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Supplement_CapitalBudgetingAndTaxes

Supplement_CapitalBudgetingAndTaxes - 6A:002 Berg Taxes and...

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6A:002 – Berg Taxes and Capital Budgeting Page 1 Supplement - Chapter 9 Taxes and Capital Budgeting Decisions In Chapter 9, we examine capital budgeting decision making. Because the costs and benefits of these decisions occur over time periods much longer than one year, we need a way to incorporate the fact that a dollar received today is worth more than a dollar received 10 years from now. Discounting (computing net present value) is one way to do this. Because it is cash, and not accounting earnings, that earns interest, we evaluate cash flows rather than accounting earnings when computing net present value. One consideration excluded from the analysis in Chapter 9, is the impact of taxes. While the firm faces many kinds of taxes, we will consider only federal income taxes. As we did when discussing Cost Volume Profit analysis, we will assume that federal income tax is a percentage of net income. Because net income is computed using accounting earnings, not cash flows, we will need to think about how these two measures differ in order to evaluate the effect of taxes. Recall that there are three primary types of cash flows associated with a capital budgeting project: (1) An initial cash outflow for the investment in the project. Generally we assume that this happens at the very beginning of the project (time 0). (2) Periodic future cash inflows from the project. These are the additional revenues and decreases in costs that result from the project. We assume they happen at the end of the period (times 1, 2, etc) (3) A one-time cash inflow that happens at the end of the life of the project. We call this the residual value . The impact of taxes on each of these items is discussed below.
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