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 depreciati***** expense on the new machine ***** reduce the tax burden, and ***** cost savings are assumed to translate directly to profit, which will increase the tax burden. The net effect is an increase in ***** 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 ***** new machine therefore becomes $1,715,925.02. The present cash *****s are the outlay for the new machine, the proceeds from the disposal of ***** old machine and the tax ***** those proceeds. This totals $1,734,000. *****refore, the NPV of the purchase ***** the new machine is -$18,074.98. Theta Widgets should not purchase ***** new machine.

2) Capital budgeting decisions are complex. There are many variables ***** must be taken into consideration. Moreover, the information being used to make ***** decision is almost entirely based on estimates. The more accurate the inputs, the stronger the dec*****ion, 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 ***** *****. For the most part, cost ***** ***** reflects past conditions. There may be some element of future *****, but as soon ***** a variable such as inflation differs from the ***** rate of inflation, the figures changes. The cost of capital used to make the decision h***** an assumed rate ***** ***** built into it. If the ***** of inflation increases, that cost of capital ***** obsolete. For this reason, comp*****ies should set a conservative hurdle rate that assumes some adverse movement in the rate ***** inflation. Even in doing so, most companies will bear the risk of a sharp spike in *****flation rates.

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

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

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

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