CTC 475Income 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

ObjectivesUnderstand 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 TaxesIncome Tax

Function of net income (gross revenues-deductions)Federal, State and/or Local

Sales TaxTax on purchases Independent of income

Property TaxTax on amount of property you own—(schools, counties) Independent of income

Excise TaxTax on amount of sales of non-necessary goods & services Independent of income

Which tax do we consider?Usually income tax

Corporate Income TaxesCorporationsProfessional AssociationsBusiness TrustsJoint Stock CompaniesInsurance CompaniesCertain Limited Partnerships

Corporate Income Tax RatesTaxable Income (TI)Taxable Income (TI) Tax Rate (%)Tax Rate (%)

0<TI<=50K0<TI<=50K 15%15%

50K<TI<=75K50K<TI<=75K 25%25%

75K<TI<=100K75K<TI<=100K 34%34%

100K<TI<=335K100K<TI<=335K 39%39%

335<TI<=10,000K335<TI<=10,000K 34%34%

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 ProblemA 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 InvestmentW/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 ProblemIncreased tax liability:

$20,500-$7,500=$13,050

$13,050/$45,000=29%

29% of 45K would be paid in taxes

ATCFNet Income=Gross Income-Deductions

(salaries, wages, repairs, rent, etc.)

Taxable Income=Net Income-Depreciation

Tax=Tax Rate * Taxable Income

ATCF=BTCF-Taxes

Example Problem-ATCFCost Basis = $82KSalvage Value = $5KEstimated useful life = 7 yearsMARR=15%Reduction in expenses =$23.5/yrDepreciate using MACRS-GDS5-year propertyDetermine PW of BTCF & ATCF

PW of BTCF PW=-$82K+$23.5K(P/A15,7)+5K(P/F15,7)PW=$17,649

ATCF-Calculate DepreciationEOYEOY CalculationCalculation Depreciation Depreciation

(MACRS)(MACRS)

11 20%*$82K=20%*$82K= $16,400$16,400

22 32%*$82K=32%*$82K= $26,240$26,240

33 19.2%*$82K=19.2%*$82K= $15,744$15,744

44 11.52%*$82K11.52%*$82K==

$9,446$9,446

55 11.52%*$82K11.52%*$82K==

$9,446$9,446

66 5.76%*$82K=5.76%*$82K= $4,723$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)

AA BB CC DD EE FF

B-CB-C D*.34D*.34 B-EB-E

EOYEOY BTCFBTCF Deprec.Deprec. TITI TaxTax ATCFATCF

00 -82K-82K -82K-82K

11 23.5K23.5K 16,40016,400 7,1007,100 2,4142,414 21,0821,0866

22 23.5K23.5K 26,24026,240 -2,740-2,740 -932-932 24,4324,4322

33 23.5K23.5K 15,74415,744 7,7567,756 2,6372,637 20,8620,8633

44 23.5K23.5K 9,4469,446 14,0514,0544

4,7784,778 18,7218,7222

55 23.5K23.5K 9,4469,446 14,0514,0533

4,7784,778 18,7218,7222

66 23.5K23.5K 4,7234,723 18,7718,7777

6,3846,384 17,1117,1166

77 23.5K23.5K 23,5023,5000

7,9907,990 15,5115,5100

77 5K 5K (salvage)(salvage)

5,0005,000 1,7991,799 3,3003,300

PW of ATCFMust take each year back to zero (no series

because each year has a different number)

PW=-$82K+$21,086(P/F15,1)+$24,432(P/F15,2)

+$20,863(P/F15,3)+$18,722(P/F15,4) +$18,722(P/F15,5)+$17,116(P/F15,6) +$15,510(P/F15,7)+$3,300(P/F15,7)

PW of ATCF=$3,010 (still cost effective)

ATCF’s are impacted by:Depreciation methodsRecovery periodPlanning horizonDifferent tax rates BTCF

Other comments:Depreciation is not a cash flow but is needed

to determine taxesTaxes are a cash flowUnder MACRS-GDS the sum of depreciation

amounts should equal the cost basisNegative taxes--assumes a company is able to

reduce it’s overall taxes

MARRIn 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 MARRFor ATCF, use after-tax MARR

Before-Tax MARR; After-Tax MarrApproximate 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%

Next lectureEstimating cash flows

Inflation