Reviewing…
We covered the following depreciation
methods:
• Straight Line
• Declining Balance
• Sum of Years Digits
• Units of Production
• MACRS – Modified Accelerated
Cost Recovery System
Effective Tax Rates
Terminology:
Federal Tax Rate (FTR)
Federal Taxable Income
Federal Taxes = Federal Tax Rate x
Federal Taxable Income
State Tax Rate (STR)
State Taxable Income
State Taxes = State Tax Rate x
State Taxable Income
Effective Tax Rates
• State taxes are deductible when
calculating Federal taxable
income.
• Effective Tax Rate =
FTR (1 – STR) + STR
Marginal Tax Rates
• Tax rates for corporations and
individuals vary depending on
the amount of taxable income.
• Different tax rates apply to
incremental income.
Marginal Tax Rates
2010 Federal Personal (Single) Tax Schedule
Taxable Income
Tax Rate
$0 to $8,350
10%
$8,350 to $33,950
15%
$33,950 to $82,250
25%
$82,250 to $171,550
28%
$171,550 to $372,950
33%
$372,950 and up
35%
These marginal tax rates apply to personal income – and business
income that is reported via personal income tax returns
(proprietorships and partnerships).
Corporations have an additional surtax in some income ranges,
sometimes resulting in a higher marginal tax rate (see next slide).
Marginal Tax Rates
2010 Federal Corporate Tax Schedule
Taxable Income
$0 to $50,000
$50,001 to $75,000
$75,001 to $100,000
$100,001 to $335,000
$335,001 to $10,000,000
$10,000,001 to $15,000,000
$15,000,001 to $18,333,333
$18,333,334 and up
Tax Rate
15%
25%
34%
39%
34%
35%
38%
35%
Average Tax Rate vs.
Marginal Tax Rate
Example:
$125,000 in taxable income
Average Tax Rate:
Marginal Tax Rate:
Assumptions
• Company already has taxable
income.
• We need to know the marginal
tax rate.
• Assume project will keep me in
the same marginal tax bracket.
After Tax Analysis
1. Determine Taxable Income:
( + ) Income
( - ) Expenses
( - ) Interest Paid
( - ) Depreciation (Not a real cash flow)
2. Determine Taxes
• Use the marginal tax rate
3. Determine After Tax Cash Flow
( + ) Income
( - ) Expenses
( - ) Loan Payments
( - ) Tax cash flow
After Tax Analysis
Example:
Determine year 1 cash flows with
marginal tax rate of 39%:
Gross Income = $7,000
Cost of Goods Sold = $1,000
Operating Expense = $3,000
Depreciation Charge = $2,000
Loan Payment = $2,802
Interest Expense = $1,200
Sale of Asset
1. End of the year taxable income from
sale = Sale Price – Book Value
2. Tax cash flow from sale of the asset
= taxable income from sale
x marginal tax rate
3. After tax cash flow =
sale price – tax cash flow from
sale of the asset
Early Sale of Asset
Half Year Convention:
1. It is assumed that an asset is put into
service half-way through the initial year –
so only ½ year of depreciation may be
claimed in Year 1.
•
MACRS table takes care of this, automatically
2. If selling an asset before the final year of
MACRS depreciation, only ½ year of
depreciation may be claimed in that year …
•
•
Reduce depreciation amount by ½, and…
Increase book value by ½ depreciation amount
Sale of Asset Example
A machine was purchased on January
1, 1999, for $10,000. It has been
depreciated using the MACRS 5 year
schedule. It can be sold for $8,000 on
December 31, 2001. Determine the
After Tax Cash Flow (ATCF) for the sale
of the machine. The marginal tax rate
is 35%.
Sale of Asset Example
with a Twist - 1!
A machine was purchased on January
1, 1999, for $10,000. It has been
depreciated using the MACRS 5 year
schedule. It can be sold for $8,000 on
January 1, 2002. Determine the After
Tax Cash Flow (ATCF) for the sale of
the machine. The marginal tax rate is
35%.
Sale of Asset Example
with a Twist - 2!
A machine was purchased on January
1, 1999, for $10,000. It has been
depreciated using the MACRS 5 year
schedule. It can be sold for $2,000 on
December 31, 2001. Determine the
After Tax Cash Flow (ATCF) for the sale
of the machine. The marginal tax rate
is 35%.