AfterTax Economic Analysis Gross Income GI total income

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After-Tax Economic Analysis Gross Income (GI) – total income realized from all revenue-producing sources,

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. EGR 312 - 27 1

After-Tax Economic Analysis Taxable Income (TI) – the amount upon which taxes are based.

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 = _______ EGR 312 - 27 2

After-Tax Economic Analysis Corporate Federal Income Tax Rate Schedule (2003) TI Limits $1 -$50,

After-Tax Economic Analysis Corporate Federal Income Tax Rate Schedule (2003) TI Limits $1 -$50, 000 TI Range Tax Rate T Maximum Tax for TI Range Maximum Tax Incurred $50, 000 0. 15 $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 0. 35 1. 75 mil 5. 15 mil 3. 33 mil 0. 38 1. 267 mil 6. 417 mil unlimited 0. 35 unlimited over $15 - $18. 33 mil over $18. 33 mil Graduated tax rate schedule (table 17 -1, pg. 571) EGR 312 - 27 3

After-Tax Economic Analysis Average Tax Rate – because the marginal tax rate varies as

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) EGR 312 - 27 4

Example: Problem 17. 5 a) Average Tax Rate Taxes on $300, 000 = __________

Example: Problem 17. 5 a) Average Tax Rate Taxes on $300, 000 = __________ Ave tax rate = ____________ Effective Tax Rate (assume state tax = 7% Te = _______________ EGR 312 - 27 5

CFBT – vs – CFAT • Cash flow before tax (CFBT) – all cash

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 EGR 312 - 27 6

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

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) EGR 312 - 27 7

After-Tax Economic Analysis Example 17. 3 from Book Cash Flow Before Taxes Year GI

After-Tax Economic Analysis Example 17. 3 from Book Cash Flow Before Taxes Year GI E 0 P and S CFBT ($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 Total $260, 000 Cash Flow After Taxes Year GI E 0 P and S D TI Taxes CFAT ($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) $31, 680 $78, 320 $27, 412 $232, 588 Total EGR 312 - 27 $150, 000 $550, 000 $221, 500 8

Definitions Capital Gains (CG): Occurs when selling price is greater than first cost. Capital

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 EGR 312 - 27 9

After-Tax Economic Analysis DR $0 BV CG P SP When selling price exceeds first

After-Tax Economic Analysis DR $0 BV CG 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. EGR 312 - 27 10

After-Tax Economic Analysis CL $0 SP BV P When selling price is below book

After-Tax Economic Analysis CL $0 SP BV P When selling price is below book value a capital loss occurs. EGR 312 - 27 11

After-Tax Economic Analysis Considering capital gains, depreciation recovery and capital losses, TI = gross

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 EGR 312 - 27 12

After-Tax PW and AW Analysis • Relationship between before-tax MARR and after-tax MARR: Before-tax

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%. EGR 312 - 27 13

After-Tax PW and AW Analysis • Approach 1: Find the PW or AW of

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. ) EGR 312 - 27 14

After-Tax Economic Analysis Using cash flows from Example 17. 3, and an after-tax MARR

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 PW = - $550, 000 + $110, 000(P/F, 7%, 1) + $133, 100(P/F, 7%, 2) + $108, 460(P/F, 7%, 3) + $ 93, 676(P/F, 7%, 4) + $ 93, 676(P/F, 7%, 5) + $232, 588(P/F, 7%, 6) CFAT 0 ($550, 000) 1 $110, 000 2 $133, 100 3 $108, 460 4 $93, 676 5 $93, 676 6 $232, 588 Total $221, 500 = _______ EGR 312 - 27 15