CHAPTER 10
MAKING CAPITAL INVESTMENT
DECISIONS
Answers to Concepts Review and Critical Thinking Questions
1. In this context, an opportunity cost refers to the value of an asset or other input that will be used in a
project. The relevant cost is what the asset or input is actually worth today, not, for example, what it
cost to acquire.
2. For tax purposes, a firm would choose MACRS because it provides for larger depreciation deductions
earlier. These larger deductions reduce taxes, but have no other cash consequences. Notice that the
3. It’s probably only a mild over-simplification. Current liabilities will all be paid, presumably. The cash
portion of current assets will be retrieved. Some receivables won’t be collected, and some inventory will
another.
4. Management’s discretion to set the firm’s capital structure is applicable at the firm level. Since any one
particular project could be financed entirely with equity, another project could be financed with debt,
5. The EAC approach is appropriate when comparing mutually exclusive projects with different lives that
will be replaced when they wear out. This type of analysis is necessary so that the projects have a
common life span over which they can be compared; in effect, each project is assumed to exist over an
6. Depreciation is a non-cash expense, but it is tax-deductible on the income statement. Thus depreciation
causes taxes paid, an actual cash outflow, to be reduced by an amount equal to the depreciation tax
7. There are two particularly important considerations. The first is erosion. Will the essentialized book
simply displace copies of the existing book that would have otherwise been sold? This is of special
B-178 SOLUTIONS
from the sale of new books. Thus, it is important to examine whether the new book would displace sales
of used books (good from the publisher’s perspective) or new books (not good). The concern arises any
time there is an active market for used product.
8. Definitely. The damage to Porsche’s reputation is definitely a factor the company needed to consider. If
the reputation was damaged, the company would have lost sales of its existing car lines.
9. One company may be able to produce at lower incremental cost or market better. Also, of course, one of
the two may have made a mistake!
10. Porsche would recognize that the outsized profits would dwindle as more product comes to market and
competition becomes more intense.
Solutions to Questions and Problems
NOTE: All end of chapter problems were solved using a spreadsheet. Many problems require multiple steps.
Due to space and readability constraints, when these intermediate steps are included in this solutions
manual, rounding may appear to have occurred. However, the final answer for each problem is found
without rounding during any step in the problem.
Basic
1. The $6 million acquisition cost of the land six years ago is a sunk cost. The $6.4 million current aftertax
value of the land is an opportunity cost if the land is used rather than sold off. The $14.2 million cash
2. Sales due solely to the new product line are:
is relevant. The net sales figure to use in evaluating the new line is thus:
$247,000,000 + 238,500,000 – 81,900,000 = $403,600,000