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 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 increase in ***** burden from the ***** machine 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 *****refore becomes $1,715,925.02. The present cash flows are the outlay for the new *****, ***** proceeds from the ***** of the ***** machine and the tax ***** those *****. This *****tals $1,734,000. Therefore, the NPV ***** the purchase of the new machine is -$18,074.98. Theta Widgets should not purchase ***** new *****.

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 decision, but much of what goes into a capital budgeting ***** is variable.

Inflation, for example, can have a signifi*****t imp*****ct on the outcome of the decision. For the most part, cost of capital reflects past conditions. *****re may be some element ***** future *****, but as soon ***** a ***** such as inflation differs from the ***** rate of inflation, the figures changes. The cost of capital used to make the ***** has an assumed ***** ***** inflation built ***** it. If the rate of inflation increases, that cost of capital becomes obsolete. For this reason, comp*****ies should set a conservative hurdle ***** ***** assumes ***** adverse movement in the rate ***** inflation. 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. ***** ***** adversely affect ***** future ***** ***** ***** cash *****. This in turn will reduce the present value of those flows, ***** can erode ***** positive ***** present value that was derived in order ***** ***** the investment decision in the first place. A firm will ideally be able to pass the *****flation on ***** their customers in order to balance off the deteriorati***** in value of the cash flows.

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

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

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