1. EGR 312 - 271 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.

2. EGR 312 - 272 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 = _____________

3. EGR 312 - 273 After-Tax Economic Analysis Corporate Federal Income Tax Rate Schedule (2003) TI LimitsTI RangeTax Rate T Maximum Tax for TI Range Maximum Tax Incurred $1-$50,000$50,0000.15$7,500 $50,001-$75,00025,0000.256,25013,750 $75,001-$100,00025,0000.348,50022,250 $100,001-$335,000235,0000.3991,650113,900 $335,001-$10 mil9.665 mil0.343.2861 mil3.4 mil over $10 - $15 mil5 mil0.351.75 mil5.15 mil over $15 - $18.33 mil3.33 mil0.381.267 mil6.417 mil over $18.33 milunlimited0.35unlimited Graduated tax rate schedule (table 17-1, pg. 571)

4. EGR 312 - 274 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 (T e ) – the total rate paid by corporations, including federal, state and local taxes. Note state taxes can be deducted from federal taxes. So: T e = state rate + (1-state rate)( federal rate)

5. EGR 312 - 275 Example: Problem 17.5 a) Average Tax Rate Taxes on $300,000 = ____________________ Ave tax rate = _______________________ Effective Tax Rate (assume state tax = 7% T e = ______________________________

6. EGR 312 - 276 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

7. EGR 312 - 277 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(T e ) TI = GI – E – D CFAT = GI – E – P + S – (GI – E – D)(T e )

8. EGR 312 - 278 After-Tax Economic Analysis Example 17.3 from Book Cash Flow Before Taxes YearGIEP and SCFBT 0($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$260,000 Total$260,000 Cash Flow After Taxes YearGIEP and SDTITaxesCFAT 0($550,000) 1$200,000($90,000)$110,000$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)$150,000$31,680$78,320$27,412$232,588 Total$550,000$221,500

9. EGR 312 - 279 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 – BV t Capital Loss (CL): Occurs when a depreciable asset is disposed of for less than its current book value. CL = BV t - SP

10. EGR 312 - 2710 After-Tax Economic Analysis $0 BV P SP DR CG When selling price exceeds first cost then both a capital gain and a depreciation recovery occur. $0 BV SP P DR When selling price exceeds book value but is less than he first cost then a depreciation recovery occurs.

11. EGR 312 - 2711 After-Tax Economic Analysis $0 SP BV P CL When selling price is below book value a capital loss occurs.

12. EGR 312 - 2712 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

13. EGR 312 - 2713 Relationship between before-tax MARR and after- tax MARR: Before-tax MARR = T e for corporations is often between 30 and 50%. After-Tax PW and AW Analysis After-tax MARR 1 - T e

14. EGR 312 - 2714 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.)

15. EGR 312 - 2715 After-Tax Economic Analysis Using cash flows from Example 17.3, and an after-tax MARR of 7%, the PW of this alternative is: 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) = ______________ YearCFAT 0($550,000) 1$110,000 2$133,100 3$108,460 4$93,676 5 6$232,588 Total$221,500