l:26 project cost elements and income tax rate to be used

(c) 2001 Contemporary Engineering Economics

1www.izmirekonomi.edu.tr

L:26 Project Cost Elements and Income Tax Rate to Be Used

ECON 320 Engineering EconomicsMahmut Ali GOKCEIndustrial Systems EngineeringComputer Sciences


www.izmirekonomi.edu.tr

Chapter 9 – Chapter Opening Story

Home Depot – 1,487 retail storesPlant to install self-service checkouts in about 300 high volume stores ($40 million) Use less number of cashiers, shoplifting, and improve customer satisfaction

How do you estimate these cost savings?



Engineering Economic Decisions

• Evaluation of a Fixed Asset– Equipment– Buildings

• Valuation of Fixed Assets– Based on usable after-tax cash flows the asset

produces



General Cost Terms

Manufacturing Costs

Direct materials

Direct labor

Mfg. Overhead Non-manufacturing Costs

Overhead

Marketing

Administrative



Classifying Costs for Financial Statements

Matching Concept: The costs incurred to generate particular revenue should be recognized as expenses in the same period that the revenue is recognized.

Period costs: Those costs that are matched against revenues on a time period basis Matched against periods, they

become expenses immediately Product costs:Those costs that

are matched against revenues on a product basis. Matched against products,

become expenses when the product is sold



Cost Classification for Predicting Cost Behavior

Volume index Cost Behaviors

Fixed costs

Variable costs

Mixed costs Average unit costs



Volume Index Cost behavior how a cost item will

react/respond to changes in the level of business activity.

Def: The unit measure used to define “volume” Might be based on production

inputs or outputs Examples:

Automobile – “miles” driven Generating plant – “kWh” produced Stamping machine – “parts”

stamped Fixed and variable cost is two most

common cost behavior patterns



Fixed Costs

Def: The costs of providing a company’s basic operating capacity

Cost behavior: Remain constant over the relevant range



Variable Costs Def: Costs that vary

depending on the level of production or sales Depends on volume

Cost behavior: Increase or decrease proportionally according to the level of volume

Marginal contribution= unit sales price-unit variable cost



Mixed Costs

Partly fixed, partly variable costs Depreciation of a car,

Car depreciates as time goes by, no matter how much you drive.

Car depreciates more if you drive it more. Electric bill:

Electric usage for lighting heating: independent of production volume

More production, more machines work, use more electricity



Average Unit Cost

Def: activity cost per unit basis

Cost Behaviors: Fixed cost per unit varies

with changes in volume. Variable cost per unit of

volume is a constant.



Practice Problem

You have 3000 units to produce. Total labor cost = $20,000 Total material cost = $25,000 Total overhead cost = $15,000 Total fixed cost = $40,000 What is the average cost per unit?

Average cost = ($100,000)/3,000 = $33.33/unit



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

?



Incremental Income Tax Rate

Before Undertaking

Project

After Undertaking

Project

The Effect

of Project

Gross revenue $200,000 $240,000 $40,000

Expenses 130,000 150,000 20,000

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 in project evaluation.



Before After Incremental

Taxable income $70,000 $90,000 $20,000

Income taxes 12,500 18,850 6,350

Average tax rate 17.86% 20.94%

Incremental tax rate 31.75%

$0 $20,000 $40,000 $60,000 $80,000 $100,000

Regular income from operation

$20,000 incrementaltaxable income due toundertaking project

Marginal tax rate15% 25% 34%

$5,000at 25%

$15,000at 34%

0.25($5,000/$20,000) + 0.34($15,000/$20,000) = 31.75%

l:26 project cost elements and income tax rate to be used

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