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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 RatesEffective Tax RatesEffective Tax RatesEffective 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 RatesEffective Tax RatesEffective Tax RatesEffective Tax Rates

• State taxes are deductible when calculating Federal taxable income.

• Effective Tax Rate = FTR (1 – STR) + STR

Marginal Tax RatesMarginal Tax RatesMarginal Tax RatesMarginal 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 RatesMarginal Tax RatesMarginal Tax RatesMarginal Tax Rates2010 Federal Personal (Single) Tax

ScheduleTaxable 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 RatesMarginal Tax RatesMarginal Tax RatesMarginal Tax Rates2010 Federal Corporate Tax

ScheduleTaxable Income Tax Rate

$0 to $50,000 15%

$50,001 to $75,000 25%

$75,001 to $100,000 34%

$100,001 to $335,000 39%

$335,001 to $10,000,000 34%

$10,000,001 to $15,000,000 35%

$15,000,001 to $18,333,333 38%

$18,333,334 and up 35%

Average Tax Rate vs. Average Tax Rate vs. Marginal Tax RateMarginal Tax Rate

Average Tax Rate vs. Average Tax Rate vs. Marginal Tax RateMarginal Tax Rate

Example:$125,000 in taxable income

Average Tax Rate:

Marginal Tax Rate:

AssumptionsAssumptionsAssumptionsAssumptions

• 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 AnalysisAfter Tax AnalysisAfter Tax AnalysisAfter Tax Analysis1. 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 AnalysisAfter Tax AnalysisAfter Tax AnalysisAfter Tax Analysis

Example:Determine year 1 cash flows with marginal tax rate of 39%:Gross Income = $7,000Cost of Goods Sold = $1,000Operating Expense = $3,000Depreciation Charge = $2,000Loan Payment = $2,802Interest Expense = $1,200

Sale of AssetSale of AssetSale of AssetSale 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 AssetEarly Sale of AssetEarly Sale of AssetEarly 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 ExampleSale of Asset ExampleSale of Asset ExampleSale 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%.

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 Sale of Asset Example with a Twist - 1!with a Twist - 1!

Sale of Asset Example Sale of Asset Example with a Twist - 1!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 $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%.

Sale of Asset Example Sale of Asset Example with a Twist - 2!with a Twist - 2!

Sale of Asset Example Sale of Asset Example with a Twist - 2!with a Twist - 2!