A firm is evaluating a new machine to replace an existing, older machine. The change in depreciation is $3,000. The firm's marginal tax rate is 30 percent. Which of the following statements is true?
A) Depreciation does not affect the calculation of the supplemental operating cash flow.
B) Depreciation is added to the net income to calculate the supplemental operating cash flow.
C) Depreciation expense is added to the initial outlay incurred to purchase an asset.
D) Depreciation is deducted from the terminal cash flows from an asset.
E) Depreciation is included in capital budgeting only if it exceeds the tax expense of an asset.

Question

Quizplus · Accepted Answer

Depreciation is added to the net income to calculate the supplemental operating cash flow. The change in depreciation would result in a change in net income, which is used to calculate the cash flows. The change in net income is calculated as: Change in depreciation × (1 − marginal tax rate), which in this case is $3,000 × (1 − 0.30) = $2,100. This amount is then added to the net income to calculate the supplemental operating cash flow.

A Firm Is Evaluating a New Machine to Replace an Existing