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98.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. 99.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. 100.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 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. 101.The most important thing to remember is that real cash flows should be discounted at the real interest rate and nominal cash flows should be discounted at the nominal discount rate. Since real cash flows do not include inflation, discounting real cash flows at the nominal rate will artificially reduce the NPV and lead the analyst to reject projects that otherwise should be accepted. Likewise, since nominal cash flows do include inflation, they must be discounted at the nominal discount rate which includes inflation. Discounting nominal cash flows at the real discount rate will result in an artificially high NPV and thus lead to accepting projects that should otherwise not be accepted. Since most cash flows are nominal, nominal rates are used more often in practice.
Categorych06 Summary # of QuestionsAACSB: Analytic96AACSB: Reflective Thinking5Blooms: Analyze3Blooms: Apply57Blooms: Evaluate2Blooms: Remember11Blooms: Understand28Difficulty level: 1 Easy31Difficulty level: 2 Medium60Difficulty level: 3 Hard10Ross - Chapter 06101Topic: Alternative Definitions of Operating Cash Flow12Topic: Incremental Cash Flows: The Key to Capital Budgeting19Topic: Inflation and Capital Budgeting18Topic: Some Special Cases of Discounted Cash Flow Analysis12Topic: The Baldwin Company: An Example40