TVM, WACC and the Impact on the Decision to Expand
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You estimate an increase in sales of 150,000 per year for the first two years, then 250,000 per year over the following 3 years. You will need to invest in 300,000 worth of new equipment. What is the time value of money and how does it apply in this situation? What is the weighted average cost of capital and how does it impact the decision to expand? What is marginal weighted average cost of capital and how does it impact the decision to expand your division?
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Solution Summary
The solution describes how the time value of money (TMV) and weighted average cost of capital (WACC) effect the decision to expand.
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The time value of money is the net effect of inflation and other external environmental factors upon the value of money in the future. In the above situation, the future value of the cash flows would need to be carefully considered in order to understand the actual future value of them. For example, a $300,000 cash outlay now for new equipment will have a real value of $300,000 today. However, because inflation will drive down the value of the dollar over time, the first $150,000 cash inflow will be worth less than that amount in one year relative to its ...
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