows are the outlay for the new machine, ***** proceeds from the ***** of ***** ***** ***** and the tax ***** those proceeds. This totals $1,734,000. Therefore, the NPV of ***** purchase of the new machine is -$18,074.98. Theta Widgets should not purchase the new *****.

2) Capital budgeting decisions are complex. There are many variables that must be taken into consideration. Moreover, ***** information being used to make the decision is almost entirely based on estimates. The more accurate ***** inputs, the stronger the decision, but much of what goes into a capital budgeting decision is variable.

Inflation, for example, can have a signifi*****t impact on the outcome of the *****. For the most part, cost of capital reflects past conditions. *****re may be some element ***** future decisions, but as soon as a variable such as inflation differs from ***** ***** rate of inflation, the figures changes. The cost of capital used to make the decision h***** an assumed ***** of ***** built into it. If the rate of inflation increases, that cost of capital becomes obsolete. For this reason, comp*****ies should set a conservative hurdle ***** that assumes some adverse movement in the rate of *****. Even in doing so, most companies will bear ***** risk of a sharp spike in *****flation rates.

***** future cash flows would, in theory, need to be discounted at a higher rate to reflect the change ***** inflation. ***** will adversely affect the ***** value of those cash flows. This in turn will reduce ***** present ***** of those flows, and can erode the positive ***** present value that was derived in order to make the investment ***** in the first place. A firm will ideally ***** able to pass the inflation on to their customers in ***** to balance off the deterioration ***** value of the cash flows.

***** ***** decisions are filled with uncertainty. There ***** several ways for a company to limit this uncertainty or build in safeguards against adverse consequences. The first is to get ***** best information possible prior to making an investment dec*****ion. ***** figures ***** for future cash flows are going ***** be estimates, but some estimates are better than others. The ***** the quality of the in*****mation in the first place, ***** more ***** your NPV calculations will be.

*****nother way to deal ***** ***** is to make conservative estimates. A project that only has a positive

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