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Mastering After-Tax Cash Flows: Tax Concepts and Interest Influence

Learn how to develop After-Tax Cash Flows (ATCF) by incorporating depreciation and interest on borrowed funds. Understand tax implications of depreciation and interest as key cash flow components. Explore various borrowing methods and their impact on ATCF calculations.

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Mastering After-Tax Cash Flows: Tax Concepts and Interest Influence

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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 Effect of interest on ATCF

  3. Objective • Know how to develop an ATCF taking into account both depreciation and interest on borrowed money

  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 of (principle and interest). • Pay nothing until end of repayment period.

  7. Example Problem-Method 1-4 • Borrowed amount = $40K • $40K borrowed at 18% per year over 5 years; equal payments • 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 (BTCF-depreciation only and all equity)

  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 higher than if company had funded 100% with equity)

  18. ATCF’s are impacted by: • Depreciation methods • Recovery period • Planning horizon • Different tax rates • Interest rates on borrowed money

  19. Next lecture • Sensitivity Analyses • Optimistic-Pessimistic

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