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Engineering Economic Analysis

Engineering Economic Analysis. Chapter 12  Income Taxes. Taxes.

johnamorris
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Engineering Economic Analysis

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  1. Engineering Economic Analysis Chapter 12  Income Taxes rd

  2. Taxes • The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration. -Amendment XVI, U.S. Constitution • It takes only a majority to institute the Fair Tax but a 2/3 vote to repeal an amendment. • Thus it is possible to have the Fair Tax enacted with continued taxation under the current IRS. rd

  3. Personal Income • Personal Exemptions $3400 • Itemized deductionsExcessive medical and dental exceeding 1.5% of AGI • State and local tax • Home mortgage interest • Charitable donations • Casualty and theft losses (> $100 + 10% AGI) • Miscellaneous deductions (> 2% of AGI) • Car and other business expenses • Tax benefits for work-related education • Standard Deduction • Single taxpayer $5350Married filing jointly ($10,700) • Taxable income = AGI – PE – Itemized-deduct or Standard Deduction rd

  4. Taxes • Income • Property • Sales • Excise rd

  5. Classification of Business Expenditures • Capital ExpendituresDepreciable assetsNon-depreciable assets • ExpensedAll other business expenditures • Taxable income = GI – Expensed - Depreciation rd

  6. Corporate Taxes Item Gross income ~ total income from all revenue producing sources Expenses ~ all corporate costs incurred in the business Cost of goods sold Depreciation Operating expenses Taxable operating income ~ amount on which taxes are assessed Income taxes ~ amount of taxes based on some form of income Net income rd

  7. Corporate Tax Rate rd

  8. Taxable Income • Year 1 Year 2 Year 3 • Gross Income $200 $200 $200Special Tooling -60 0 0 (3-year life)Expenditures -140 -140 -140Cash results $0 $60 $60 • Use st line depreciation with 0 salvage to get 60/3 = $20 Taxable Income $40 $40 $40 • Computed as (200 – 20 – 140) = $40 to show that taxable income is a better indicator of performance rd

  9. Computing Corporate Tax A corporation buys a $75K machine that for the first year brings in $200K of revenue with $84K operating expenses and $4K of depreciation. Compute taxes paid at 30% rate and net income.How much was generated from operations? Taxable income = GI – Expensed – Depreciation = 200K – 84K – 4K = 112K Taxes = 112K * 0.30 = $33.6K taxes paid => Net Income = Taxable Income * 0.70 = 112K * 0.7 = $78.4K $78.4K + 4K = $82.4K generated from operations. rd

  10. Corporate Tax Given a boat was bought for $80K with a 10-year life and $10K salvage value. First year operating expenses and revenues show Operating revenue $250,000Operating expenses $90,000Depreciation $7,000 If the company’s tax rate is 34%, compute the net income for the first year. (250K – 90K – 7K) * 0.66 = $100,980 rd

  11. Corporate Tax Compute the effective tax rate and marginal tax rate for a firm with taxable income of $90,000. Taxes paid = 0.15(50K) + 0.25(25K) + 0.34(15K) = $18,850 = 13.75K + 0.34(90K – 75K) = $18,850Effective tax = 18,850 / 90,000 = 20.94%; marginal tax rate = 34%Effective rate is also called the average tax rate. rd

  12. MACRS Depreciation A 5-year MACRS tool costing $60K has calculated salvage values of $20K in year 3, $10K in year 5 and $5K in year 6. Compute the gain or loss if disposed of in years 3, 5 and 6. DC3 = $60K(0.2 + 0.32 + 0.192/2) = $36,960 => BV3 = $23,040Loss = 20K – 23,040 = -$3,040 DC5 = $60K(0.2 + 0.32 + 0.192 + 0.1152 + 0.1152/2) = $53,088BV5 = $60K – 53,088 = $6,912 => Gain = 10K - $6,912 = $3,088. DC6 = $60K with BV6 = 0 => Gain is $5K. (macrs 5)  (20.0 32.0 19.2 11.52 11.52 5.76)(Dmacrs 60e3 5)  (12000 19200 11520 6912 6912 3456) rd

  13. Federal and State Tax A corporation has $2M in revenue and $1.2M in expenses. If the marginal federal tax rate is 34% and the state rate is 6% compute the combined taxes paid. Taxable Income = $2M – $1.2M = $800K Method I: 0.34 + 0.06 – (0.34 * 0.06) = 37.96% combined F&S $800K * 0.3796 = $303,680. Method II: State Tax = $800K * 0.06 = $ 48,000 Federal tax = (800K – 48K) = 752K (* 0.34) = $255,680 $303,680 rd

  14. Personal Income Tax 2007 • Individual income tax rate schedule for single and married filing jointly • Taxable Income $ • Tax Rate Filing Single Filing Married and Jointly0.10 $0–7,825 $0–15,6500.15 $7,826–31,850 $15,651–63,7000.25 $31,851–77,100 $63,701–128,5000.28 $77,101–160,850 $128,501–195,8500.33 $160,851–349,700 $195,851–349,7000.35 Over $349,700 Over $349,700 • Compute tax for a single with a taxable income of $55K.Tax = 0.10(7,825) + 0.15(24,024) + 0.25(23,149) = $10,173.35 • Compute tax for a couple filing jointly with a taxable income of $150K. Tax = 0.1(15,650) + 0.15(48049) + 0.25(64799) + 0.28(150K – 128,501) = $30,991.82 => effective tax rate of 30991.82/150K = 20.66% 12/20/2019 rd rd 14

  15. Personal Income Tax • Joe and Holly earn $82K and have 4 personal exemptions and the standard deduction of $9500. Interest & dividends amount to $6050 • Gross income = salaries + interest & dividends, capital-g • = $82K + 3550 + 2500 = $88,050 • Taxable income = gross – exemptions – deductions • = 88,050 -4(3100) – 9500 = $66,150. • Taxes = 15,651(0.10) + 63,700 – 15,650)0.15 + • (66,150 – 63,700)(0.25) • = $9385; of which 9385/88050 = 10.7% effective. rd

  16. Income Taxes Find the breakeven number of days for purchasing a truck for $13K with 3K salvage value at end of a 7- year life with $1100 annual expense and $35 daily expense, or lease for $83 a day based on 10% ATCF and 50% tax rate. Use straight line depreciationN BTCF SLine TI 50% Tax ATCF0 -$13K -$13K1-7 48X–1100 1428.57 48X–2528.57 –24X+1264.29 24X+164.29 7 3000 300013K(F|P,10%,7) = (24X+164.29)(F|A,10%,7) + 300025,333.32 = 226.69X+ 1558.64 +3000X = 91.61 days rd

  17. Income Taxes 12-47. House and lot sell for $155K. Land is $45K and home is $110K. Rent inputs $12K yearly with st-line depreciation 27.5 year life. Mary wants a 10% ATCF. Find selling price at year n = 10 for Mary in 28% tax rate. n BTCF SLN TI 28%Tax ATCF0 -155K -155K1-10 12K 110K/27.5 = 4K 8K -2.24K 9.76K10 X (X – 115K) -0.28X + 32.2K 0.72X + 32.2K BV10 = 155K – 10(4K) = 115K 155K = 9.76K(P/A, 10%, 10) + (0.72X + 32.2K)(P/F, 10%, 10)  X = $297,612.25. rd

  18. Incremental ATCF Analysis 12-52 MARR = 10% n BTCF DC TI 20% Tax ATCF IRR -25 -25 B 1-5 7.5 5 2.5 - 0.50 7 12.38% -10 -10 C 1-5 3 2 1 - 0.20 2.8 12.38% -5 -5 D 1-5 1.7 1 0.7 - 0.14 1.56 16.92% -15 -15 E 1-5 5 3 2 - 0.40 4.6 16.17% -30 -30 F 1-5 8.7 6 1.7 - 0.34 8.16 11.21% rd

  19. Incremental ATCF Analysis MARR = 10% D is > MARR; begin incremental analysis in order of cost. C-D (IRR ‘(-5 1.24 1.24 1.24 1.24 1.24)) 7.63% E-D (IRR ‘(–10 3.04 3.04 3.04 3.04 3.04))  15.8% E B-E (IRR ‘(-10 2.4 2.4 2.4 2.4 2.4))  6.4% => E F-E (IRR ‘(-15 3.56 3.56 3.56 3.56 3.56))  6% => E E is best. rd

  20. Taxable Income A small company has taxable income of $50K and is thinking of another project which will increase taxable income by $45K. a) Compute the increase in taxes if the project is assumed.b) Repeat analysis if taxable income is $400K. a) (0.15 * 50K) = $7500 without project (under $50 K => 15% tax) With 95K TI 13,750 + (0.34 * 20K) = $20,550 Taking on the $45K project increases taxes by ($20.55K - $7.5K) = $13.05K, implying 13,050/45,000 = 29% of project is taxes. b) 113.9K + (0.34 * 65K) = $136,000 taxes for TI = $400K 136/400 = 34% which is about the same for the additional $45K project. 0.34 * $45K = $15,300 for total tax of $151,300. rd

  21. ATCF Deductions other than interest and depreciation Gross income (Income less Tax exemptions) After-tax Cash flow Income taxes Interest on borrowed money rd

  22. After Tax Cash Flow • = - Pn (capital investments) • + Sn (revenues from sales of assets) • - t(Sn - Bn) (taxes on gains from sales of assets) • - W (net working capital) • + (1 – t)Rn (after tax ordinary revenues) • - (1 – t)En (AT operating expenses, labor energy, materials • + tDn (depreciation tax savings) • - (1 –t)IPn (AT interest payments) • - PPn (Principal payments) • + B (loans received) rd

  23. Problem 12-21 n BTCF DDB TI 46% Tax ATCF0 -100K -100K1 30K 50K -20K 9.2K 39.2K2 30K 25K 5K -2.3K 27.7K3 35K 12.5K 22.5K -10.35K 24.65K4 40K 6.25K 33.75K -15.525K 24.475K5 10K 0 10K -4.6K 5.4K6 10K 0 10K -4.6K 11.65K6 6.25K 0 Tools sold for salvage value of $6,250 (IRR ‘(-100000 39200 27700 24650 24470 5400 11650))  11.61% rd

  24. Problem 12-22 Loan Payment = $25,237.66 n BTCF DDB P I TI 46% Tax ATCF0 - 20K - 20,000.001 30K 50K 17237.66 8000 -28,000 12,880 17,642.342 30K 25K 18961.43 6276.23 -1276.23 587.06 5,349.403 35K 12.5K 20857.57 4380.09 18,119.91 -8,335.16 1,427.184 40K 6.25K 22943.33 2294.33 31,455.67 -14,469.60 292.745 10K 0 10,000 - 4,600 5,400.006 10K 0 10,000 - 4,600 11,650.006 6.25K 0 0 (IRR ‘(-20000 17642.34 5349.40 1427.18 292.74 5400 11650)) 34.31%. rd

  25. Problem 12-39 • First cost = $25K, life 4 years, salvage value = $5K, • UAB = $8K MARR = 10% in 40% tax bracket, MACRS 3 • n BTCF Dep TI Tax (40%) ATCF0 -25K -25K1 8K 8333 -333 133.20 8133.22 8K 11112 -3112 1244.8 9244.83 8K 3702 4292 -1719.20 6280.84 8K 1852 6148 -2459.20 5540.80 + 5K • (list-pgf '(-25e3 8133.2 9244.8 6280.8 10540.8) 10) •  $1952.51 => Granny should invest. RoR = 13.48% rd

  26. Problem 12-54 • Year 0 1 2 3 4 5 ATAX = 10%A -3K 1K 1K 1K 1K 1K SOYDB -5K 1K 1.2K 1.4K 2.6K 2.8K ST-LINE • n~A BTCF Dep TI Tax 34% ATCF0 -3K -3K1 1K 1K 0 0 1K2 1K 800 200 -68 9323 1K 600 400 -136 8644 1K 400 600 -204 796 5 1K 200 800 -272 728 14.39% ATCF-A • 0~B -5K -5K1 1K 1K 0 0 1K2 1.2K 1K 200 -68 11323 1.4K 1K 400 -136 12644 2.6K 1K 1600 -544 20565 2.8K 1K 1800 -612 2188 13.68% ATCF-BIRRB-A: (IRR '(-2e3 0 200 400 1260 1460))  12.99% => B > A rd

  27. Problem 12-57 • Buy for $1M or lease for $200K/yr. Annual income is $800K, annual costs are 200K with resale value at $400K. • 10-year life with st-line, tax at 40%, ATCF i = 10% • n BTCF Dep TI Tax 40% ATCF0 -1M -1M1-10 600K 60K 540K -216K 384K10 400K-1M(A/P,10%, 10) + 384K + 400K(A/F, 10%, 10) = $246,352.76 BUY • LEASE: (800K -200K -200K)0.40 = $160K tax or $240K cash flow • EUAB – EUAC = $800K - $200K - $200K -160K = $240K • Better to Buy and net $6352.76 rd

  28. ATCF Use st-line depreciation with an ATCF of 8% and tax rate of 40% to choose the best system for 6-year lives.A B C First cost $40K $50K $35KUAB 5K 3.5K 10KSalvage 8K 5K 3K Year BTCF St-Line TI Tax 40% ATCFA 1-6 5K 5.333K -0.333 133.33 5133; 8K SalvageB 1-6 3.5K 7.5K -4K 1600 5100; 5KC 1-6 10K 5.333K 4666.67 -1866.67 8133; 3K (UIRR 40e3 5133 6 8e3)  -0.75% (UIRR 5e3 -3e3 6 5e3)  -200% A-C(UIRR 50e3 5100 6 10e)  -8.23% (UIRR 5e3 -3033 6 2e3)  -88% B-C(UIRR35e3 8133 6 3e3)  11.95% C is best rd

  29. ATCF • An asset bought for $100K with S = $20K after 5 years is depreciated MACRS 5-year rates. Expense average $18K annually with an effective tax rate of 30%. After 5 years of service the asset is sold for $22K. The ATCF for the sale of the asset is closest to • $27,760 b) $17,130 c) $26,870 d) $20,585 • (dmacrs 100e3 5) (20000 32000 19200 11520 11520 5760) • 22K + 5,760 = $27,760 rd

  30. Taxes on Capital Gains • A 3-year property class type equipment bought for $30,000 is sold for $20,000 at the end of three years. • The company is at a 34% tax bracket. The tax is • $5,125.89 b) $7,201.45 c) $6,044.18 d) $7,182.35 • (dmacrs 30E3 3)(9999 13335 4443 2223) • Must pay capital gains on (20K – 2223) = $17777 or • 0.34 * 17777 = $6044.18 rd

  31. Corporate Taxes • Pace Corporation had a taxable income of $300,000 in 2007. Which of the following expression may be used to • compute the federal income tax liability for the company? • a) 15% of taxable income • b) 25% of taxable income • $113,900 + 34% over $100,000 • $22,250 + 39% over $100,000 • See Tax table Page 395 of text, rd

  32. Taxes • First cost of equipment = $6,000; Salvage value after 5 years = $1,500MACRS depreciation is used as a 5-year property; Income-tax rate for the company = 34%; Capital gains are taxed at 15% rate. • Cash flow is -6000 1600 1600 1600 1600 1600 1600 + 9000 salvage • Find ATCF RoR (dmacrs 6E3 5)  (1200 1920 1152 691.2 691.2 345.6) • n BTCF Dep TI Tax Rate ATCF0 -6000 -$60001 1600 1200 400 -136 14642 1600 1920 -320 108.8 1708.83 1600 1152 448 -152.32 1447.684 1600 691.2 908.8 -309 1291.005 1600 691.2 908.8 -309 1291.06 1600 345.6 1254.4 -426.5 1173.56 9000 Capital gain = Market value – Cost basis = 9K - 6K = 3K at 15% Depreciation recapture is cost basis – book value = $6000 – 0 tax @ 34% rd

  33. Income or Profit and Loss Statement Revenue $300,000Operating Expenses 250,000 Gross Profit 50,000Administrative Costs 10,000Other Income 5,000 Net Income Before Tax 45,000Tax 20,000Net Income of Net Profit After tax 25,000Dividends 10,000Retained Earnings 15,000 rd

  34. Balance Sheet Assets Liabilities and Owners EquityCash $50,000 Accounts Payable $30,000Securities 5,000 Note Payable 20,000Accounts Receivable 5,000 Taxes Payable 10,000Inventory 90,000 Common Stock 300,000Equipment 200,000 Retained Earnings 90,000Buildings 100,000 Total Liability and Total Assets $450,000 Owners Equity $450,000 rd

  35. Balance Sheet Engineered Industries K Assets LiabilitiesCurrent assets Current liabilities Cash 1940 Accounts Payable 1150 Accounts Receivable 950 Notes Payable 80 Securities 4100 Inventories 1860 Accrued expense 950 (-) Bad debt provision -80 Total current liabilities 2180Fixed assets Long-term liabilities 1200 Land 335 Plant & Equipment 6500(-) Accumulated depr -2350 Equity Preferred stock 110 Other assets Common stock 650 Prepays/deferred charges 140 Capital Surplus 930 Intangibles 420 Retained earnings 8745 Total other assets 560 Total equity 10,435Total assets 13,815 Total liabilities and equity 13,815 rd

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