Contemporary Engineering Economics, 4 th edition, © 2007 Income Tax Rate To Be Used in Economic Analysis Lecture No. 37 Chapter 9 Contemporary Engineering Economics Copyright © 2006

Contemporary Engineering Economics, 4 th edition, © 2007 What Income Tax Rate Should be Used in Project Analysis? Regular Business Project Revenues Expenses $200,000 $130,000 $40,000 $20,000 Taxable Income Income Taxes $70,000 $12,500 $20,000 ?

Contemporary Engineering Economics, 4 th edition, © 2007 Before Undertaking Project After Undertaking Project The Effect of Project Gross revenue$200,000$240,000$40,000 Expenses130,000150,00020,000 Taxable income$70,000$90,000$20,000 Income taxes$12,500$18,850$6,350 Average tax rate 17.86% 20.94% 31.75% This is the tax rate that should be used in project evaluation. Incremental Income Tax Rate

Contemporary Engineering Economics, 4 th edition, © 2007 BeforeAfterIncremental Taxable income$70,000$90,000$20,000 Income taxes12,50018,8506,350 Average tax rate17.86%20.94% Incremental tax rate31.75% $0 $20,000$40,000$60,000$80,000$100,000 Regular income from operation $20,000 incremental taxable income due to undertaking project Marginal tax rate 15%25%34% $5,000 at 25% $15,000 at 34% 0.25($5,000/$20,000) ($15,000/$20,000) = 31.75% Illustration of Incremental Tax Rate

Contemporary Engineering Economics, 4 th edition, © 2007 Consideration of State Income Taxes Example: Given t f = 35% and t s = 7% Find: t m Combined tax rate = – (0.35)(0.07) = 39.55%

Contemporary Engineering Economics, 4 th edition, © 2007 Example 9.17 Combined State and Federal Income Taxes Financial Data:  Gross revenue = $1,000,000  All expenses (excluding income taxes) = $400,000  t f = 35%, t s = 7%  t m = – (0.070(0.35) = 39.55% Solution:  State taxable income = $600,000  State taxes = (0.07)($600,000) = $42,000  Federal taxable income = $600,000 - $42,000 = $558,000  Federal taxes = (0.35)($558,000) = $195,300  Or (0.3955)$600,000 = $237,300