Question

In the context of investment appraisal, discuss how accelerated tax allowances might influence decision making by companies.

Answer 1

Investment appraisals are usually done through time value of money by using discount rates based on cost of capital. Accelerated tax allowances charges higher depreciation expense in initial years. Higher depreciation charges in initial years increases the cash flows of the organization since depreciation is tax deductible and companies can save tax on them. Higher tax savings on depreciation leads to higher present value of tax shield of depreciation. This will have positive impact on the net present value and has a favourable impact ton investment appraisal. When projects have positive net present value the investments are accepted by the companies. Hence companies favour investments which give accelerated tax allowances in initial years.