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

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 ***** machine of $37,400 per year, which subtracts from the cost *****, giving a net *****nnual cash flow of $432,600. The net present value of the new machine *****refore becomes $1,715,925.02. The present cash *****s are the outlay for the new *****, ***** proceeds from the ***** of ***** ***** machine and the tax on those *****. This totals $1,734,000. *****refore, the NPV ***** ***** purchase of the new machine is -$18,074.98. Theta Widgets should not ***** the new machine.

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

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

The future ***** flows would, in theory, need to be discounted at a higher r*****e to reflect the change in *****flation. ***** ***** adversely affect ***** ***** value of ***** cash flows. This in turn will reduce the present value of those *****, and can erode the positive ***** present ***** that was derived in order ***** make the investment ***** in the first place. A firm will ideally be able to pass the inflation on to *****ir 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 ***** limit this uncertainty or build in safeguards against adverse consequences. The first is to get ***** ********** information possible prior to making an investment decision. ***** figures used for future cash ***** are going ***** be estimates, but some estimates are better th***** o*****ers. The ***** the quality of the information in the first place, ***** more accurate your NPV calculations will be.

Another way to deal with ***** is to ***** conservative estimates. A project ***** only has a positive

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