7-Depreciation%20%26%20Taxes

7-Depreciation%20%26%20Taxes - Engineering Economics ECO...

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Engineering Economics ECO 1192 Lecture 7: Depreciation & Taxes Claude Théoret University of Ottawa
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ECO 1192A -- Fall 2009 Lecture 7: Depreciation & Taxes 2 Recommended Reading Fraser et al. chapters 6, 7 & 8 Newnan et al. chapter 11 & 12 Park chapter 8 & 9
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ECO 1192A -- Fall 2009 Lecture 7: Depreciation & Taxes 3 Lecture Objective Examine the impact of depreciation and income taxes on a project’s Net income Cash flows Worthiness
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ECO 1192A -- Fall 2009 Lecture 7: Depreciation & Taxes 4 Working Assumptions Assumptions dropped with this lecture Owner/equity capital only no debt capital No income taxes; no depreciation of capital assets Assumptions still applicable No price changes No uncertainty or risk No intangibles or imponderables
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Depreciation of capital assets (also known as “fixed” assets)
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ECO 1192A -- Fall 2009 Lecture 7: Depreciation & Taxes 6 Revenue-producing assets
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ECO 1192A -- Fall 2009 Lecture 7: Depreciation & Taxes 7 Working Capital Cash necessary to begin and sustain operations Purchase materials, build inventory An inflow at the beginning of a project An outflow at the end of a project Termed « capital » but ignored as a cost for tax purposes neither depreciable nor tax deductible
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ECO 1192A -- Fall 2009 Lecture 7: Depreciation & Taxes 8 Cash Flows (thus far) Net cash flows = Cash Inflows – Cash Outflows Cash Inflows Revenues from sales, investments, gifts, inheritances …. Cash Outflows Initial investment (P), operating expenses such as utilities, wages and salaries, advertising, interest on loans … Before-Tax Cash Flows (BTCF) = Revenues - costs After-Tax Cash Flows (ATCF) Revenues – operating costs - income taxes
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ECO 1192A -- Fall 2009 Lecture 7: Depreciation & Taxes 9 Depreciation (business expense) Definition : Decrease in the market value or utility of a physical or fixed asset e.g., buildings, machinery and equipment Assets that can be depreciated must be used or held for the production of income have a definite service life that exceeds one year wear out, decay, get used up, become obsolete or decrease in value from natural causes These assets are treated differently from operating expenses (e.g., wages & utilities) Operating expenses are expensed at the time they are incurred (wages are paid for a specific period of time). Physical assets are capitalized because they usually provide services beyond an accounting period.
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Depreciation of Physical Assets Reasons Example 1. use-related physical loss (wear & tear) car; light bulb; slide rule 2. time-related physical loss (even if asset is not used) car; manure spreader; slide rule affected by humidity, dust, sunshine 3. functional loss (asset is unable to meet demand expectations) slide rules; 1 st generation calculators and computers (software and hardware)
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ECO 1192A -- Fall 2009 Lecture 7: Depreciation & Taxes 11 Tax Treatment of Depreciation The Canadian tax system defines the maximum depreciation claimable in any year for a depreciable asset capital cost allowance (CCA) Generally
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This note was uploaded on 06/24/2010 for the course FIR 4440 taught by Professor Moore during the Spring '08 term at U. Memphis.

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7-Depreciation%20%26%20Taxes - Engineering Economics ECO...

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