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April 2015 MCQ on pay back Period

P

Patrova01

Member
hi
would like to refer to the solution to question 5, which is inclusive of the depreciation charge as a cost.
my understanding of the course is that depreciation charges are finance costs and shouldn't be included in project appraisal (ref. chapter 17, page 7 in course content)
may sometime please explain why we include depreciation in this question

Thanks
 
Depreciation is indeed an accounting cost, and will affect the company's expected reported profits. However it is not a cashflow - the company does not pay the depreciation as cash each year. Therefore when calculating the NPV of a project using discounted cashflows, it should not be included.
 
so it is correct to include it when evaluating a project using the pay back method? (That's what is done in the solution)
 
You are given the annual profit (which allows for depreciation). So, depreciation has to be added back in to get to cash in order to calculate the PBP.
 
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