All 34 Capital Budgeting questions
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Why is NPV considered superior to payback and ARR? How do NPV and IRR differ when ranking mutually exclusive projects? What is the cost of capital and how is it used as the discount rate? How is risk incorporated into capital budgeting decisions? How do you appraise projects with unequal lives? What is a perpetuity and how is it valued? How do you estimate the incremental cash flows for a replacement decision? What is the modified internal rate of return (MIRR) and why use it? How do real options add value in capital budgeting? How does post-audit (post-completion review) improve capital budgeting?
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Budgeting & Forecasting › Capital Budgeting

How do taxes and depreciation (capital allowances) affect project cash flows?

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Answer

Taxes reduce operating cash inflows (tax on profits) but depreciation/capital allowances create a tax shield: although depreciation isn't a cash flow, it reduces taxable profit, saving tax (tax shield = depreciation x tax rate). Capital budgeting uses after-tax cash flows, adding back the depreciation tax saving, to reflect the true cash impact.
Tax shield = Depreciation x Tax rate (a cash saving).
Real-world example Capital allowances on new plant reduce the tax bill, improving the project's after-tax cash flows and NPV.

Common follow-ups: Why is depreciation relevant despite being non-cash? | What are after-tax cash flows?

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All 34 Capital Budgeting questions