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

2. 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

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

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

5. 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).

6. 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

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

8. 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.

9. 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

10. 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

11. 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

12. 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

13. 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, Determine the After Tax Cash Flow (ATCF) for the sale of the machine. The marginal tax rate is 35%.

14. 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, Determine the After Tax Cash Flow (ATCF) for the sale of the machine. The marginal tax rate is 35%.

15. 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, Determine the After Tax Cash Flow (ATCF) for the sale of the machine. The marginal tax rate is 35%.