Depreciation must be considered when evaluating the incremental operating cash flows associated with a capital budgeting project because:
A) it represents a tax-deductible cash expense.
B) the firm has a cash outflow equal to the depreciation expense each year.
C) depreciation has an impact on the taxes paid by the firm, which is a cash flow.
D) depreciation is a sunk cost.
E) depreciation is a cash flow that doesn't change.

Question

Quizplus · Accepted Answer

Depreciation has an impact on the taxes paid by the firm, which is a cash flow. Depreciation is a non-cash expense that reduces taxable income and therefore reduces taxes paid by the firm. This tax savings represents a cash flow that must be considered when evaluating the incremental operating cash flows associated with a capital budgeting project. A is incorrect because depreciation is a non-cash expense, not a tax-deductible cash expense. B is incorrect because while the firm does have a cash outflow for the purchase of the asset, the depreciation expense is a non-cash expense. D is incorrect because depreciation is not a sunk cost - it is a non-cash expense that reduces the value of the asset over time. E is incorrect because depreciation is a non-cash expense that does change based on the method of depreciation and the useful life of the asset.

Depreciation Must Be Considered When Evaluating the Incremental Operating Cash