Capital Budgeting Items That May or May Not be Taxed as Part of A Capital Budget Project
Capital budgeting is defined as the process through which a company evaluates possible big projects or investments (Kenton, 2022). Pinkasovitch (2022) stated that when a company is faced with a capital budgeting choice, one of the first things it does is analyze whether the project will be profitable. The most prevalent techniques to project selection are the payback period (PB), internal rate of return (IRR), and net present value (NPV). Therefore, Capital budgeting decisions require careful consideration from senior management in any organization due to their long-term impact on the company’s profitability and growth (Heisinger & Hoyle, n.d.).
Capital Budgeting Items That May or May Not be Taxed as Part of A Capital Budget Project
According to Heisinger & Hoyle (n.d.), below are the major items that may not be adjusted for income taxes:
- Initial cash outflows investment: This component has no direct impact on the calculation of net income. As a result, the income tax effect is not taken into account. Year 0 includes the entire sum from this item (Heisinger & Hoyle, n.d.).
- Working capital cashflows: This item is not taxed since it has no direct impact on the calculation of net income and income tax. This item’s quantity is likewise counted in full at the moment of the inflow or outflow (Heisinger & Hoyle, n.d.).
The items that may be adjusted for income taxes according to Heisinger & Hoyle (n.d.) would be as follows:
- Cash inflows (revenues) and cash outflows (expenses): These items have a direct impact on the calculation of net income and the accompanying income tax. The significant amount from these items for capital planning purposes is the after-tax cash flows, which are calculated by multiplying the net receipts (i.e., revenue less costs) by the after-tax rate equal to 1 minus the income tax percentage. Cash inflows (expenses) are taxed at a standard government rate (e.g., 40%), as are cash outflows (deductions), because both affect overall taxable income (Heisinger & Hoyle, n.d.).
- Depreciation expense: Depreciation decreases the total amount of taxes paid since it impacts (reduces) the amount of taxable revenue. Companies deciding whether or not to pursue a long-term investment frequently consider the cash benefit associated with depreciation (also known as a depreciation tax shield) because income taxes paid are reduced as a result of recording depreciation expense. The tax shield or tax savings value from this item can be calculated by multiplying the depreciation expense by the income tax rate (Heisinger & Hoyle, n.d.).
Conclusion
Before making any capital budgeting decisions, a careful study must be undertaken. It necessitates an awareness of key components involved in capital budgeting procedures and computations. As a result, finance managers and organizations as a whole must assess pertinent information such as cash inflows and outflows, as well as the impact of income taxes on specific products, in order to make informed decisions.
References
Heisinger, K., & Hoyle, J. B. (n.d.). Accounting for Managers. https://2012books.lardbucket.org/books/accounting-for-managers/index.html
Kenton, W. (2022, March 10). Capital budgeting: What it is and methods of analysis. Investopedia. Retrieved November 29, 2022, from https://www.investopedia.com/terms/c/capitalbudgeting.asp
Pinkasovitch, A. (2022, January 27). An introduction to capital budgeting. Investopedia. Retrieved November 29, 2022, from https://www.investopedia.com/articles/financial-theory/11/corporate-project-valuation-methods.asp
Note:
This article is written based on University of The People Financial Management (BUS 5111) written assignment by Fristy Tania in November 2022
