Concepts Review and Critical Thinking Questions

1. Opportunity Cost In the context of capital budgeting, what is an opportunity cost?

2. Depreciation Given the choice, would a firm prefer to use MACRS depreciation or straight-line depreciation? Why?

3. Net Working Capital In our capital budgeting examples, we assumed that a firm would recover all of the working capital it invested in a project. Is this a reasonable assumption? When might it not be valid?

4. Stand-alone Principle Suppose a financial manager is quoted as saying, "Our firm uses the stand-alone principle. Because we treat projects like minifirms in our evaluation process, we include financing costs because they are relevant at the firm level." Critically evaluate this statement.

5. Equivalent Annual Cost When is EAC analysis appropriate for comparing two or more projects? Why is this method used? Are there any implicit assumptions required by this method that you find troubling? Explain.

6. Cash Flow and Depreciation "When evaluating projects, we're only concerned with the relevant incremental aftertax cash flows. Therefore, because depreciation is a noncash expense, we should ignore its effects when evaluating projects." Critically evaluate this statement.

7. Capital Budgeting Considerations A major college textbook publisher has an existing finance textbook. The publisher is debating whether or not to produce an "essentialized" version, meaning a shorter (and lower-priced) book. What are some of the considerations that should come into play?

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