Which statement about the effect of accelerated depreciation on early-year cash flow is most accurate?

• A. It reduces cash flow in the early years.
• B. It increases cash flow in the later years but not early.
• C. It increases after-tax cash flow in early years due to larger tax shields.
• D. It does not affect after-tax cash flow but increases accounting income.

Answer: (C)

The key idea is the tax shield created by depreciation. Depreciation lowers taxable income, so the company pays less in taxes. When depreciation is accelerated, a larger amount is deducted in the early years, producing a bigger tax shield upfront. That bigger tax saving translates into higher after-tax cash flow in those early years, since less cash leaves the business for taxes. Over the asset’s life, the total depreciation is the same, so later years see smaller depreciation and a smaller tax shield, reducing the early-year cash-flow advantage. In short, accelerated depreciation boosts after-tax cash flow early on due to larger tax shields, which is why this statement is the best choice.