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Good morning Mr Moffat, I need your help on the effect of depreciation on payback period investment appraisal.
During my revision with BPP revision kit I came across a question that calculated the depreciation as a cash flow for computing the cummulative cash flow for the payback period, I am not comfortable with this approach because I don’t think depreciation is a cash flow and should not be a determinant factor in calculating how fast a project’s initial investment is gotten back.
I await your feedback
Thank you
Depreciation is certainly not a cash flow, and it is cash flows we are interested in for the payback period.
Are you sure you have checked the answer properly? What may have happened is that the question gave profits (instead of cash flows) and so since profits are after charging depreciation it is then necessary to add back the depreciation to arrive at the cash flows.
If you tell me the number of the question (assuming it is in the current edition of the revision kit) then I will check myself also.
Ok now I see where I misunderstood the question, the payback period was only used to derive the cash flow P.A before deducting the depreciation P.A to compute the average investment.
Thank you Sir
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