Reviewing… We covered the following depreciation methods: Straight Line Declining Balance Sum of Years Digits Units of Production MACRS – Modified Accelerated Cost Recovery System

Effective Tax Rates Terminology: Federal Tax Rate (FTR) Federal Taxable Income Federal Taxes = Federal Tax Rate x Federal Taxable Income State Tax Rate (STR) State Taxable Income State Taxes = State Tax Rate x State Taxable Income

Effective Tax Rates State taxes are deductible when calculating Federal taxable income. Effective Tax Rate = FTR (1 – STR) + STR

Marginal Tax Rates Tax rates for corporations and individuals vary depending on the amount of taxable income. Different tax rates apply to incremental income.

Marginal Tax Rates 2010 Federal Personal (Single) Tax Schedule Taxable Income Tax Rate $0 to $8,350 10% $8,350 to $33,950 15% $33,950 to $82,250 25% $82,250 to $171,550 28% $171,550 to $372,950 33% $372,950 and up 35% These marginal tax rates apply to personal income – and business income that is reported via personal income tax returns (proprietorships and partnerships). Corporations have an additional surtax in some income ranges, sometimes resulting in a higher marginal tax rate (see next slide).

Marginal Tax Rates 2010 Federal Corporate Tax Schedule Taxable Income $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 $10,000,001 to $15,000,000 35% $15,000,001 to $18,333,333 38% $18,333,334 and up

Average Tax Rate vs. Marginal Tax Rate Example: $125,000 in taxable income Average Tax Rate: Marginal Tax Rate:

Assumptions Company already has taxable income. We need to know the marginal tax rate. Assume project will keep me in the same marginal tax bracket.

After Tax Analysis 1. Determine Taxable Income: ( + ) Income ( - ) Expenses ( - ) Interest Paid ( - ) Depreciation (Not a real cash flow) Determine Taxes Use the marginal tax rate Determine After Tax Cash Flow ( - ) Loan Payments ( - ) Tax cash flow

After Tax Analysis Example: Determine year 1 cash flows with marginal tax rate of 39%: Gross Income = $7,000 Cost of Goods Sold = $1,000 Operating Expense = $3,000 Depreciation Charge = $2,000 Loan Payment = $2,802 Interest Expense = $1,200

Sale of Asset End of the year taxable income from sale = Sale Price – Book Value Tax cash flow from sale of the asset = taxable income from sale x marginal tax rate After tax cash flow = sale price – tax cash flow from sale of the asset

Early Sale of Asset Half Year Convention: It is assumed that an asset is put into service half-way through the initial year – so only ½ year of depreciation may be claimed in Year 1. MACRS table takes care of this, automatically If selling an asset before the final year of MACRS depreciation, only ½ year of depreciation may be claimed in that year … Reduce depreciation amount by ½, and… Increase book value by ½ depreciation amount

Sale of Asset Example A machine was purchased on January 1, 1999, for $10,000. It has been depreciated using the MACRS 5 year schedule. It can be sold for $8,000 on December 31, 2001. Determine the After Tax Cash Flow (ATCF) for the sale of the machine. The marginal tax rate is 35%.

Sale of Asset Example with a Twist - 1! A machine was purchased on January 1, 1999, for $10,000. It has been depreciated using the MACRS 5 year schedule. It can be sold for $8,000 on January 1, 2002. Determine the After Tax Cash Flow (ATCF) for the sale of the machine. The marginal tax rate is 35%.

Sale of Asset Example with a Twist - 2! A machine was purchased on January 1, 1999, for $10,000. It has been depreciated using the MACRS 5 year schedule. It can be sold for $2,000 on December 31, 2001. Determine the After Tax Cash Flow (ATCF) for the sale of the machine. The marginal tax rate is 35%.