IENG 302 Lecture 19: Final Review and Example Exam Questions by 32Gp64yR

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									       Inflation / Deflation
• Inflation is an increase over time in
  the price of a good or service with a
  constant value – denoted ( f )
   •   Fn = P (1 + f )n       – or –       Fn = P (F/P, f, n)
   •   Pn = F (1 + f ) –n     – or –       Pn = F (P/F, f, n)

• Deflation is a decrease over time in
  the price of a good or service of
  constant value.
   •   Average inflation rate ( f ) is replaced by ( – f ) in the
       above equations
                        Constant Dollars vs.
                          Actual Dollars
                     1980                                       2009
CONSTANT
   $                    $785 / QTR                    $785 / QTR
                        Tuition & Fees                Tuition & Fees

  $A = $C (1+ f )n                                                     $C = $A (1+ f )– n

                     1980                                       2009
ACTUAL
   $                    $785 / QTR
                        Tuition & Fees
                                              $785 (1+ f )29 / QTR
                                              Tuition & Fees


                              f = Average Inflation Rate
Incorporating Inflation
• Inflation can be accounted for as
  an additional component on top of
  the MARR or interest rate:

• d = i + f + i•f     (d replaces i in tables/equations)

    where:
       • i is the effective interest rate
       • f is the constant inflation rate

•   Example:
       NPW = P + A (P/A, d, n) + F (P/F, d, n)
           Depreciation
• Depreciable Life – the period of time
  over which the asset is usable.

• Matching Concept – A fraction of the
  cost of the asset is chargeable as an
  expense in each of the accounting
  periods in which the asset provides
  service to the firm.

• Depreciation is NOT a real cash flow!
                 Cost Basis
Cost Basis – the total cost claimed as
  an expense over an asset’s life.
  Includes:
   • Actual Cost
   • All other incidental expenses:
           Freight
           Site Preparation
           Installation
These are the costs req’d to put the asset into service!
              Cost Basis
•   If the asset is purchased by trading in a
    similar asset, the difference between the
    book value and trade in allowance must
    be considered in determining the cost
    basis of the new asset.
•   If the trade-in allowance exceeds the book
    value, the difference (unrecognized gain)
    needs to be subtracted from the cost
    basis of the new asset.
•   If the book value exceeds the trade-in
    allowance, the difference (unrecognized
    loss) needs to be added to the cost basis
    of the new asset.
   Straight Line Method
                  Dn = ( I – S )
                           N

                Bn = I – Dn (n)
Where:
I = Cost Basis; Initial Price plus installation
    expenses.
S = Salvage Value
Dn = Depreciation in Year n
Bn = Book Value remaining in Year n
N = estimated years of useful life
n = the year currently under consideration
Declining Balance Method
=     1
           (Multiplier)
       N

   = % reduction each year

Dn =  I (1–)n–1

Bn = I (1–)n

Typical multipliers are 150% and 200%.

200% is also called Double Declining Balance (DDB).
Sum of Years Digits Method

    SOYD = 1 + 2 + 3 + … + N
         = N(N+1)
             2

    Dn = ( N – n + 1 ) ( I – S )
            SOYD

    Bn = Bn–1 – Dn
   Units of Production Method

Dn = Service Units Consumed During Year n ( I – S )
         Total Service Units
            n
Bn = I –  Service Units Consumed During Year n ( I – S )
                Total Service Units
            MACRS
• MACRS is a simpler, more rapid
  depreciation method.

• MACRS has been required for
  tax purposes since 1981 / 1986.

• MACRS book value is the legal
  standard for valuing equipment
  for tax purposes.
MACRS Depreciation Schedule
Class:      3            5            7           10        15
 Year    200% DB     200% DB      200% DB     200% DB     150% DB
  1       33.33        20.00        14.29       10.00      5.00
  2       44.45        32.00        24.49       18.00      9.50
  3       14.81*       19.20        17.49       14.40      8.55
  4        7.41        11.52*       12.49       11.52      7.70
  5                    11.52        8.93*        9.22      6.93
  6                    7.54         8.92         7.37      6.23
  7                                 8.93        6.55*      5.90*
  8                                 4.46         6.55      5.90
  9                                              6.56      5.91
  10                                             6.55      5.90
  11                                             3.28      5.91
  12                                                       5.90
  13                                                       5.91
         * Year to switch to straight line depreciation
  14                                                       5.90
  15      Values shown are percentages                     5.91
  16                                                       2.95
                         MACRS

Dn = (Year n MACRS Class Table Value)( I )

                    n
Bn = ( I )[1 – ( Year n MACRS Class Table Values )]
                   j=1

NOTE: If selling an asset BEFORE the final year of depreciation:
   •    Selling year depreciation is ½ Dn value lower, and …
   •    Selling year book value is ½ Dn value higher!
     Marginal Tax Rates
•   Tax rates for corporations and individuals vary
    depending on the amount of taxable income.

•   Different tax rates apply to incremental income.

•   Assume project will keep us in the same
    marginal tax bracket.

•   Terms:
    Federal Tax Rate (FTR)
    Federal Taxable Income

    Federal Taxes = ( FTR ) (Federal Taxable Income)
     Marginal Tax Rates
2009 Federal Corporate Tax Schedule
        Taxable Income        Tax Rate
 $0 to $50,000                 15%
 $50,001 to $75,000            25%
 $75,001 to $100,000           34%
 $100,001 to $335,000          39%
 $335,001 to $10,000,000       34%
 $10,000,001 to $15,000,000    35%
 $15,000,001 to $18,333,333    38%
 $18,333,334 and up            35%
     After Tax Analysis
1. Determine Taxable Income:
   ( + ) Income
   ( - ) Expenses (COGS and O & M)
   ( - ) Interest Paid
   ( - ) Depreciation
2. Determine Taxes
   • Use the marginal tax rate
3. Determine After Tax Cash Flow:
   ( + ) Income
   ( - ) Expenses
   ( - ) Loan Payments
   ( - ) Taxes
                 Sale of Asset
1. If selling an asset before the final year of tax
   depreciation, you may only claim ½ of the
   depreciation for that year:
      so the depreciation is ½ Dn lower,
      and the book value is ½ Dn higher

2. End of year taxable income from sale:
       = Sale Price – Book Value*
   * Subtract depreciation, if not already accounted for in that year
3. Tax cash flow from sale of the asset:
        = (Taxable income from sale) (Marginal Tax Rate)

4. After tax cash flow:
        = Sale Price – Tax cash flow from sale of the asset
      Project Profitability
1. NPW of ATCF > 0


2. EAW of ATCF > 0

3. Rate of Return > MARR

  Need to know MARR, Inflation Rates, Interest Rate, …
  Need estimates of amounts & timing of cash flows, …
  Need to know marginal tax rates, depreciation methods

								
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