For Concept 1, the statement is correct regarding the effects on:

A. the real tax savings from depreciation, but incorrect regarding the real after-tax interest expense.

B. both the real tax savings from depreciation and the real after-tax interest expense.

C. neither the real tax savings from depreciation nor the real after-tax interest expense.

Linda Pyle is head of analyst recruiting for PPA Securities. She has been very frustrated by the number of job applicants who, in spite of their stellar pedigrees, seem to have little understanding of basic financial concepts. Pyle has written a set of conceptual questions and simple problems for the human resources department to use to screen for the better candidates in the applicant pool. A few of her corporate finance questions and problems are given below.
Concept 1. “A company invests in depreciable assets, financed partly by issuing fixed-rate bonds. If inflation is lower than expected, the value of the real tax savings from depreciation and the value of the real after-tax interest expense are both reduced.”

Concept 2. “Sensitivity analysis and scenario analysis are useful tools for estimating the impact on a project’s NPVof changing the value of one capital budgeting input variable at a time.”

Concept 3. “When comparing two mutually exclusive projects with unequal lives, the IRR is a good approach for choosing the better project because it does not require equal lives.”

Concept 4. “Project-specific betas should be used instead of company betas whenever the risk of the project differs from that of the company.”

Problem. “Fontenot Company is investing h100 in a project that is being depreciated straight-line to zero over a two-year life with no salvage value. The project will generate earnings before interest and taxes of h50 each year for two years.

Fontenot’s weighted average cost of capital and required rate of return for the project are both 12 percent, and its tax rate is 30 percent.”