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CTC 475 Review

This comprehensive overview navigates through crucial financial concepts such as Average Tax Cash Flow (ATCF) and Economic Value Added (EVA). It covers the intricacies of various tax types, graduated income tax calculations, and the significance of depreciation. The different methods of financing projects—equity versus debt—and their impact on taxable income are explored. Practical examples demonstrate the calculations for ATCF, methods of borrowing, and the relationship between before-tax and after-tax MARR. Ideal for finance professionals seeking to enhance their project evaluation skills. ###

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CTC 475 Review

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  1. CTC 475 Review • Taxes • Types of taxes • Income tax is graduated • ATCF • Calculate Depreciation • BTCF-Depreciation=TI • Tax=TI*tax rate • ATCF=BTCF-Tax

  2. CTC 475 ATCF/EVA

  3. Objective • Know how to develop an ATCF and EVA cash flow • Know the relationship between before- and after-tax MARR

  4. Tax Concepts • Depreciation is not a cash flow but is needed to determine taxes • Interest on borrowed money is a cash flow and is also needed to determine taxes

  5. Interest • Can finance a project with equity (owner’s funds) or debt (borrowed funds) • If money is borrowed principle and interest must be repaid • Interest is a cash flow and affects taxable income • Principle is a cash flow but does not affect taxable income

  6. Methods for borrowing money • Periodic payment of interest with all principle being repaid at end of repayment period. • Uniform payment of principle. • Uniform payment (principle and interest). • Pay nothing until end of repayment period.

  7. Example Problem-Method 1-4 • Borrowed amount = $40K • 18% per year compounded annually • Repayment period-5 years

  8. Method 1-Pay Interest Periodically

  9. Method 2-Pay Principal Periodically

  10. Method 3-Uniform Payment

  11. Method 4-Pay All at End

  12. Example Problem-ATCF • Cost Basis = $82K • $42K equity • $40K borrowed at 18% per year over 5 years; equal payments • Salvage Value = $5K • Estimated useful life = 7 years • MARR=15% • Reduction in expenses =$23.5/yr • Depreciate using MACRS-GDS • 5-year property • Determine PW of BTCF & ATCF

  13. PW of BTCF • PW=$17,649 (BTCF) • PW=$3,010 (ATCF-depreciation only and assuming equity used for original costs)

  14. ATCF-Calculate Depreciation

  15. Calculate Payment Size • Assume method 3 (uniform payment) • Payment Size, A=$40,000(A/P18,5) • Payment size = $12,792

  16. Calculate Interest & Principle

  17. PW of ATCF • Must take each year back to zero (no series because each year has a different number) • PW=-$42K+$10,743(P/F15,1)+$13,746(P/F15,2) +$9,774(P/F15,3)+$7,156(P/F15,4) +$5,695(P/F15,5)+$17,116(P/F15,6) +$15,510(P/F15,7)+$3,300(P/F15,7) • PW of ATCF=$6,010 (cost effective and more cost effective than if company had funded 100% with equity)

  18. See Book page 329:

  19. Don’t include interest in ATCF • Double counting because interest rates should be included in the determination of MARR • MARR>WACC (weighted average cost of capital) • Debt Capital (bonds; interest on borrowed money) • Equity Capital (stocks, money on hand)

  20. Before/After Tax MARR • AT MARR=BT MARR*(1-effective income tax rate) • Given: BT MARR=15% • Calculate: AT MARR (34% tax rate)=9.9% • Calculate: AT MARR (40% tax rate)=9.0% • Calculation exact if no depreciation, tax credits, etc. (otherwise, just an estimate)

  21. Economic Value Added-EVA • EVAk=NOPATk-MARR*BV(k-1) • NOPAT-Net Operating Profit After Taxes • K is the year of interest • MARR is minimum attractive rate of return • BV is book value

  22. EVA • Annual equivalent worth of EVA is equal to AW of ATCF

  23. EVA Example-page 343 • Cost Basis = $84K • Salvage Value = $0 • Estimated useful life = 4 years • AT MARR=12% • Annual expenses =$30K/yr • Gross revenues=$70K/yr • Depreciate using Straight Line • Tax Rate=50% • Determine AW of ATCF and EVA

  24. ATCF

  25. AW of ATCF • AW=-$84,000(A/P12,4)+$30,500=$2,844

  26. EVA Calculation

  27. AW of EVA • PW=-$580(P/F12,1)+$1,940(P/F12,1)+$4,460(P/F12,3)+$6,980)P/F12,4) • AW=PW*(A/P12,4)=$2,844

  28. Dealing with Uncertainty Sensitivity Optimistic-Pessimistic Next lecture

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