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. Th***** makes the tax burden on the disposal as $34,000. The depreciation expense on the new machine will 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 ***** in ***** burden from the ***** mach*****e of $37,400 per year, which subtracts from ***** cost savings, giving a net ********** cash flow of $432,600. ***** net present value of the new machine therefore becomes $1,715,925.02. The present cash flows are the outlay for the new machine, ***** proceeds from the ***** of ***** old machine and the tax ***** those proceeds. This *****tals $1,734,000. Therefore, the NPV ***** ***** purchase of the new machine is -$18,074.98. Theta Widgets should not purchase the new *****.

2) Capital budgeting decisions are 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 ***** inputs, the str*****ger the decision, but much of what goes into a capital budgeting ***** is variable.

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

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

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

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


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