12/22/2015rd1 Engineering Economic Analysis Chapter 12 Income Taxes.

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Engineering Economic AnalysisEngineering Economic Analysis

Chapter 12 Income Taxes

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TaxesTaxes

The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration. -Amendment XVI, U.S. Constitution

It takes only a majority to institute the Fair Tax but a 2/3 vote to repeal an amendment.

Thus it is possible to have the Fair Tax enacted with continued taxation under the current IRS.

Personal IncomePersonal IncomePersonal Exemptions $3400

Itemized deductionsExcessive medical and dental exceeding 1.5% of AGI

State and local tax

Home mortgage interest

Charitable donations

Casualty and theft losses (> $100 + 10% AGI)

Miscellaneous deductions (> 2% of AGI)

Car and other business expenses

Tax benefits for work-related education

Standard Deduction

Single taxpayer $5350Married filing jointly ($10,700)

Taxable income = AGI – PE – Itemized-deduct or Standard Deduction

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TaxesTaxes

Income

Property

Sales

Excise

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Classification of Business ExpendituresClassification of Business Expenditures

Capital ExpendituresDepreciable assetsNon-depreciable assets

ExpensedAll other business expenditures

Taxable income = GI – Expensed - Depreciation

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Item

Gross income ~ total income from all revenue producing sources

Expenses ~ all corporate costs incurred in the business Cost of goods sold Depreciation Operating expenses

Taxable operating income ~ amount on which taxes are assessed

Income taxes ~ amount of taxes based on some form of income

Net income

Corporate TaxesCorporate Taxes

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Corporate Tax RateCorporate Tax RateTaxable Income Tax Rate Corporate Income tax

Not over $50K 15% 15% over $0 7500

$50K-75K 25% $7.5K+25% over $50K 6250

$75K-100K 34% $13.75K+34% over $75K 8500

$100K-335K 39% $22.25K+39% over $100K 91650

$335K-10M 34% $113.9K+34% over $335K 3.2861M

$10M-15M 35% $3.4M+35% over $10M 1.75M

$15M-18.3M 38% 5.150M+38% over $15M 1.254M

$18.3M and up 35% 6.416666 + 0.35% over 18.3M

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Taxable IncomeTaxable Income

Year 1 Year 2 Year 3

Gross Income $200 $200 $200Special Tooling -60 0 0 (3-year life)Expenditures -140 -140 -140Cash results $0 $60 $60

Use st line depreciation with 0 salvage to get 60/3 = $20 Taxable Income $40 $40 $40

Computed as (200 – 20 – 140) = $40 to show that taxable income is a better indicator of performance

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Computing Corporate TaxComputing Corporate Tax

A corporation buys a $75K machine that for the first year brings in $200K of revenue with $84K operating expenses and $4K of depreciation. Compute taxes paid at 30% rate and net income.How much was generated from operations?

Taxable income = GI – Expensed – Depreciation = 200K – 84K – 4K

= 112K

Taxes = 112K * 0.30 = $33.6K taxes paid =>

Net Income = Taxable Income * 0.70 = 112K * 0.7 = $78.4K

$78.4K + 4K = $82.4K generated from operations.

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Corporate TaxCorporate Tax

Given a boat was bought for $80K with a 10-year life and $10K salvage value. First year operating expenses and revenues show

Operating revenue $250,000Operating expenses $90,000Depreciation $7,000

If the company’s tax rate is 34%, compute the net income for the first year.

(250K – 90K – 7K) * 0.66 = $100,980

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Corporate TaxCorporate TaxTaxable Income Tax Rate Corporate Income tax

Not over $50K 15% 15% over $0

$50K-75K 25% $7.5K+25% (X - $50K)

$75K-100K 34% $13.75K+34%(X – $75K)

Compute the effective tax rate and marginal tax rate for a firm with taxable income of $90,000.

Taxes paid = 0.15(50K) + 0.25(25K) + 0.34(15K) = $18,850 = 13.75K + 0.34(90K – 75K) = $18,850Effective tax = 18,850 / 90,000 = 20.94%; marginal tax rate = 34%Effective rate is also called the average tax rate.

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MACRS DepreciationMACRS Depreciation

A 5-year MACRS tool costing $60K has calculated salvage values of $20K in year 3, $10K in year 5 and $5K in year 6. Compute the gain or loss if disposed of in years 3, 5 and 6.

DC3 = $60K(0.2 + 0.32 + 0.192/2) = $36,960 => BV3 = $23,040Loss = 20K – 23,040 = -$3,040

DC5 = $60K(0.2 + 0.32 + 0.192 + 0.1152 + 0.1152/2) = $53,088BV5 = $60K – 53,088 = $6,912 => Gain = 10K - $6,912 = $3,088.

DC6 = $60K with BV6 = 0 => Gain is $5K.

(macrs 5) (20.0 32.0 19.2 11.52 11.52 5.76)(Dmacrs 60e3 5) (12000 19200 11520 6912 6912 3456)

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Federal and State TaxFederal and State Tax

A corporation has $2M in revenue and $1.2M in expenses. If the marginal federal tax rate is 34% and the state rate is 6% compute the combined taxes paid.

Taxable Income = $2M – $1.2M = $800K

Method I: 0.34 + 0.06 – (0.34 * 0.06) = 37.96% combined F&S $800K * 0.3796 = $303,680.

Method II: State Tax = $800K * 0.06 = $ 48,000 Federal tax = (800K – 48K) = 752K (* 0.34) = $255,680

$303,680

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Personal Income TaxPersonal Income Tax20072007

Individual income tax rate schedule for single and married filing jointly

Taxable Income $

Tax Rate Filing Single Filing Married and Jointly

0.10 $0–7,825 $0–15,650

0.15 $7,826–31,850 $15,651–63,7000.25 $31,851–77,100 $63,701–128,5000.28 $77,101–160,850 $128,501–195,8500.33 $160,851–349,700 $195,851–349,7000.35 Over $349,700 Over $349,700

• Compute tax for a single with a taxable income of $55K. Tax = 0.10(7,825) + 0.15(24,024) + 0.25(23,149) = $10,173.35

• Compute tax for a couple filing jointly with a taxable income of $150K. Tax = 0.1(15,650) + 0.15(48049) + 0.25(64799) + 0.28(150K – 128,501) = $30,991.82 => effective tax rate of 30991.82/150K = 20.66%

Personal Income TaxPersonal Income Tax

Joe and Holly earn $82K and have 4 personal exemptions and the standard deduction of $9500. Interest & dividends amount to $6050

Gross income = salaries + interest & dividends, capital-g

= $82K + 3550 + 2500 = $88,050

Taxable income = gross – exemptions – deductions

= 88,050 -4(3100) – 9500 = $66,150.

Taxes = 15,651(0.10) + 63,700 – 15,650)0.15 +

(66,150 – 63,700)(0.25)

= $9385; of which 9385/88050 = 10.7% effective.

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Income TaxesIncome TaxesFind the breakeven number of days for purchasing a truck for $13K with 3K salvage value at end of a 7- year life with $1100 annual expense and $35 daily expense, or lease for $83 a day based on 10% ATCF and 50% tax rate. Use straight line depreciation N BTCF SLine TI 50% Tax ATCF0 -$13K -$13K1-7 48X–1100 1428.57 48X–2528.57 –24X+1264.29 24X+164.29 7 3000 3000

13K(F|P,10%,7) = (24X+164.29)(F|A,10%,7) + 300025,333.32 = 226.69X+ 1558.64 +3000X = 91.61 days

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Income TaxesIncome Taxes

12-47. House and lot sell for $155K. Land is $45K and home is $110K. Rent inputs $12K yearly with st-line depreciation 27.5 year life. Mary wants a 10% ATCF. Find selling price at year n = 10 for Mary in 28% tax rate.

n BTCF SLN TI 28%Tax ATCF0 -155K -155K1-10 12K 110K/27.5 = 4K 8K -2.24K 9.76K10 X (X – 115K) -0.28X + 32.2K 0.72X + 32.2K

BV10 = 155K – 10(4K) = 115K

155K = 9.76K(P/A, 10%, 10) + (0.72X + 32.2K)(P/F, 10%, 10) X = $297,612.25.

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Incremental ATCF Analysis 12-52Incremental ATCF Analysis 12-52

n BTCF DC TI 20% Tax ATCF IRR -25 -25

B 1-5 7.5 5 2.5 - 0.50 7 12.38%-10 -10

C 1-5 3 2 1 - 0.20 2.8 12.38% -5 -5

D 1-5 1.7 1 0.7 - 0.14 1.56 16.92%-15 -15

E 1-5 5 3 2 - 0.40 4.6 16.17%-30 -30

F 1-5 8.7 6 1.7 - 0.34 8.16 11.21%

MARR = 10%

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Incremental ATCF AnalysisIncremental ATCF Analysis

D is > MARR; begin incremental analysis in order of cost.

C-D (IRR ‘(-5 1.24 1.24 1.24 1.24 1.24)) 7.63%

E-D (IRR ‘(–10 3.04 3.04 3.04 3.04 3.04)) 15.8% E

B-E (IRR ‘(-10 2.4 2.4 2.4 2.4 2.4)) 6.4% => E

F-E (IRR ‘(-15 3.56 3.56 3.56 3.56 3.56)) 6% => E E is best.

MARR = 10%

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Taxable IncomeTaxable IncomeA small company has taxable income of $50K and is thinking of another project which will increase taxable income by $45K. a) Compute the increase in taxes if the project is assumed.b) Repeat analysis if taxable income is $400K.

a) (0.15 * 50K) = $7500 without project (under $50 K => 15% tax) With 95K TI 13,750 + (0.34 * 20K) = $20,550 Taking on the $45K project increases taxes by ($20.55K - $7.5K) = $13.05K, implying 13,050/45,000 = 29% of project is taxes.

b) 113.9K + (0.34 * 65K) = $136,000 taxes for TI = $400K

136/400 = 34% which is about the same for the additional $45K project. 0.34 * $45K = $15,300 for total tax of $151,300.

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ATCFATCF

After-taxCash flow

Gross income

(Income less

Tax exemptions)

Income taxes Interest on borrowed money

Deductions other than interest and depreciation

After Tax Cash FlowAfter Tax Cash Flow

= - Pn (capital investments)

+ Sn (revenues from sales of assets)

- t(Sn - Bn) (taxes on gains from sales of assets)

- W (net working capital)

+ (1 – t)Rn (after tax ordinary revenues)

- (1 – t)En (AT operating expenses, labor energy, materials

+ tDn (depreciation tax savings)

- (1 –t)IPn (AT interest payments)

- PPn (Principal payments)

+ B (loans received)

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Problem 12-21Problem 12-21

n BTCF DDB TI 46% Tax ATCF0 -100K -100K1 30K 50K -20K 9.2K 39.2K2 30K 25K 5K -2.3K 27.7K3 35K 12.5K 22.5K -10.35K 24.65K4 40K 6.25K 33.75K -15.525K 24.475K5 10K 0 10K -4.6K 5.4K6 10K 0 10K -4.6K 11.65K6 6.25K 0

Tools sold for salvage value of $6,250

(IRR ‘(-100000 39200 27700 24650 24470 5400 11650)) 11.61%

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Loan Payment = $25,237.66

n BTCF DDB P I TI 46% Tax ATCF0 - 20K - 20,000.001 30K 50K 17237.66 8000 -28,000 12,880 17,642.342 30K 25K 18961.43 6276.23 -1276.23 587.06 5,349.403 35K 12.5K 20857.57 4380.09 18,119.91 -8,335.16 1,427.184 40K 6.25K 22943.33 2294.33 31,455.67 -14,469.60 292.745 10K 0 10,000 - 4,600 5,400.006 10K 0 10,000 - 4,600 11,650.006 6.25K 0 0 (IRR ‘(-20000 17642.34 5349.40 1427.18 292.74 5400 11650)) 34.31%.

Problem 12-22Problem 12-22

Problem 12-39Problem 12-39

First cost = $25K, life 4 years, salvage value = $5K,

UAB = $8K MARR = 10% in 40% tax bracket, MACRS 3

n BTCF Dep TI Tax (40%) ATCF0 -25K -25K1 8K 8333 -333 133.20 8133.22 8K 11112 -3112 1244.8 9244.83 8K 3702 4292 -1719.20 6280.84 8K 1852 6148 -2459.20 5540.80 + 5K

(list-pgf '(-25e3 8133.2 9244.8 6280.8 10540.8) 10)

$1952.51 => Granny should invest. RoR = 13.48%

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Problem 12-54Problem 12-54Year 0 1 2 3 4 5 ATAX = 10%A -3K 1K 1K 1K 1K 1K SOYDB -5K 1K 1.2K 1.4K 2.6K 2.8K ST-LINE

n~A BTCF Dep TI Tax 34% ATCF0 -3K -3K1 1K 1K 0 0 1K2 1K 800 200 -68 9323 1K 600 400 -136 8644 1K 400 600 -204 7965 1K 200 800 -272 728 14.39% ATCF-A

0~B -5K -5K1 1K 1K 0 0 1K2 1.2K 1K 200 -68 11323 1.4K 1K 400 -136 12644 2.6K 1K 1600 -544 20565 2.8K 1K 1800 -612 2188 13.68% ATCF-BIRRB-A: (IRR '(-2e3 0 200 400 1260 1460)) 12.99% => B > A

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Problem 12-57Problem 12-57

Buy for $1M or lease for $200K/yr. Annual income is $800K, annual costs are 200K with resale value at $400K.

10-year life with st-line, tax at 40%, ATCF i = 10%

n BTCF Dep TI Tax 40% ATCF0 -1M -1M1-10 600K 60K 540K -216K 384K10 400K-1M(A/P,10%, 10) + 384K + 400K(A/F, 10%, 10) = $246,352.76 BUY

LEASE: (800K -200K -200K)0.40 = $160K tax or $240K cash flow

EUAB – EUAC = $800K - $200K - $200K -160K = $240K

Better to Buy and net $6352.76

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ATCF ATCF Use st-line depreciation with an ATCF of 8% and tax rate of 40% to choose the best system for 6-year lives.

A B CFirst cost $40K $50K $35KUAB 5K 3.5K 10KSalvage 8K 5K 3K

Year BTCF St-Line TI Tax 40% ATCFA 1-6 5K 5.333K -0.333 133.33 5133; 8K SalvageB 1-6 3.5K 7.5K -4K 1600 5100; 5KC 1-6 10K 5.333K 4666.67 -1866.67 8133; 3K

(UIRR 40e3 5133 6 8e3) -0.75% (UIRR 5e3 -3e3 6 5e3) -200% A-C(UIRR 50e3 5100 6 10e) -8.23% (UIRR 5e3 -3033 6 2e3) -88% B-C

(UIRR 35e3 8133 6 3e3) 11.95% C is best

ATCFATCF

An asset bought for $100K with S = $20K after 5 years is depreciated MACRS 5-year rates. Expense average $18K annually with an effective tax rate of 30%. After 5 years of service the asset is sold for $22K. The ATCF for the sale of the asset is closest to

a)$27,760 b) $17,130 c) $26,870 d) $20,585

(dmacrs 100e3 5) (20000 32000 19200 11520 11520 5760)

22K + 5,760 = $27,760

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Taxes on Capital GainsTaxes on Capital Gains

A 3-year property class type equipment bought for $30,000 is sold for $20,000 at the end of three years.

The company is at a 34% tax bracket. The tax is

a)$5,125.89 b) $7,201.45 c) $6,044.18 d) $7,182.35

(dmacrs 30E3 3) (9999 13335 4443 2223)

Must pay capital gains on (20K – 2223) = $17777 or

0.34 * 17777 = $6044.18

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Corporate TaxesCorporate Taxes

Pace Corporation had a taxable income of $300,000 in 2007. Which of the following expression may be used to

compute the federal income tax liability for the company?

a) 15% of taxable income

b) 25% of taxable income

c)$113,900 + 34% over $100,000

d)$22,250 + 39% over $100,000

See Tax table Page 395 of text,

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TaxesTaxesFirst cost of equipment = $6,000; Salvage value after 5 years = $1,500MACRS depreciation is used as a 5-year property; Income-tax rate for the company = 34%; Capital gains are taxed at 15% rate.

Cash flow is -6000 1600 1600 1600 1600 1600 1600 + 9000 salvage

Find ATCF RoR (dmacrs 6E3 5) (1200 1920 1152 691.2 691.2 345.6)

n BTCF Dep TI Tax Rate ATCF0 -6000 -$60001 1600 1200 400 -136 14642 1600 1920 -320 108.8 1708.83 1600 1152 448 -152.32 1447.684 1600 691.2 908.8 -309 1291.005 1600 691.2 908.8 -309 1291.06 1600 345.6 1254.4 -426.5 1173.56 9000 Capital gain = Market value – Cost basis = 9K - 6K = 3K at 15% Depreciation recapture is cost basis – book value = $6000 – 0 tax @ 34%

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Income or Profit and Loss Statement Income or Profit and Loss Statement

Revenue $300,000Operating Expenses 250,000 Gross Profit 50,000Administrative Costs 10,000Other Income 5,000

Net Income Before Tax 45,000Tax 20,000Net Income of Net Profit After tax 25,000Dividends 10,000Retained Earnings 15,000

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Balance SheetBalance Sheet

Assets Liabilities and Owners EquityCash $50,000 Accounts Payable

$30,000Securities 5,000 Note Payable 20,000Accounts Receivable 5,000 Taxes Payable 10,000Inventory 90,000 Common Stock 300,000Equipment 200,000 Retained Earnings 90,000Buildings 100,000

Total Liability and Total Assets $450,000 Owners Equity $450,000

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Assets LiabilitiesCurrent assets Current liabilities Cash 1940 Accounts Payable 1150 Accounts Receivable 950 Notes Payable 80 Securities 4100 Inventories 1860 Accrued expense 950 (-) Bad debt provision -80 Total current liabilities 2180

Fixed assets Long-term liabilities 1200

Land 335 Plant & Equipment 6500(-) Accumulated depr -2350 Equity

Preferred stock 110 Other assets Common stock 650 Prepays/deferred charges 140 Capital Surplus 930 Intangibles 420 Retained earnings 8745 Total other assets 560 Total equity 10,435

Total assets 13,815 Total liabilities and equity 13,815

Balance Sheet Engineered Industries KBalance Sheet Engineered Industries K