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Understanding Depreciation Methods and Effective Tax Rates for Asset Management

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15 diapositives · 293 Views · Jul 13, 2014

This review covers various depreciation methods including Straight Line, Declining Balance, and MACRS. It explains the terminology of effective tax rates, including federal and state tax implications. Readers will learn how marginal tax rates impact taxable income and after-tax cash flow calculations, using examples to illustrate the effects of depreciation and asset sales on financial statements. The document provides a detailed analysis of after-tax cash flows when selling assets under different scenarios, ensuring a comprehensive understanding of the tax implications involved.

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  1. Reviewing… • We covered the following depreciation methods: • Straight Line • Declining Balance • Sum of Years Digits • Units of Production • MACRS – Modified Accelerated Cost Recovery System

  2. Effective 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

  3. Effective Tax Rates • State taxes are deductible when calculating Federal taxable income. • Effective Tax Rate = • FTR (1 – STR) + STR

  4. Marginal Tax Rates • Tax rates for corporations and individuals vary depending on the amount of taxable income. • Different tax rates apply to incremental income.

  5. Marginal Tax Rates 2010 Federal Personal (Single) Tax Schedule 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).

  6. Marginal Tax Rates 2010 Federal Corporate Tax Schedule

  7. Average Tax Rate vs. Marginal Tax Rate Example: $125,000 in taxable income Average Tax Rate: Marginal Tax Rate:

  8. Assumptions • Company already has taxable income. • We need to know the marginal tax rate. • Assume project will keep me in the same marginal tax bracket.

  9. After Tax Analysis • 1. Determine Taxable Income: • ( + ) Income • ( - ) Expenses • ( - ) Interest Paid • ( - ) Depreciation (Not a real cash flow) • Determine Taxes • Use the marginal tax rate • Determine After Tax Cash Flow • ( + ) Income • ( - ) Expenses • ( - ) Loan Payments • ( - ) Tax cash flow

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

  11. Sale of Asset • End of the year taxable income from sale = Sale Price – Book Value • Tax cash flow from sale of the asset = taxable income from sale x marginal tax rate • After tax cash flow = • sale price – tax cash flow from sale of the asset

  12. Early Sale of Asset Half Year Convention: • 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 • 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

  13. Sale 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%.

  14. Sale of Asset Example 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 $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%.

  15. Sale of Asset Example with a Twist - 2! 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%.