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 ***** 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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