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


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WACC

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

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

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

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

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

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

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