# What is the value of the depreciation tax shield in

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82. What is the value of the depreciation tax shield in year 2 of the project? A. \$134,000 B. \$240,000 C. \$334,000 D. \$400,000 E. \$1,000,000 Depreciation tax shield = \$5,000,000 5 .40 = \$400,000 Difficulty level: Medium Topic: DEPRECIATION TAX SHIELD Type: PROBLEMS 83. What is the amount of the after-tax salvage value of the equipment? After-tax salvage value = \$5,000,000 .10 (1 - .40) = \$300,000 Difficulty level: Medium Topic: AFTER-TAX SALVAGE VALUE Type: PROBLEMS 84. What is the recovery amount attributable to net working capital at the end of the project? NWC recapture = .10 \$2,300,000 = \$230,000 Difficulty level: Medium Topic: CHANGE IN NET WORKING CAPITAL Type: PROBLEMS

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Chapter 06 - Making Capital Investment Decisions 6-44 Essay Questions 85. This chapter introduced three new methods for calculating project operating cash flow (OCF). Under what circumstances is each method appropriate? Three additional formulations of OCF provided in this chapter are the bottom-up, top-down, and tax-shield approaches. The first is useful when the analyst has prepared pro forma income statements for a project (since OCF is equal to net income plus depreciation). The top-down approach defines OCF as sales minus costs minus taxes, and is useful if one has reliable estimates of the relevant dollar costs (perhaps in a situation where fixed and variable costs are the focus of the analysis). Finally, the tax-shield approach separately illustrates the project benefits associated with after-tax gross profit (revenue gains and/or cost reductions) and with the depreciation tax shield. Topic: OPERATING CASH FLOW Type: ESSAYS 86. When is it appropriate to use the equivalent annual cost (EAC) methodology, and how do you make a decision using it? The EAC should be used to evaluate two or more mutually exclusive projects with different lives that will be replicated essentially forever. The manager should choose the project whose EAC is lowest, that is, the least negative EAC value. Topic: EQUIVALENT ANNUAL COST Type: ESSAYS 87. Should financing costs be included as an incremental cash flow in capital budgeting analysis? Financing costs are not an incremental cash flow for capital budgeting purposes. Financing costs are a direct consequence of how the project is financed, not whether the project is economically viable. Financing costs are embedded in the required rate of return used to discount project cash flows. Topic: FINANCING COSTS Type: ESSAYS
Chapter 06 - Making Capital Investment Decisions 6-45 88. Explain the half year convention used in MACRS depreciation. MACRS depreciation assumes all assets were placed in service at mid-year which allows for one full year of straight line depreciation without regard to salvage value in the first year of use. Thus, if an assets were placed in service in the first or the last month or the fiscal year, or any place in between, the asset is written off at the mid-year point. This method provides a tax incentive for capital investment in years when the firm is in higher tax brackets, thus providing an impetus for capital expenditure and continued growth.
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