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Capital budgeting

1. Which of the following statements is CORRECT?

a. Because depreciation is not a cash expense, it plays no role in capital budgeting.

b. Under current laws and regulations, corporations must use straight-line depreciation for all assets whose lives are 3 years or longer.

c. Under MACRS depreciation, firms write off assets slower than they would under straight-line depreciation, and as a result projects' forecasted NPVs are normally lower than they would be if straight-line depreciation were required for tax purposes.

d. Under MACRS depreciation, firms can write off assets faster than they could under straight-line depreciation, and as a result projects' forecasted NPVs are normally lower than they would be if straight-line depreciation were required for tax purposes.

e. Under MACRS depreciation, firms can write off assets faster than they could under straight-line depreciation, and as a result projects' forecasted NPVs are normally higher than they would be if straight-line depreciation were required for tax purposes.

2. Rowell Company spent $3 million two years ago to build a plant for a new product. It then decided not to go forward with the project, so the building is available for sale or for a new product. Rowell owns the building free and clear--there is no mortgage on it. Which of the following statements is CORRECT?

a. Because the building has been paid for, it can be used by another project with no additional cost. Therefore, it should not be reflected in the cash flows for any new project.

b. If the building could be sold, then the after-tax proceeds that would be generated by any such sale should be charged as a cost to any new project that would use it.

c. This is an example of an externality, because the very existence of the building affects the cash flows for any new project that Rowell might consider.

d. Because the building was built in the past, its cost is a sunk cost and thus need not be considered when new projects are being evaluated, even if it would be used by those new projects.

e. If there is a mortgage loan on the building, then the interest on that loan would have to be charged to any new project that used the building.

Solution Preview

1. e. Under MACRS depreciation, firms can write off assets faster than they could under straight-line depreciation, and as a result projects' forecasted NPVs are normally higher than they ...

Solution Summary

The solution explains two questions relating to capital budgeting

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