after-tax economic analysis
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EGR 312 - 26 1
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.
EGR 312 - 26 2
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 = _____________
EGR 312 - 26 3
After-Tax Economic Analysis
Corporate Federal Income Tax Rate Schedule (2003)
TI Limits TI Range Tax Rate TMaximum Tax
for TI RangeMaximum Tax
Incurred
$1-$50,000 $50,000 0.15 $7,500 $7,500
$50,001-$75,000 25,000 0.25 6,250 13,750
$75,001-$100,000 25,000 0.34 8,500 22,250
$100,001-$335,000 235,000 0.39 91,650 113,900
$335,001-$10 mil 9.665 mil 0.34 3.2861 mil 3.4 mil
over $10 - $15 mil 5 mil 0.35 1.75 mil 5.15 mil
over $15 - $18.33 mil 3.33 mil 0.38 1.267 mil 6.417 mil
over $18.33 mil unlimited 0.35 unlimited unlimited
Graduated tax rate schedule (table 17-1, pg. 571)
EGR 312 - 26 4
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 (Te) – the total rate paid by corporations, including federal, state and local taxes. Note state taxes can be deducted from federal taxes. So:
Te = state rate + (1-state rate)( federal rate)
EGR 312 - 26 5
Example: Problem 17.5
a) Average Tax Rate
Taxes on $300,000 = ____________________
Ave tax rate = _______________________
Effective Tax Rate (assume state tax = 7%
Te = ______________________________
EGR 312 - 26 6
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
EGR 312 - 26 7
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(Te)
TI = GI – E – D
CFAT = GI – E – P + S – (GI – E – D)(Te)
EGR 312 - 26 8
After-Tax Economic AnalysisExample 17.3 from Book
Cash Flow Before Taxes
Year GI E P and S CFBT
0 ($550,000) ($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
Year GI E P and S D TI Taxes CFAT
0 ($550,000) ($550,000)
1 $200,000 ($90,000) $110,000 $0 $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
EGR 312 - 26 9
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 – BVt
Capital Loss (CL): Occurs when a depreciable asset is disposed of for less than its current book value.
CL = BVt - SP
EGR 312 - 26 10
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.
EGR 312 - 26 11
After-Tax Economic Analysis
$0 SP BV P
CL
When selling price is below book value a capital
loss occurs.
EGR 312 - 26 12
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
EGR 312 - 26 13
• Relationship between before-tax MARR and after-tax MARR:
Before-tax MARR =
Te for corporations is often between 30 and 50%.
After-Tax PW and AW Analysis
After-tax MARR 1 - Te
EGR 312 - 26 14
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.)
EGR 312 - 26 15
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)
= ______________
Year CFAT
0 ($550,000)
1 $110,000
2 $133,100
3 $108,460
4 $93,676
5 $93,676
6 $232,588
Total $221,500
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