Capital Budgeting Decisions Flashcards

An asset costs $80,000 and is depreciated straight-line over 4 years to zero. The annual depreciation tax shield at a 25% tax rate is:

Answer: $5,000

Depreciation = $20,000/year; tax shield = $20,000 x 0.25 = $5,000.

In computing incremental cash flow, an increase in net working capital is treated as:

Answer: A cash outflow at the start

Increased working capital ties up cash, so it is an outflow at project initiation.

The discount rate that makes a project's NPV equal to zero is the:

Answer: Internal rate of return

By definition, the IRR is the rate at which NPV equals zero.

Projects with non-conventional cash flows (sign changes more than once) may have:

Answer: Multiple IRRs

Multiple sign changes in cash flows can produce more than one IRR solution.

Terminal (salvage) value received at the end of a project should be:

Answer: Added as an after-tax inflow in the final year

Salvage proceeds, net of tax effects, are an inflow in the final year of analysis.

Which approach is best for comparing projects with unequal lives?

Answer: Equivalent annual annuity

The equivalent annual annuity converts NPVs to a comparable annual basis across different lifespans.

Opportunity costs in capital budgeting should be:

Answer: Included as a relevant cost of the project

Forgone benefits from the next-best use of a resource are relevant and must be included.