Depreciation impacts the calculation of a project’s payback period because it affects the overall cash flow of the project. Specifically, the correct statement is:
A) Depreciation is added to the annual cash inflows.
This adjustment occurs because depreciation is a non-cash expense. When calculating cash inflows for a project, we often add back non-cash charges like depreciation to get a better picture of the actual cash generated. Therefore, including depreciation can lead to a quicker payback period since it increases the annual cash inflows.
To summarize, understanding how depreciation works in financial accounting is crucial. It helps project owners accurately assess their investment’s viability and the time frame in which they can expect a return.