Blank L., Tarquin A. Engineering Economy (McGraw-Hill Series in Industrial Engineering and Management)
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CHAPTER SUMMARY
TABLE
17-7
Summary
of
Internation
al
Corporate
Tax
Rates
';
'
Tax Rate
Levied
on
T
axable
Income
, %
~
40
36
to
< 40
32 to < 36
28
to
< 32
24 to <
28
20 to < 24
< 20
For These
Countries
United States, Japan, Saudi Arabia
Canada, Germany, South Africa
China, France, India, Mexico, New Zealand,
Spain, Turkey
Austra
li
a, I
nd
onesia, United Kingdom,
Republic
of
Korea
Ru
ssia, Taiwan
Singapore
Hong Kong, Iceland, Ireland, Hnngar
y,
Poland
*Sources; Extracted from KPMG's Corporate Tax Rates Survey, January 2004 (av
ai
lable at
www.kpmg.comI
RUT
2000_
pr
odldocumenls
I912
004ctrs.pd
f)
. and from c
ount.l"y
websites on
taxation for corporations.
Interne
t:
Further deta
il
s are available on the Japanese Ministry
of
Finance
website at www.mof.go.jp.
The effective t
ax
rate varies considerably among countries.
Some
countries
le
vy
taxes only at
th
e federal level, while others impose taxes at several levels
of
government (federal, state or provincial, prefecture, county, and city
).
A summary
of
inte
rn
ational co
rp
orate average tax rates is presented
in
Table
17
- 7 for a wide
range of industria
li
zed countries. These include income taxes at all reported levels
of
government within each country; however, other types
of
taxes may be imposed
by a partic
ul
ar governme
nt.
Although these average rates
of
taxa
ti
on will vary
from year to year, especially as tax reform is enacted, it can be surmised that most
corporations face
ef
fective rates
of
about 20% to
40
%
of
taxable income.
If
one
were to examine
th
e individual published rates over recent years, it is clear
th
at
countries, especia
ll
y in Europe, have reduced their corporate tax rates conside
r-
a
bl
y, as much as 15% to 20%
in
a s
in
gle year
in
s
ome
cases. This reduction e
n-
courages corporate
in
ves
tm
ent and business expansion within country border
s.
CHAPTER
SUMMARY
After-tax analysis does not usually change the decision to select one alterna
ti
ve
over another; however, it does
off
er a much clearer estimate
of
the monetary
impact of taxes. After-tax
PW
, AW, and
ROR
evaluations
of
one or
mor
e alter-
natives are pe
rf
ormed on the CFAT
se
ries us
in
g exactly the
same
procedures as
in
previous chapters . The after-tax
MARR
is used in a
ll
PW
and
AW
computa-
tion
s,
a
nd
in
deciding between two
or
more alternatives using increment
al
ROR analysis.
Income tax rates for
U.S. corpora
ti
ons and individual taxpayers are graduate
d-
hi
gher taxable
in
comes pay
hi
gher
in
c
ome
taxes. A single-value, effective tax
605
606
PROBLEMS
CHAPTER
17
After-Tax Economic Analysis
rate Te is usually applied in an after-tax economic analysis. Taxes are reduced
because
of
tax-deductible items, such as depreciation and operating expenses.
Because depreciation is a noncash flow, it is important to
consider
depreciation
only
in
the
TI
computations, and not directly in the
CFBT
and CFAT calculations.
Accordingly, key general cash flow after-tax relations for each year are
CFBT
= gross income - expenses - initial investment + salvage value
CFAT =
CFBT
- taxes =
CFBT
- (taxable
income)(T
e)
TI = gross
income
- expenses - depreciation + depreciation recapture
If
an alternative's estimated contribution to corporate financial worth
is
the eco-
nomic measure, the economic value added (EVA) should be detennined.
Unlike
CFAT, the EVA includes the effect
of
depreciation.
EVA = net profit after taxes -
cost
of
invested capital
= NPAT - (after-tax
MARR)(book
value) =
TI
- taxes -
i(BV)
The
equivalent annual worths
of
CFAT and EVA estimates are the
same
numeri-
cally, due to the fact that they interpret the annual cost
of
the capital investment
in
different, but equivalent manners when the time value
of
money
is
taken into
account.
In a replacement study, the tax impact
of
depreciation recapture
or
capital
loss, eith
er
of
which may
occur
when the defender
is
traded for the challenger,
is
accounted for
in
an after-tax analysis.
The
replacement study procedure
of
Chapter
II
is
applied.
The
tax analysis may not reverse the decision to replace
or
retain the defender, but the effect
of
taxes will likely reduce (possibly by a
significant amount) the economic advantage
of
one
alternative
over
the other.
Basic Tax Computations
(a) A corporation reports that it had a
negative
$200,000
net profit on its
annual income statement.
17
.1 Write the equation to calculate TI and
NPAT for a corporation, using only the
following terms: gross income, tax rate,
business expenses,
and depreciation.
17.2 Describe the basic difference between
an
in
come tax and a property tax for an
individua
l.
17.3 From the following list, sel
ect
the tax-
related term that
is
best described by each
eve
nt
below: depreciation, operating ex-
pense,
ta
xab
Le
income, income tax,
or
net
profit
[{tier
taxes.
(b) An asset with a current book value
of
$80
,000 was utilized on a new
processing line to increase sales by
$200
,000 this year.
(c) A machine has an annual, straight
line write-off
equal
to $21,000.
(d)
The
cost to maintain equipment
during the
past
year
was $3,680,200.
(e)
A particular supermarket collected
$23,
550
in lottery ticket sales last
year.
Based
on winnings paid to
individuals holding these tickets, a
rebate
of
$250 was sent to the store
manager.
17.4 Two companies have the following val-
ues on their annual tax returns.
Sales reve
nu
e, $
Interest reve
nu
e, $
Expenses, $
Depreciation, $
Compa
ny 1
1,500,000
31,000
~754
,
000
148,000
Company
2
820,000
25
,000
-
591
,000
1
8,
000
(a) Calculate the federal income tax for
the year.
(b) Determine the percent
of
sales rev-
enue each company
will pay in fed-
eral income taxes.
(c) Estimate the taxes using an effec-
tive rate
of
34%
of
the entire TI. De-
termine the percentage error made
relative to the exact taxes
in
part (a).
17.5 Last year, one separate division
of
Com-
pete.com, a dot-com sports industry ser-
vice
firm
that provides real-time analysis
of
mechanical stress due
to
athlete injury,
had
$300,000 in taxable income. This
year, TI is estimated to be
$500,000.
Calculate
the federal income taxes and
answer the following.
(a) What was the average federal tax
rate paid last year?
(b) What is the marginal federal tax
rate on the additional TI?
(c) What will be the average federal tax
rate this year?
(d) What will be the NPAT on
just
the
additional
$200,000
in
taxable in-
come?
17
.6 Yamachi and Nadler
of
Hawaii have a
gross income
of
$6.5 million for the year.
Depreciation and expenses total $4.1 mil-
lion.
If
the combined state and local tax
rate is 7.6%, use an effective federal rate
of
34% to estimate the income taxes,
us
in
g the effective tax rate equation.
PROBLEMS
607
17
.7 Rotana Construction, Inc
.,
has operated
for the last
21
years in a northern U.S.
state where the state income tax on cor-
porate revenue is 6% per year. Rotana
pays an average federal tax
of
23
% and
reports taxable income
of
$7 million. Be-
cause
of
pressing labor cost increases, li-
ability insurance premium increases, and
other cost increases, the president wants
to move to another state to reduce the
total tax burden. The new state may have
to be willing to offer tax allowances or an
interest-free grant for the first couple
of
years in order to attract the company.
You
are an engineer with the company and are
asked to do the following.
(a) Determine the effective tax rate for
Rotana.
(b) Estimate the state tax rate that would
be necessary to reduce the overall
effective tax rate by 10% per year.
(c) Determine what the new state
would have to do financially for
Rotana to move there and to reduce
its effective tax rate to 22% per year.
17.8 Workman Tools reported a TI
of
$80,000
last year.
If
the state income tax rate is
6
%,
determine the (a) average federal tax
rate,
(b) overall effective tax rate, (c) total
taxes to be paid based on the effecti
ve
tax
rate, and
(d)
total taxes paid to the state
and paid to the federal government.
17.9 Donald is a civil engineer with an annual
salary
of
$98,000. He has dividends and
interest
of
$7500 for the year. Total ex-
emptions and deductions are
$10,500.
(a) Calculate federal income taxes
as
a
person filing single.
(b) Determine what percentage
of
his
annual salary goes toward federal
income taxes.
(c) Calculate by how much the total
of
exemptions and deductions has to
increase for Donald's income taxes
to go down by 10%.
608
CHAPTER
17
After-Tax Economic Analysis
CF
BT and CFAT
17
.10 What is the basic difference between
cash flow after taxes (CFAT) and net
profit after taxes
(NPAT)?
17.11
Der
i ve a general relation for calculating
CFAT under the situation that
th
ere
is
no
annual depreciation to deduct and it
is
a
year
in
which no investment P
or
salvage
S occurs.
17.12 Where
is
depreciation considered in the
CFBT
and CFAT expressions used to an-
alyze
an
engineering economy alterna-
tiv
e's
cash flow estimates?
17 .13 Four years ago ABB purchased an asset
for
$3
00
,000 wi
th
an estimated
sa
lvage
of
$60,000. Depreciation was $60,000
per year.
The
fo
ll
owing annual gross in-
comes a
nd
expenses were recorded.
The
asset was sold for $60,000 after 4 years.
(a) Tabulate the cash flows by hand
after an effective 32% tax rate is ap-
plied.
Use the format
of
Table
17
-3
.
(b) Continue the table above and calcu-
late the net income
(N!) estimates.
(c) Set up the spreadsheet and determine
the annual CFAT and NI values.
Additionally, plot these values
versus year
of
ownership.
Year
of
owner
ship
Gross
in
come, $
Expenses, $
2 3 4
80
,000
150
,000 120,000 100,000
- 20,000 - 40,000 - 30,000
-5
0,000
17.14 Four years ago Hartcourt-Banks pur-
chased an asset for
$200,000 with an
estimated
S = $40,000. MACRS depre-
ciation was charged over a 3-year recov-
ery period.
The
fo
ll
owing gross incomes
and expenses were recorded, and an ef-
fective tax rate
of
40
% was applied. Tab-
ulate CFAT u
nd
er the assumption that
the asset was
(a)
di
scarded for $0 after
4 years and (b) sold for $20,000 after
4 year
s.
For this tabulation only, neglect
any taxes that may be
in
curred on the sale
of
the asset.
Year
of
ownership
2 3 4
Gross
in
come, $
Expenses, $
80,000
150
,000 120,000
100
,000
-2
0,000
-40,000
- 30,000 - 50,000
17
.15 A petroleum engineer with Halstrom Ex-
ploration must estimate the minimum re-
quired cash flow before taxes
if
the CFAT
is
$2,000,000.
The
effective federal tax
rate is 35%, and the state tax rate is 4.5%.
A total
of
$1 million
in
tax-deductible de-
preciation will be charged
th
is year.
Est
i-
mate the required CFBT.
17.16 A division
of
Hanes has the following
data at the end
of
a year.
Total revenue
= $48 million
Depreciation
= $8.2 million
Operating expenses = $28 million
For
an
effective federal tax rate
of
35%
and state tax rate
of
6.5%, determine
(a) CFAT,
(b)
percentage
of
total reve
nu
e
expended on taxes, and
(c) net income
for the year.
17
.
17
Wal-Mart Distribution Centers has put
into service forklifts and conveyors pur-
chased for
$250,000. Use a s
pr
eadsheet
to tabulate the
CFBT
, CFAT, and NPAT
for 6 years
of
ownership, using an effec-
tive tax rate
of
40% and the estimated
cash flow and depreciation amounts
shown. Salvage
is
expected to be zero.
Year
I
2
3
4
5
6
Gr
oss
In
co
me, $
90,000
100,000
60,000
60,000
60,000
40,000
Oper
a
tin
g
Ex
pe
nses, $
- 20,000
- 20,000
- 22,000
- 24,000
- 26,000
- 28,000
MAC
RS
Dep
reciation, $
50,000
80,000
48,000
28,800
28,800
14,400
17.18 A
hi
ghway construction company pur-
chased pipeline boring equipment for
$80,000 and depreciated it us
in
g
MACRS and a 5-year recovery period. It
had no estimated salvage and produced
an
nu
al GI - E amounts
of
$50,
000
,
which were taxed at an effec
ti
ve 38%.
The company decided to
pr
ematurely se
ll
the equipm
ent
after 2 full years
of
use.
(a) Find the price if
th
e company wants
to se
ll
it for exactly the amount re-
flected by the
c
un-
ent book value.
(b) Determjne the CFAT values
if
the
equipment was actually sold after
2 years for the amount determined
in part (a) and no replacement was
acquired.
Depreciation Method Effects on Taxes
17
.
19
An ove
rl
and freight
com
pany has pur-
chased new trailers for
$
l50
,
000
and ex-
pects to realize a net
$80,000
in
gross
in
come over operat
in
g expenses for each
of
the next 3 years.
The
trailers have a re-
covery period
of
3 year
s.
Assume an
ef
-
fective tax rate
of
35% and an interest
rate
of
l5% per year.
(a) Show the advantage
of
accelerat
ed
depreciation by calculati ng
th
e pre-
sent worth
of
taxes for the
MAC
RS
method versus the classical
SL
method. S
in
ce
MACRS
takes an
additional year to fully depreciate
the basi
s,
assume no
CFBT
beyond
year 3, but include any negative tax
as a tax sav
in
gs.
(b) Show that the total taxes are the
same for both methods.
17.20 Work Problem 17.19 us
in
g one spread-
shee
t.
17.21 Perfo
rm
an
analysis u
si
ng a spreadsheet
between the following two depreciation
options for a company operat
in
g
in
a
South American country. Select the pre-
felTed method based on the better
PW
of
tax va
lu
e at i = 8% and Te =
40
%.
PROBLEMS
609
Option
1
Option
2
Initial
in
vestment, $
- 100,000 - 100,000
CFBT, $/year
40,000 40,000
Deprecia
ti
on method
Straight line
Double declining
ba
lance
Recovery period, years
5 8
17
.
22
Imperial Chern, Inc
.,
an international
chemical products company headquar-
tered in the United Kingdom, purchased
two identical systems used in the manu-
facture
of
synthetic fibers. One system is
located in Pennsylvania in the United
States, the other in
Genoa
, Italy. Each is
estimated to generate additional annual
CFBT
of
$65,000
USD
for the next
6 year
s.
The company's division
in
Italy
is incorporated there and may not use
MACRS
for depreciation. Assume the
classical straight line method is the one
approved for foreign corporations with
incorporated units in Ital
y.
The
U.S.
in
-
corporated unit uses MACRS, the same
as any
U.S.-ba
se
d corporation would.
(a) What is the difference
in
the present
worth
of
taxes and total taxes for the
6 years?
Why
are these two totals n
ot
equal?
For
tills analysis, use the full
6 years as the evaluation period and an
interest rate
of
12% per year. Neglect any
capital gains, losses,
or
depreciation re-
capture at sale time, and assume that any
negat
iv
e income tax is a tax savings.
Asset
Asset
Located
Located
in
U.S.
in
Italy
Fi
rst cost, $
- 250,000
- 250,000
Salvage va
lu
e, $
25
,000
25,000
Total annual CFBT, $/year
65
,000
65,000
Tax rate, %
40
40
Depreciation method
MACRS
Classical SL
(no half-year
convention)
Recovery period, years
5
5
610
CHAPTER
17
After-Tax Economic Analysis
17
.
23
An asset with a first cost
of
$9000 is
depreciated by MACRS over a 5-year
recovery period. The CFBT is estimated
at
$10,000 the first 4 years and $5000
thereafter
as
long
as
the asset
is
retained.
The effective tax rate
is
40%, and money
is
worth 10% per year. In present worth
dollars, how much
of
the cash flow gen-
erated
by
the asset over its recovery
period is lost to taxes? Work using hand
or spreadsheet calculations as directed by
the instructor.
17.24 The effective tax savings in a year TS
1
due to depreciation
is
calculated
as
TS
1
= (depreciation)(effective tax rate)
=
(D)(T
e)
(a) Develop a relation for the present
worth
of
tax savings
PW
TS
'
and ex-
plain how it may be utilized rather
than the PW
t
ax
criterion in evaluat-
in
g the effect
of
depreciation on
taxe
s.
(b) Calculate PW
TS
for an asset using
MACRS with a first cost
of
$80,000,
no
salvage value, and a
recovery period
of
3 years. Use
i =
10
% per year and Te = 0.42.
17.25 An engineering graduate has taken over
hi
s father's power tool manufacturing
bu
si ness, Hartley Tools. The company has
purchased new equipment for
$200,000
with
an
expected life
of
10 years and
no
salvage value.
For
tax purposes, the
depreciation choices are as follows:
• Alternative straight line depreciation
with the half-year convention and a re-
covery period
of
10 years
• MACRS depreciation with a recovery
period
of
5 years
The anticipated CFBT is
$60,000 per year
for only 10 years. The effective tax rate
for Hartley
is
42% including all taxes. Use
a spreadsheet to determine the following:
(a) Rate
of
return before taxes over the
total
of
11
years.
(b) Rate
of
return after taxes over the
total
of
11
years.
(c) The depreciation method that mini-
mizes the time value
of
taxes. Use
an interest rate
of
10% per year, and
consider any negative tax as a tax
savings in the year incurred.
Depreciation Recapture and Capital
Gains
(Losses)
17.26 Determine any depreciation recapture or
capital gain or capital loss generated by
each event described below.
Use them to
determine the amount
of
the income tax
effect,
if
the effective tax rate
is
30
%.
(a) A strip
of
land zoned as
'Com
mer-
cial A' purchased 8 years ago for
$2.6 million was
ju
st sold at a
15
% profit.
(b) Earthmoving equipment purchased
for
$155,000 was depreciated us
in
g
MACRS over a 5-year recovery pe-
riod. It was sold at the end
of
the
fifth year
of
ownership for $10,000.
(c) A MACRS-depreciated asset with a
7-year recovery period has b
ee
n
sold after 8 years at an amount
equal to
20%
of
its first cost, which
was
$150,000.
l7.27 Determine any depreciation recapture or
capital gain
or
capital loss generated
by
each event described below. Use them to
determine the amount
of
the income tax
effect,
if
the effective tax rate is 40%.
(a) A 21-year-old asset was removed
from service and sold for
$500.
When purchased, the asset was en-
tered on the books with a basis
of
P = $180,000, S = $5000, and n =
18
years. Classical straight line
depreciation was used for the entire
recovery period.
(b) A high-technology machine was
sold internationally for
$10,000
more than its purchase price
just
after
it
was
in
service 1 year.
The
asset had P = $100,000, S =
$1000, and n = 5 years and was de-
preciated by the
MACRS method
for
I year.
17
.28 Set up a spreadsheet, using a modification
of
the column headings
in
Table t 7-3(b) to
(a) graphically compare the annual CFAT
series and
(b) numerically compare the
total CFAT
of
two depreciation
models-
MACRS depreciation and
SL
deprecia-
tion with the half-year convention.
Use
the following asset situation.
First cost
= $10,000
Salvage
estimate = $500
Recovery period = 5 years
GI -
E = $5000 per year for
6 years
The
asset was sold for $500 after 6 years
of
use.
The
effective tax rate averaged
38% per year over the time
of
ownership.
17.29 Mercy Hospital, a for-profit corporation,
purchased sterilization equipment at a
cost
of
$40,000.
MACRS,
with a recov-
ery period
of
5 years and an estimated
salvage
of
$5000, was used to write
off
the capital investment.
The
equipment
increased gross
in
come by $20,000
and expenses by $3000 per year. A full
2 years after purchasing it, the hospital
sold the equipment to a newly organized
clinic for
$21,000.
The
effect
iv
e tax rate
is
35%. Determine the (a) income taxes
and
(b) cash flow after taxes for the asset
in
the year
of
the
sa
le.
17.30 A couple
of
years ago the company
Health4AII purchased land, a building,
and two depreciable assets from another
corporation. These have all recently been
disposed of.
Use the information shown
PROBLEMS
611
to determine the presence and amount
of
any capital gain, capital loss,
or
deprecia-
tion recapture.
Recovery
Current
Purchase Period, Book Sales
Asset
Price, $ Years Value, $ Price, $
Land - 200,000
Building - 800,000
27.5
Cleaner
- 50,500
3
Circulator
- 10,000
3
300,000
15
,500
5,000
245,000
255,000
18
,500
10
,500
17
.3
1
In Problem
17.14(b), Hartcourt-Banks
sold a 4-year-old asset for
$20,000.
The
asset was depreciated using the 3-year
MACRS method. (a) Recalculate the
CFAT
in
the year
of
sale, taking into ac-
count any additional tax effects caused
by the
$20,000 sale price. (b)
What
is
the
change
in
the CFAT from the amount
in
Problem 17.14?
17.32
(UsessameassetdataasinProblem
I6A4.)
An asset with a first cost
of
$45,000 has a
life
of
5 years, a salvage value
of
$3000,
and an anticipated
CFBT
of
$15,000 per
year. Determine the depreciation sched-
ule for classical
SL
and for switching
from DDB to
SL
to maximize deprecia-
tion.
Use i = 18% and an effective tax
rate
of
50% to determine how much the
present worth
of
taxes decreases when
switching is allowed. Assume that the
asset is sold for
$3000
in
year 6 and that
any negative tax
or
capital loss at sale
time generates a tax savings.
17
.33 Retrieve IRS Publication 544 from the
Web and use the material in the chapter
on reporting gains and losses to explain
the calculations necessary to deter-
mine net capital gain and net capital loss
on
Section 1231 property transactions.
Describe how they are to be reported on
a corporate tax return.
612
CHAPTER
17 After-Tax Economic Analysis
After-
Tax
Economic
Analysis
17.34
Comp
ute the required before-tax return
if
an after-tax r
et
urn
of
9% per year is ex-
pected a
nd
the state and local tax rates
total 6%.
The
effective federal tax rate is
35%.
17
.35 A division
of
TexacoChevron has a
TI
of
$8.95 million for a tax year.
If
the state
tax rate averages 5% for all
th
e states
in
which the corporation operates, find the
equival
ent
after-tax
ROR
required
of
projects that are justified only if they can
demonstrate a before-tax return
of
22%
per year.
17
.
36
John made an
an
nual return
of
8% after
taxes on a stock inves
tm
ent. His sister
told him this is equivalent to a
l2
% per
year before-tax return.
What
percent
of
taxa
bl
e income is she assuming will be
taken by
in
come
taxes?
17
.
37
An engineer co-owns a real estate rental
property bus
in
ess, which
just
purchased
an
apartment
comp
lex for $3,500,
000
,
us
in
g a
ll
equity cap
it
a
l.
For the next
8 year
s,
an annual gross income before
taxes
of
$480,
000
is expected, offset by
estimated annual expenses
of
$100,000.
The
owners hope to sell the property
after 8 years for the currently appraised
value
of
$4,050,000. The applicable tax
rate for ordinary taxable
in
come is 30%.
The property will be straight l
in
e depre-
ciated over a 20-year life with a salvage
va
lu
e
of
zero. Neglect
th
e half-year con-
vention
in
depreciation computations.
(a) Tabulate the after-tax cash flows for
the 8 years
of
ownersh
ip
, and (b) deter-
mine the b
ef
or
e-tax and after-tax rates
of
return. Use either ha
nd
or
comput
er
pre-
se
nt
ation
of
the CFAT tabulation template
in
Table
17
-3
, altered to accommodate
this situation.
17
.38 An asset has the following series
of
CFBT
and CFAT estimates that have been en-
tered into the indicated columns and rows
of
a spreadsheet. The company uses a rate
of
return
of
14 % per
yea
r before taxes and
9% per year after taxes. Write the spread-
sheet
fu
nctions for each se
ri
es that will
display the three results
of
PW
, A W, a
nd
ROR
. In solving this problem, use the
spreadsheet functions
NPV
,
PY
, and
IRR
at a minimum.
Column
Ro
w
A B C
4 Year CFBT, $ CFAT, $
5
0
- 200,000
- 2
00
,0
00
6
75
,000
62
,000
7 2
75
,000 60,000
8 3
75
,000 52,000
9 4
75
,000 53,000
10
5
90
,000
65
,000
17.39 NewsRecord, Inc., has owned two sub-
sidiary companies for the last 4 years and
expects to retain ownership for 4 more
years
of
one company and se
ll
th
e other
company now. You
ha
ve been asked to
peIiornl
an
economic analysis to determi ne
which one to sell. When purchased, North
Enterprises (NE) costs
$20 million a
nd
The
Southern Exchange (
TSE
) costs $
40
mil-
lion. Capital assets cost
$
10
million for
NE
and $20 million for TSE when pur-
chased 4 years ago, and they will continue
to be MACRS depreciated using
n.
= 7 for
the remaining 4 years
of
their lives. The
NE
company will require new investment
funds
of
$500,000 immediate
ly
due to
some bad decisions made previous
ly
.
TSE
does not require new inves
tm
ent funds.
Annual estimates
of
fu
ture gross
in
-
come
(revenue) and expenses are made.
All values in the table are in
$1000 units.
The
effective tax rate is 35% per year.
The board
of
directors has set the corpo-
rate
af
ter-tax
MARR
at 25% per yea
r.
North
Enterprises
(NE)
Years
from
now
1
2 3 4
Gross income, $ 2000 2500
3000 3500
Expenses, $
- 500 - 800 - 1100 - 1400
To make the retain/sell recommendation,
consider only the next 4 years
of
after-tax
cash flows to determine the breakeven
ROR
value. (Note: Since these are entire
corporations being analyzed, a negative
income tax should not
be
considered as a
tax savings. In this case, the income tax
amount is estimated to be zero for the
year.)
17.40 A civil engineer must choose between
two pieces
of
equipment used to supple-
ment the pumping
of
concrete into foun-
dation settings.
First cost, $
Sa
lv
age, $
C
FBT/ye
ar, $
Life, years
Machine
A
- 35,500
4,000
8,000
7
Machine
B
-
19
,000
3,000
6,500
7
Both machines have an estimated 7-year
useful life; however,
MACRS
deprecia-
tion
is
over a 5-year recovery period. The
effective tax rate
is
40
%, and the after-tax
MARR
is
8% per year. Compare the two
machines, using present worth after-tax
analysis.
Perform the analysis (a) by
computer and
(b)
by
hand.
17.41 Two alternatives are to be evaluated by
Ned. His boss wants to know the rate
of
return value compared to the corporate
after-tax
MARR
of
7% per year used to
decide upon any new capital investment.
Perform
th
e analysis (a) before taxes and
(b) after taxes with Te = 50% and classi-
cal
SL
depreciation. (Develop the hand
or
spreadsheet solution
per
your instructor.)
PROBLEMS
613
The
Southern
Exchange
(TSE)
1 2
3 4
4000 3000 2000 1000
-800
-1200
-1500
- 2000
17.42
x Y
Fi rst
cost
, $
-12,000
- 25,000
AOC
, $/year - 3,000 - 1,500
Salvage, $
3,000 5,000
n, years
10
to
Two machines
have the following
estimates.
Machine
A
Machine
B
First cost, $
-
15
,000 - 22,000
Salvage, $ 3,000 5,000
AOC, $/year
-3
,000 - 1,500
Life, years
]0
10
Either machine
is
to be used for a total
of
10 years, then sold for the estimated sal-
vage value. The before-tax
MARR
is 14%
per year, after-tax
MARR
is 7% per year,
and
Te is 50%. Select a machine on the
basis
of
(a) before-tax
PW
analysis,
(b) after-tax
PW
analysis using classical
SL
depreciation over the 10-year life, and
(c) after-tax
PW
analysis using MACRS
depreciation with a 5-year recovery period.
17.43 A senior engineer at Tuskegee Industries
developed per unit estimates for state-
of
-
the-art truck tire balancing machines to be
utilized for the next 3 years.
Up
to 1000
of
these will be purchased for their 450 out-
lets.
If
after-tax
MARR
= 8%, MACRS
depreciation (with no GI - E
in
year 4)
and
Te = 40%,
(a)
develop a
PW
versus i
chart that shows the after-tax breakeven
ROR, and
(b)
use SOLVER to determine
the first cost
of
B to make the two break
even
if
all other estimates are retained.
614
CHAPTER
17
After-Tax Economic Analysis
Alternative
A
Alternative
B
Fi
rst cost, $
Salvage, $
-
10
,000
o
4,500
3
-
13
,000
2,000
5,000
3
GI
-
£,
$/year
Recovery period,
y
ear
s
17.44 A European candy manufacturing plant
manager must select a new irradiation
system to ensure the safety
of
specific
products, while being economical.
The
two alternatives available have the fol-
lowing
est
imates.
Fi rst cost, $
CFBT, $/year
Life, years
System
A
-
15
0,000
60,000
3
System
B
- 85,000
20,000
5
The
company
is
in
the 35% tax bracket
and assumes classical straight line depre-
ciation for alternative comparisons per-
formed at an after-tax
MARR
of
6% per
year. A salvage value
of
zero is used
when depreciation is calculated. System B
ca
n be so
ld
after 5 years for an estimated
10
%
of
its first
co
s
t.
Sy
stem A has no an-
ticipated salvage va
lu
e. Determine which
is
more economical.
17.45
Use
(a) hand calculations and (b) spread-
sheet relations to find the after-tax rate
of
return for the following desalinization
plant equipment over a 5-year time pe-
riod.
The
equipment, designed for special
jobs, will cost $2500, will have no salvage
value, and will last no more than 5 years.
Revenue minus expenses is estimated to
be $ 1500
in
year 1 and o
nl
y
$300
each ad-
ditional year
of
use.
The
effective tax rate
is
30
%.
(I)
Use
classical
SL
depreciation.
(2)
Use
MACRS
depreciation.
17.46 Automatic inspection equipment pur-
chased for
$78,000 by Stimson
Engineer
-
ing generated an average
of
$26,
080
annua
ll
y
in
before-tax cash flow during
its 5-year estimated life. This represents
a return
of
20
%.
However
, the corporate
finance officer determined that the CFAT
was $18,
000
for the first year only and is
decreasing by
$1000
per year thereafter.
If
the president wants to rea
li
ze an after-
tax return
of
12
% per
year
, for how many
more years must the
equipment
remain
in
servic
e?
17.47
Solve
Problem 17.46, us
in
g the NPV
function in Excel.
17.48 Tabulate CFAT for
Problem 17.42 esti-
mates, using classical straight line depre-
ciation over 10 years. (a) Estimate the
breakeven rate
of
return using a PW ver-
sus i graph. (b) Select the better machine
at each
of
the following after-tax
MARR
values: 5%,
9%
, 10%, and 12% per year.
17.49 In
Example
17.8, P =
$50
,000, S = 0,
n = 5,
CFBT
=
$20
,000, and Te =
40
% for
a fiber optics cable manufacturer. Straight
line depreciation is used to
compute
an
after-tax i* = 18.03%.
If
the
owner
re-
quires an after-tax return
of
20% per year,
determine an estimate allowed for (a) the
first
co
st and (b) the annual CFBT. When
you determine
one
of
these va
lu
es, as-
sume
that the other parameter retains the
value estimated
in
Examp
le 17.8.
Assume
the effective tax rate remains at
40
%.
Solve this problem by hand.
17.50 Work Problem
17
.49, using a spreadsheet
and SOLVER for after-tax returns
of
(a) 20% and (b) 10%
per
year. Explain
why the P and
CFBT
values have in-
creased or decreased when a ROR value
higher and lower than 18.03% is used.
After-Tax Replacement Study
17.
51
Scotty Paper Company-Canada
emp
loyee
Ste
ll
a Needleson was asked to deter-
mine if the current process
of
dying writ-
ing paper should be retained
or
a new,