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

2) Capital budgeting decisions ***** 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 imp*****ct on the outcome of ***** *****. For the most part, cost of capital reflects past conditions. There may be some element of future *****, but as soon as a ***** such as inflation differs from ***** ***** rate ***** inflation, the figures changes. The cost of capital used to make the decision h***** an assumed rate ***** inflation built ***** it. If the rate of inflation increases, that cost of capital becomes obsolete. For this reason, comp*****ies should set a conserv*****tive hurdle ***** ***** assumes ***** adverse movement in the rate ***** inflation. Even in doing so, most companies will bear the risk of a sharp spike in *****flation rates.

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

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

Another way to deal with uncertainty is to make conservative estimates. A project ***** only has a *****

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