In capital budgeting, why are depreciation methods and tax rate changes relevant?

• A. They affect after-tax cash flows and overall profitability through tax shields.
• B. They only affect accounting profit, not cash flows.
• C. They have no impact on project value.
• D. They always increase project NPV regardless of rate.

Answer: (A)

Depreciation and tax rates shape after-tax cash flows, which determine a project's value. Depreciation is a non-cash expense that lowers taxable income, creating a tax shield that reduces taxes paid. The timing and size of that shield depend on the depreciation method: accelerated methods front-load deductions, boosting early cash flows and potentially increasing NPV, while straight-line spreads deductions evenly over the life.

Tax rates determine how large that shield is: higher rates make the depreciation tax saving more valuable, while lower rates reduce it. Because these shields directly affect how much cash the project actually generates after taxes, they influence profitability and overall value, not just accounting profit. They don’t always raise NPV regardless of rate, since the benefit depends on both how depreciation is used and what the tax rate is.