Describe and explain capital budgeting items that may or may not be taxed as part of a
capital budget project.
Capital budgeting is a process of evaluating long-term investments or major projects (Kenton,
2020). The investment may be the construction of a new office, purchasing new equipment, or
introducing a new product. Hence, the firm will assess if the investments will yield profit or not.
Companies could evaluate the lifetime cash flow of the proposed project to determine the return.
If the return is greater than a specified benchmark it will be accepted otherwise it will be
rejected.
Capital budgeting in basic terms is the process of appraising an investment. We can use several
methods like net present value (NPV), rate of return, and payback method. When we do this
analysis we can consider taxes that would affect the cash flows. We will consider four capital
budgeting items and the effect of taxes on their evaluation. The four budgeting items are
presented below (Heisinger & Hoyle, 2012): -
• Investment cash outflows
• Working capital cash outflows and inflows
• Revenue cash inflows and expense cash outflows
• Depreciation
As presented above, the first two items are investment cash outflows and working capital cash
outflows and inflows. Investment cash outflows are outflows that the company makes on long-
term investment (Lisa, 2021). While, working capital cash flows are related to the amount of
money a firm pays for its short-term obligations (Furhmann, 2021). Both of these items, don't
affect the net income directly. Subsequently, when preparing cash flow their amount will not be
adjusted for income taxes.
Revenue is the earnings a firm makes through business operation while expenses are costs
incurred because of the business operation. Revenues and expenses affect the net income a
company makes, consequently affecting income taxes paid. Hence, we have to find the after-tax
cash flow for these items. The after-tax amount for revenue or expense is equal to the product of
before-tax amounts by (1- tax rate) (Heisinger & Hoyle, 2012).
capital budget project.
Capital budgeting is a process of evaluating long-term investments or major projects (Kenton,
2020). The investment may be the construction of a new office, purchasing new equipment, or
introducing a new product. Hence, the firm will assess if the investments will yield profit or not.
Companies could evaluate the lifetime cash flow of the proposed project to determine the return.
If the return is greater than a specified benchmark it will be accepted otherwise it will be
rejected.
Capital budgeting in basic terms is the process of appraising an investment. We can use several
methods like net present value (NPV), rate of return, and payback method. When we do this
analysis we can consider taxes that would affect the cash flows. We will consider four capital
budgeting items and the effect of taxes on their evaluation. The four budgeting items are
presented below (Heisinger & Hoyle, 2012): -
• Investment cash outflows
• Working capital cash outflows and inflows
• Revenue cash inflows and expense cash outflows
• Depreciation
As presented above, the first two items are investment cash outflows and working capital cash
outflows and inflows. Investment cash outflows are outflows that the company makes on long-
term investment (Lisa, 2021). While, working capital cash flows are related to the amount of
money a firm pays for its short-term obligations (Furhmann, 2021). Both of these items, don't
affect the net income directly. Subsequently, when preparing cash flow their amount will not be
adjusted for income taxes.
Revenue is the earnings a firm makes through business operation while expenses are costs
incurred because of the business operation. Revenues and expenses affect the net income a
company makes, consequently affecting income taxes paid. Hence, we have to find the after-tax
cash flow for these items. The after-tax amount for revenue or expense is equal to the product of
before-tax amounts by (1- tax rate) (Heisinger & Hoyle, 2012).
