Heads-Up15: Importance of considering depreciation when making capital budgeting decisions.

Statemmt I: Depreciation is a non-cash expense; however, it is an important part of determining incremental cash flows because it reduces the interest expense paid by the firm.

Statement 2: If we use the double-declining balance method of depreciation for tax purposes, the NPV of the project we are considering should be higher than if we use the straight-line method.

A. Both correct

B. First is incorrect, second is correct.

C. First is correct, second is incorrect.

This is a wag, B? I’m ashamed I don’t know the second one by heart, I’ve seen that pop up countless times.

DePreciation reduces taxes, not interest. B

So the logic for the second one is higher depreciation earlier leads to less taxes and bigger cash flows earlier?

Yea, you should have that down pat! L1 stuff yo!

well i mean I finished L1 is 2008, and took time off to get my CAIA, I’m a bit rusty!

depreciation reduce book value so reduce the interest cost.

the second one is undermined can be higher or lower, am I right, choose C?

B is correct.

… How does taking depreciation reduce interest cost? Depreciation is an accounting measure that has no impact on any debt service payment you make