Question

Capital budgeting decisions often involve huge expenditures in long-term assets. Such assets are subject to depreciation.

How does this depreciation affect the calculations involved to reach a capital budgeting decision?  Or does it affect it at all?  How do we account for depreciation in these calculations?

Answer 1

1)Capital budgeting is a long term expenditure decision or long term investment decisions weither to invest or not in a particular interest proposal.

2)before going to invest your money into the project we need to analyse risk and return analysis and time period safety and security of funds.

3)capital budgeting methods are categorized into the traditional and discounted cash flow methods

4)Traditional methods are based on the dollar received today is equals to the worth dollar received in tommorrow. They Pay back period and ARR

5) discounted cash flow methods are based on time value of money and discounting principle . they are NPV PI and IRR.

@Depreciation and capital budgeting @

Depreciation is the important concept in capital budgeting to determine the cash flows for each year. Depreciation is a non cash expense and ideally should not effect the cash flows that's why added back to the cash in flow for each year after deducting tax.

Ex if operating cash flows are given we need to convert them as cash flows before depreciation and after tax

Steo1: deduct depreciation from operating cash flows

2) After deducting depreciation we should deduct tax from each year to get net cash flows

3) Add back depreciation to the net cash flows

All the methods are calculated based on the cash flows before depreciation and after tax except Accounting Rate of Return. ARR is always calculated on net cash flows .

Depreciation =asset -scrap value /estimated life