CAF-7 · Chapter 13 · Question 9 of 15
In an NPV calculation involving taxation, how should the accounting depreciation of machinery be treated?
Test yourself: pick an answer
Reveal answer & explanation
Correct answer: C) It must be ignored entirely as it is a non-cash item, but the tax savings (tax shield) generated by tax allowable depreciation must be included as a cash inflow
Explanation
Accounting depreciation is a non-cash allocation and is excluded from DCF analysis. However, tax authorities grant 'tax-allowable depreciation,' which reduces the company's tax bill. This tax saving is a real cash benefit and must be recorded as an inflow.
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