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. Th***** makes the tax burden on the disposal as $34,000. The depreciati***** expense on the new machine ***** reduce the ***** burden, and the 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 the cost *****, giving a net annual cash flow of $432,600. The net present value of ***** new machine therefore becomes $1,715,925.02. The present cash flows are the outlay for the new *****, the proceeds from the disposal of the old machine and the tax ***** those proceeds. This totals $1,734,000. *****refore, the NPV ***** the purchase of the new machine is -$18,074.98. Theta Widgets should not purchase the new *****.

2) Capital budgeting decisions ***** complex. There are many variables that must be taken into consideration. Moreover, the 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 into a capital budgeting ***** is variable.

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

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

Capital investment ***** ***** 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 dec*****ion. ***** figures used for future cash ***** are going to be estimates, but some estimates ***** better than others. The ***** the quality of ***** in*****mation in the first place, the more ***** your NPV calculations will be.

*****nother way ***** deal ***** ***** is to make conservative estimates. A project that only has a *****

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