How does depreciation affect the calculation of a project's payback period?

• A. Depreciation shortens the payback period by increasing cash flows.
• B. Depreciation is included in the payback period calculation as a cash outflow.
• C. Depreciation does not affect the payback period because it is a non-cash expense.
• D. Depreciation increases the payback period by reducing net income.

Answer: (C)

Verified step by step guidance

1. Understand the concept of depreciation: Depreciation is the allocation of the cost of a tangible asset over its useful life. It is a non-cash expense, meaning it does not directly involve cash outflows or inflows.
2. Review the payback period calculation: The payback period measures the time it takes for a project to recover its initial investment through cash inflows. It focuses solely on cash flows, not accounting expenses like depreciation.
3. Clarify the role of depreciation in cash flow: Since depreciation is a non-cash expense, it does not directly affect cash inflows or outflows. Therefore, it does not impact the calculation of the payback period.
4. Address common misconceptions: Some may mistakenly believe depreciation affects the payback period by increasing or decreasing cash flows. However, this is incorrect because depreciation only impacts accounting measures like net income, not cash flow.
5. Conclude the correct answer: Depreciation does not affect the payback period because it is a non-cash expense and is excluded from cash flow calculations used in determining the payback period.