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 (%) 0<TI<=50K15% 50K<TI<=75K25% 75K<TI<=100K34% 100K<TI<=335K39% 335<TI<=10,000K34%

Tax Rate is Graduated On first 50K company pays 15% On next 25K company pays 25% On next 25K company pays 34% On next 235K company pays 39% >235K 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 (TI=$50K) Tax=15% * $50K = $7,500 (effective rate =15%) With Investment (TI=$95K) Tax=15% * $50K +25% * $25K +34% * $20K =$20,550 (effective rate=21.6%)

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/A 15,7 )+5K(P/F 15,7 ) PW=$17,649

ATCF-Calculate Depreciation EOYCalculation Depreciation (MACRS) 120%*$82K=$16, %*$82K=$26, %*$82K=$15, %*$82K=$9, %*$82K=$9, %*$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)

ABCDEF B-CD*.34B-E EOYBTCFDeprec.TITaxATCF 0-82K-82K 123.5K16,4007,1002,41421, K26,240-2, , K15,7447,7562,63720, K9,44614,0544,77818, K9,44614,0534,77818, K4,72318,7776,38417, K23,5007,99015, K (salvage) 5,0001,7993,300

PW of ATCF Must take each year back to zero (no series because each year has a different number) PW=-$82K+$21,086(P/F 15,1 )+$24,432(P/F 15,2 ) +$20,863(P/F 15,3 )+$18,722(P/F 15,4 ) +$18,722(P/F 15,5 )+$17,116(P/F 15,6 ) +$15,510(P/F 15,7 )+$3,300(P/F 15,7 ) 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%

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