MSci261-2007-Ch_8 - Chapter 8 Taxes MSci 261 Managerial and...

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Chapter 8 1 Chapter 8 Chapter 8 MSci 261: Managerial and Engineering Economics Spring 2007 Instructor: Bon Koo Taxes Taxes
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Chapter 8 2 Overview Overview Governments in most countries levy taxes on individuals and corporations, for health, infrastructure, defense, etc. For a company, Taxes reduce net profits associated with an investment. Thus, considering the effects of taxes on the viability of a project is very important. Types of tax Direct tax: Income tax (personal or corporation), Property tax Indirect tax: Sales tax [Other taxes: inheritance tax, retirement tax, tariff,
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Chapter 8 3 1.1. Income tax: personal 1.1. Income tax: personal Personal income tax Levied on personal taxable income (= income – tax credits) Tax credits: medical expense, education fee, pension, etc. Progressive tax rate: rate increases with income levels Example of personal income tax rate (2006) Income Federal tax rate Ontario tax rate Income Less $36,378 15% 6.05% Less $34,758 - $72,756 22% 9.15% -$69,517 - $118,285 26% 11.16% Over $69,517 Over $118,285 29%
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Chapter 8 4 1.2. Income tax: corporate 1.2. Income tax: corporate Corporate income tax Levied on taxable income (= revenue – expenses) Expenses: operating expense and capital expense Flat tax rate: independent of the level of firm’s profit Corporate tax rate Rates depend on the location, type and size of the firm Tax rates range from 17% to 52%. Small business deduction: Government levies less tax (often less than 20% of the profit) on small business
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Chapter 8 5 1.1. Income tax: OECD countries 1.1. Income tax: OECD countries
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Chapter 8 6 2. MARR, IRR and tax 2. MARR, IRR and tax Taxes reduce profits associated with a project. MARR before-tax Our basic definition of MARR up to this chapter Should be set high enough to pay the tax later. MARR after-tax MARR after-tax 2245 MARR before-tax × (1 t) where t is the tax rate IRR after-tax 2245 IRR before-tax × (1 t) If the before-tax MARR is 12% and the corporate tax rate is 45%, what is the after-tax MARR?
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Chapter 8 7 Example 2-1: MARR, IRR and tax Example 2-1: MARR, IRR and tax Eddy just completed an IRR analysis of a project for his firm. The 9% after-tax IRR was larger than the 5% after-tax MARR, and the project was deemed acceptable. However, his boss wants to compare the before-tax IRR with the before-tax MARR. If the company pays 40% corporate taxes, what figures should he report to this boss? From MARR after-tax 2245 MARR before-tax x (1 t) 0.05 2245 MARR before-tax x (1 0.4) MARR before-tax 2245 8.3% From IRR after-tax 2245 IRR before-tax x (1 t) 0.09 2245 IRR x (1 0.4) IRR 2245 15%
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Chapter 8 8 3. Capital expense and tax 3. Capital expense and tax Firms have a strong incentive to report a large expense to reduce the amount of tax paid. (= revenue expenses) Expenses: operating expense + capital expense Operating expense is straightforward in tax calculation.
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