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

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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 ***** reduce the tax 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 new machine of $37,400 per year, ***** subtracts from ***** cost savings, giving a net ********** cash flow of $432,600. ***** net present value of the new ***** therefore becomes $1,715,925.02. The present cash flows are the outlay for the new machine, the proceeds from the disposal of the old machine and the tax ***** 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 are complex. There are many variables ***** must be taken into consideration. Moreover, the information being used to make the decision is almost entirely based on estimates. The more accurate ***** 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 the *****. For the most part, cost of capital reflects past conditions. There may be some element of future decisions, but as soon as a ***** such ***** inflation differs from the ***** rate ***** inflation, ***** figures changes. The cost of capital used to make the decision has an assumed ***** of ***** built into it. If the rate of inflation increases, that cost of capital ***** obsolete. For this reason, comp*****ies should set a conserv*****tive 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 cash flows would, in theory, need to be discounted at a higher r*****e to reflect the change ***** inflation. ***** ***** adversely affect ***** ***** ***** of those cash *****. This in turn will reduce the present value of those flows, ***** can erode the positive ***** present ***** that was derived in order to make the investment decision in the first place. A firm will ideally ***** able to pass the inflation on to ********** customers in order to balance off the deteriorati***** in value of the cash flows.

***** ***** decisions ***** filled with uncertainty. There are several ways ***** 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 decision. ***** figures used for future cash flows are going to be estimates, but some ***** are better th***** others. The higher the quality of the in*****mation in the first place, the more ***** your NPV calculations will be.

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


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