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CTC 475 Review

CTC 475 Review. Taxes Types of taxes Income tax is graduated ATCF Calculate Depreciation BTCF-Depreciation=TI Tax=TI*tax rate ATCF=BTCF-Tax. CTC 475. ATCF/EVA. Objective. Know how to develop an ATCF and EVA cash flow Know the relationship between before- and after-tax MARR.

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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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