Lec%2030_Full

# Lec%2030_Full - IE 343 Engineering Economics Lecture 30...

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IE 343 Engineering Economics Lecture 30: Chapter 7 - Depreciation and Income Taxes Instructor: Tian Ni Nov.7, 2011 IE 343 Fall 2011 1

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After-tax economic analysis IE 343 Fall 2011 2
Similar profitability analysis as before, but use after-tax cash flows (ATCF) instead of before-tax cash flows (BTCF), and use an after-tax MARR. IE 343 Fall 2011 After-tax economic analysis 3

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Recall Chapter 6 Comparing Alternatives: Study Period = Useful Lives Equivalent Worth Method Rate of Return Method (Incremental Analysis): Study Period ≠ Useful Lives Case 1: Repeatability Assumption holds. Case 2: Study period > Useful life. Coterminated Assumptions Case 3: Study period < Useful life. imputed(implied) market value technique IE 343 Fall 2011 After-tax economic analysis 4
R k = cash inflow in year k. E k = cash outflow in year k. d k = sum of all noncash, or book, cost in year k, such as depreciation deduction. t = annual income tax rate. T k = income tax liability (or credit) for year k. BTCF k = Before-tax cash flows in year k. ATCF k = After-tax cash flows in year k. IE 343 Fall 2011 After-tax economic analysis - Terminology 5

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Taxable income = R k - E k - d k T k = -t(R k - E k - d k ) Therefore, when R k > ( E k + d k ), a tax liability (i.e. negative cash flow) occurs. When R k < ( E k + d k ), a decrease in the tax amount (a credit) occurs. BTCF k = R k - E k ATCF k = BTCF k + T k = (R k – E k ) – t(R k – E k – d k ) = (1 - t)(R k – E k ) + td k IE 343 Fall 2011 After-tax economic analysis Depreciation Deduction is a Plus for ATCF! That’s why we prefer to depreciate more at earlier time. 6
IE 343 Fall 2011 After-tax economic analysis – General Approach Year (A) BTCF (BTCF k ) (B) Depreciation (d k ) (C ) = (A) - (B) Taxable Income (TI) (D) = -t(C ) Cash Flow for Income Taxes (Taxes) (E) = (A) + (D) ATCF (ATCF k ) k R k - E k d k R k - E k – d k -t(R k – E k -d k ) (1-t)(R k - E k ) + td k 7

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After-tax MARR is approximately equal to Before- tax MARR × (1-income tax rate). This approximation is exact if no deduction involved. IE 343 Fall 2011 After-tax economic analysis 8 MARR tax After rate)] tax income Effective 1 ( MARR)[ tax (Before
Suppose that an asset with a cost basis of \$100,000 is expected to produce net revenues of \$30,000 per year during the six-year period, and its terminal market value is negligible. If the effective income tax rate is 40%, how much can a firm afford to spend for this asset and still earn the after-tax MARR of 10% per year. The asset is being depreciated under the ADS method over a recovery period of five years. IE 343 Fall 2011

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Lec%2030_Full - IE 343 Engineering Economics Lecture 30...

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