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CTC 475

CTC 475. Income 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. Objectives. Understand the basics of graduated taxes

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CTC 475

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  1. CTC 475 Income taxes ATCF

  2. 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

  3. Objectives • Understand the basics of graduated taxes • Know how to develop an ATCF using depreciation allowances

  4. 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

  5. Types of Taxes • Income Tax • Function of net income (gross revenues-deductions) • Federal, State and/or Local • Sales Tax • Tax on purchases • Independent of income • Property Tax • Tax on amount of property you own—(schools, counties) • Independent of income • Excise Tax • Tax on amount of sales of non-necessary goods & services • Independent of income

  6. Which tax do we consider? • Usually income tax

  7. Corporate Income Taxes • Corporations • Professional Associations • Business Trusts • Joint Stock Companies • Insurance Companies • Certain Limited Partnerships

  8. Corporate Income Tax Rates

  9. 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)

  10. Example Problem A 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?

  11. Without Investment W/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%)

  12. Example Problem • Increased tax liability: $20,500-$7,500=$13,050 • $13,050/$45,000=29% • 29% of 45K would be paid in taxes

  13. ATCF • Net Income=Gross Income-Deductions (salaries, wages, repairs, rent, etc.) • Taxable Income=Net Income-Depreciation • Tax=Tax Rate * Taxable Income • ATCF=BTCF-Taxes

  14. Example Problem-ATCF • Cost Basis = $82K • Salvage Value = $5K • Estimated useful life = 7 years • MARR=15% • Reduction in expenses =$23.5/yr • Depreciate using MACRS-GDS • 5-year property • Determine PW of BTCF & ATCF

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

  16. ATCF-Calculate Depreciation

  17. 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)

  18. PW of ATCF • Must 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)

  19. ATCF’s are impacted by: • Depreciation methods • Recovery period • Planning horizon • Different tax rates • BTCF

  20. Other comments: • Depreciation is not a cash flow but is needed to determine taxes • Taxes are a cash flow • Under MACRS-GDS the sum of depreciation amounts should equal the cost basis • Negative taxes--assumes a company is able to reduce it’s overall taxes

  21. MARR • In 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 MARR • For ATCF, use after-tax MARR

  22. Before-Tax MARR; After-Tax Marr • Approximate 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%

  23. Next lecture • Estimating cash flows • Inflation

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