CTC 475
Income taxes
ATCF
CTC 475 Review
Depreciation
Historical Methods
Straight Line (SL)
Declining Balance (DB-200% or 150%)
Sum of the Years Digits (SOYD or SYD)
Current Method
MACRS-GDS or ADS
Objectives
Understand the basics of graduated taxes
Know how to develop an ATCF using depreciation
allowances
Tax Concepts
Taxes affect cash flows
Any economic analysis should be on an after-tax
basis
ATCF’s are develop by adjusting BTCF’s for taxes
paid or received
Taxes are affected by BTCF, tax rate and depreciation
Types of Taxes
Income Tax
Function of net income (gross revenues-deductions)
Federal, State and/or Local
Sales Tax
Tax on purchases
Independent of income
Property Tax
Tax on amount of property you own—(schools, counties)
Independent of income
Excise Tax
Tax on amount of sales of non-necessary goods & services
Independent of income
Which tax do we consider?
Usually income tax
Corporate Income Taxes
Corporations
Professional Associations
Business Trusts
Joint Stock Companies
Insurance Companies
Certain Limited Partnerships
Corporate Income Tax Rates
Taxable Income (TI) Tax Rate (%)
0235K company pays 34%
(up to 10 million)
Example Problem
A small company with TI=$50K is considering an
investment which would increase it’s TI by $45K (Total
= $95K)
What would be the company’s increased tax liability?
Without Investment
W/O Investment With Investment
(TI=$50K) (TI=$95K)
Tax=15% * $50K Tax=15% * $50K
+25% * $25K
+34% * $20K
=$20,550
= $7,500 (effective rate=21.6%)
(effective rate =15%)
Example Problem
Increased tax liability:
$20,500-$7,500=$13,050
$13,050/$45,000=29%
29% of 45K would be paid in taxes
ATCF
Net Income=Gross Income-Deductions (salaries,
wages, repairs, rent, etc.)
Taxable Income=Net Income-Depreciation
Tax=Tax Rate * Taxable Income
ATCF=BTCF-Taxes
Example Problem-ATCF
Cost Basis = $82K
Salvage Value = $5K
Estimated useful life = 7 years
MARR=15%
Reduction in expenses =$23.5/yr
Depreciate using MACRS-GDS
5-year property
Determine PW of BTCF & ATCF
PW of BTCF
PW=-$82K+$23.5K(P/A15,7)+5K(P/F15,7)
PW=$17,649
ATCF-Calculate Depreciation
EOY Calculation Depreciation (MACRS)
1 20%*$82K= $16,400
2 32%*$82K= $26,240
3 19.2%*$82K= $15,744
4 11.52%*$82K= $9,446
5 11.52%*$82K= $9,446
6 5.76%*$82K= $4,723
Notes:
If you add depreciation amounts (MACRS-GDS) you
should get the cost basis
Also remember that depreciation lasts one more year
than the recovery period (i.e. 6 instead of 5 years)
A B C D E F
B-C D*.34 B-E
EOY BTCF Deprec. TI Tax ATCF
0 -82K -82K
1 23.5K 16,400 7,100 2,414 21,086
2 23.5K 26,240 -2,740 -932 24,432
3 23.5K 15,744 7,756 2,637 20,863
4 23.5K 9,446 14,054 4,778 18,722
5 23.5K 9,446 14,053 4,778 18,722
6 23.5K 4,723 18,777 6,384 17,116
7 23.5K 23,500 7,990 15,510
7 5K (salvage) 5,000 1,799 3,300
PW of ATCF
Must take each year back to zero (no series
because each year has a different number)
PW=-$82K+$21,086(P/F15,1)+$24,432(P/F15,2)
+$20,863(P/F15,3)+$18,722(P/F15,4)
+$18,722(P/F15,5)+$17,116(P/F15,6)
+$15,510(P/F15,7)+$3,300(P/F15,7)
PW of ATCF=$3,010 (still cost effective)
ATCF’s are impacted by:
Depreciation methods
Recovery period
Planning horizon
Different tax rates
BTCF
Other comments:
Depreciation is not a cash flow but is needed to
determine taxes
Taxes are a cash flow
Under MACRS-GDS the sum of depreciation amounts
should equal the cost basis
Negative taxes--assumes a company is able to reduce
it’s overall taxes
MARR
In the previous example, the same MARR was used to
determine PW of the BTCF and ATCF
A lower MARR is acceptable for after-tax cash flows
General Rule:
For BTCF, use before-tax MARR
For ATCF, use after-tax MARR
Before-Tax MARR; After-Tax Marr
Approximate relationship between the two:
BT MARR=AT MARR/(1-Effective Tax Rate)
Example:
BTCF MARR=25% and tax rate is 40%
ATCF MARR is approximately 15%
Next lecture
Estimating cash flows
Inflation