After-Tax Economic Analysis

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					               After-Tax Economic Analysis
       Gross Income (GI) – total income realized from all
          revenue-producing sources, including items such
          as the sales of assets, royalties, license fees, etc…

       Income Tax – amount of taxes based on gross income.
           Corporate taxes are typically paid quarterly, and
           are actual cash flows.

       Operating Expenses (E) – all corporate costs incurred
          in the transaction of business.



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               After-Tax Economic Analysis
       Taxable Income (TI) – the amount upon which taxes
          are based.
          TI = ______________
       Where D is depreciation defined in previous lecture.

       Tax Rate (T) – percentage of TI owed in taxes. This
          rate is graduated, based on TI. (See table 17-1)

       Net Profit after taxes (NPAT) – amount remaining each
           year when income taxes are subtracted from
           taxable income.
           NPAT = _____________
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                  After-Tax Economic Analysis
                             Corporate Federal Income Tax Rate Schedule (2003)


                                                                  Maximum Tax for    Maximum Tax
               TI Limits             TI Range      Tax Rate T          TI Range          Incurred

     $1-$50,000                        $50,000             0.15            $7,500          $7,500

     $50,001-$75,000                     25,000            0.25             6,250          13,750

     $75,001-$100,000                    25,000            0.34             8,500          22,250

     $100,001-$335,000                 235,000             0.39            91,650         113,900

     $335,001-$10 mil                  9.665 mil           0.34         3.2861 mil         3.4 mil

     over $10 - $15 mil                    5 mil           0.35           1.75 mil        5.15 mil

     over $15 - $18.33 mil              3.33 mil           0.38          1.267 mil       6.417 mil

     over $18.33 mil                   unlimited           0.35          unlimited       unlimited



      Graduated tax rate schedule (table 17-1, pg. 571)
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                 After-Tax Economic Analysis
      Average Tax Rate – because the marginal tax rate
         varies as TI varies, the average tax rate is
         calculate as:
         Ave tax rate = total taxes / TI

      Effective Tax Rate (Te) – the total rate paid by
          corporations, including federal, state and local
          taxes. Note state taxes can be deducted from
          federal taxes. So:

               Te = state rate + (1-state rate)( federal rate)

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                    Example: Problem 17.5
      a) Average Tax Rate
          Taxes on $300,000 = ____________________

               Ave tax rate = _______________________

           Effective Tax Rate (assume state tax = 7%

               Te = ______________________________




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                       CFBT – vs – CFAT
     •     Cash flow before tax (CFBT) – all cash flows
           throughout the year without considering taxes. Note,
           all our PW, FW, AW analysis to this point have been
           CBFT cash flows.

                     CFBT = GI – E – P + S
               where P is initial investments and S is salvage.

     •     Cash flow after tax (CFAT) – includes the cash flow
           impact of taxes.

                     CFAT = CFBT - taxes


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                     CFBT – vs – CFAT
     •     Knowing CFAT = CFBT – taxes …

     •     Taxes are calculated taking depreciation (D) into
           account, however depreciation is not a cash flow,
           but taxes are.

           Taxes = TI(Te)
           TI = GI – E – D

           CFAT = GI – E – P + S – (GI – E – D)(Te)



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                    After-Tax Economic Analysis
                                   Example 17.3 from Book
                     Cash Flow Before Taxes
 Year          GI              E              P and S     CFBT
   0                                     ($550,000)     ($550,000)
   1      $200,000       ($90,000)                      $110,000
   2      $200,000       ($90,000)                      $110,000
   3      $200,000       ($90,000)                      $110,000
   4      $200,000       ($90,000)                      $110,000
   5      $200,000       ($90,000)                      $110,000
   6      $200,000       ($90,000)        $150,000      $260,000
Total                                                   $260,000

                      Cash Flow After Taxes
 Year          GI          E             P and S            D         TI         Taxes        CFAT
   0                                    ($550,000)                                            ($550,000)
   1      $200,000     ($90,000)                        $110,000           $0            $0    $110,000
   2      $200,000     ($90,000)                        $176,000     ($66,000)   ($23,100)     $133,100
   3      $200,000     ($90,000)                        $105,600       $4,400      $1,540      $108,460
   4      $200,000     ($90,000)                         $63,360      $46,640     $16,324       $93,676
   5      $200,000     ($90,000)                         $63,360      $46,640     $16,324       $93,676
   6      $200,000     ($90,000)         $150,000        $31,680      $78,320     $27,412      $232,588
Total                                                   $550,000                               $221,500

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                              Definitions
   Capital Gains (CG): Occurs when selling price is greater than first cost.
           Capital gain = selling price – first cost
                   CG = SP – P

   Depreciation Recovery (DR): Occurs when a depreciable asset is sold
   for more than the current book value.
           Depreciation recapture = selling price – book value
                   DR = SP – BVt

   Capital Loss (CL): Occurs when a depreciable asset is disposed of for
   less than its current book value.
                     CL = BVt - SP




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               After-Tax Economic Analysis
                                   DR     CG


                 $0           BV         P    SP
      When selling price exceeds first cost then both a capital
      gain and a depreciation recovery occur.

                                   DR


                 $0           BV    SP    P
       When selling price exceeds book value but is less than
       he first cost then a depreciation recovery occurs.

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               After-Tax Economic Analysis

                          CL


                $0      SP     BV       P


        When selling price is below book value a capital
        loss occurs.




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                After-Tax Economic Analysis

       Considering capital gains, depreciation recovery and
       capital losses,

                 TI = gross income – expenses – depreciation
                      + depreciation recapture + capital gains
                      – capital loss

               TI = GI – E – D + DR + CG - CL




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               After-Tax PW and AW Analysis

       • Relationship between before-tax MARR and after-
         tax MARR:

                Before-tax MARR = After-tax MARR
                                        1 - Te


         Te for corporations is often between 30 and 50%.




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               After-Tax PW and AW Analysis

       • Approach 1: Find the PW or AW of an alternative
         using the CFAT and the After-tax MARR. That
         alternative with the largest PW (AW) is chosen.

         Note, PW must use LCM (least common multiple of
         years.)




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                After-Tax Economic Analysis

  Using cash flows from Example 17.3, and an after-tax
  MARR of 7%, the PW of this alternative is:

                                           Year     CFAT
  PW = - $550,000                           0      ($550,000)
       + $110,000(P/F, 7%, 1)               1        $110,000
       + $133,100(P/F, 7%, 2)               2       $133,100
       + $108,460(P/F, 7%, 3)               3       $108,460
       + $ 93,676(P/F, 7%, 4)               4        $93,676
       + $ 93,676(P/F, 7%, 5)               5        $93,676
       + $232,588(P/F, 7%, 6)               6       $232,588
                                        Total       $221,500
               = ______________
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