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


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WACC

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

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

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

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

***** investment 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 ***** ********** information possible prior to making an investment decision. The figures used for future cash ***** are going to be estimates, but some estimates are better than others. The higher the quality of the in*****mation in the first place, the more ***** your NPV calculations ***** be.

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

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