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

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

Answer: (D)

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 involve actual cash outflows.
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 why depreciation does not affect cash flows: Since depreciation is a non-cash expense, it does not directly impact the cash inflows or outflows of a project. Therefore, it does not influence the payback period calculation.
4. Identify common misconceptions: Some may mistakenly believe depreciation affects the payback period by altering net income or cash flows. However, net income adjustments due to depreciation do not translate into changes in actual cash flows.
5. Conclude the correct understanding: Depreciation does not affect the payback period because the calculation is based on cash inflows, and depreciation is excluded as it is a non-cash expense.