Question

Tanya believes noncash expenses should be ignored when making capital budgeting decisions because they have no impact on cash flows. She is mistaken because:

		noncash expenses increase net income and must be added back to appropriately calculate cash flows
		noncash expenses decrease the cost of goods sold and therefore increase cash flows
		noncash expenses reduce taxable income, decrease tax payments, and increase cash flows
		noncash expenses (such as depreciation) allow a firm to spread the cost of fixed assets over many years and therefore balance cash outflows
		noncash expenses increase net working capital and therefore are cash outflows

Answer 1

Even though non cash expenses like depreciation do not have a direct effect on the cash flow of the company, they have an indirect effect. Deprection reduces the taxable profit and hence taxes. This eventually increases the cash flow. Hence, Tanya believes non cash expense should be ignored when making capital budgeting decisions because they have no impact on cash flow. She is mistaken because-

Noncash expenses reduce taxable income, decrease tax payments, and increase cash flows

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