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18-1 ©2009 Pearson Education, Inc. Publishing as Prentice Hall.

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Presentation on theme: "18-1 ©2009 Pearson Education, Inc. Publishing as Prentice Hall."— Presentation transcript:

1 18-1 ©2009 Pearson Education, Inc. Publishing as Prentice Hall

2 18-2 TAXES AND INVESTMENT PLANNING Investment models Other applications of investment models Implicit taxes and clienteles ©2009 Pearson Education, Inc. Publishing as Prentice Hall

3 18-3 Investment Models The current model The deferred model The exempt model The pension model Multiperiod strategies ©2009 Pearson Education, Inc. Publishing as Prentice Hall

4 18-4 The Current Model (1 of 2) Only after-tax dollars invested Earnings on investment taxed currently Reinvested earnings grow at after-tax rate of return ©2009 Pearson Education, Inc. Publishing as Prentice Hall

5 18-5 The Current Model (2 of 2) ATA = AT$ x [1 + R(1-t)] n ATA – After-tax accumulation AT$ – After-tax dollars R – Before tax rate of return R(1-t) After-tax rate of return t – Marginal tax rate n – Number of years ©2009 Pearson Education, Inc. Publishing as Prentice Hall

6 18-6 The Deferred Model (1 of 3) Only after-tax dollars invested Earnings on investment not taxed currently They grow at before tax rate of return Accumulated earnings taxed at end of investment horizon When investor cashes out investment ©2009 Pearson Education, Inc. Publishing as Prentice Hall

7 18-7 The Deferred Model (2 of 3) ATA = AT$ x [(1 + R) n x (1-t n ) + t n ] ATA – After-tax accumulation AT$ – After-tax dollars R – Before tax rate of return t – Marginal tax rate n – Number of years ©2009 Pearson Education, Inc. Publishing as Prentice Hall

8 18-8 The Deferred Model (3 of 3) Examples Nondeductible IRA contributions Roth IRA contributions After-tax growth of a capital asset ©2009 Pearson Education, Inc. Publishing as Prentice Hall

9 18-9 The Exempt Model (1 of 3) Only after-tax dollars invested Earnings on investment exempt from explicit taxation Special case of current or deferred model with tax rate = 0% ©2009 Pearson Education, Inc. Publishing as Prentice Hall

10 18-10 The Exempt Model (2 of 3) ATA = AT$ x (1 + R) n ATA – After-tax accumulation AT$ – After-tax dollars R – Before tax rate of return n – Number of years ©2009 Pearson Education, Inc. Publishing as Prentice Hall

11 18-11 The Exempt Model (3 of 3) Examples Roth IRA contribution Roth option for §401(k) and §403(b) plans ©2009 Pearson Education, Inc. Publishing as Prentice Hall

12 18-12 The Pension Model (1 of 3) Before-tax dollars invested Annual earnings on investment grow at before tax rate of return Entire accumulation taxed at end of investment horizon ©2009 Pearson Education, Inc. Publishing as Prentice Hall

13 18-13 The Pension Model (2 of 3) ATA = BT$ x (1 + R) n x (1-t n ) ATA – After-tax accumulation AT$ – After-tax dollars R – Before tax rate of return t – Marginal tax rate n – Number of years ©2009 Pearson Education, Inc. Publishing as Prentice Hall

14 18-14 The Pension Model (3 of 3) Deductible IRA contribution §401(k) and §403(b) plans ©2009 Pearson Education, Inc. Publishing as Prentice Hall

15 18-15 Multiperiod Strategies Models assume single amount invested for a certain period of time For periodic investments an investor may optimize his/her after-tax accumulation by investing in 1 type of investment early years and another in later years ©2009 Pearson Education, Inc. Publishing as Prentice Hall

16 18-16 Other Applications of Investment Models Pass-Through vs. C Corporation (1 of 2) Assume S corp or C corp with 1 shareholder Pass-through model ATA = contribution x [1 + R f (1-t p )] n R f – Before tax rate of return t p – Owners marginal tax rate n – Number of years ©2009 Pearson Education, Inc. Publishing as Prentice Hall

17 18-17 Other Applications of Investment Models Pass-Through vs. C Corporation (2 of 2) C corporation model ATA = contrib x [(1 + r c ) n – (1-t p ) + t p ] contrib – Capital contribution r c – Before tax rate of return t p – Owners marginal tax rate ©2009 Pearson Education, Inc. Publishing as Prentice Hall

18 18-18 Other Applications of Investment Models Current Salary vs. Deferred Comp (1 of 4) Employees point of view Current salary Pay taxes currently Invest after-tax dollars Deferred salary Pay tax in year of receipt Invest before-tax dollars ©2009 Pearson Education, Inc. Publishing as Prentice Hall

19 18-19 Other Applications of Investment Models Current Salary vs. Deferred Comp (2 of 4) Employees point of view (continued) CSI = BT$ x (1 + t po ) x (1-r p ) n DCI = BT$ x (D n ) x (1-t pn ) CSI – Current salary income DCI – Deferred compensation income D n – $ Def comp in lieu of $1 current sal t po – Employees marginal tax rate in yr 0 t pn – Employees marginal tax rate in yr n ©2009 Pearson Education, Inc. Publishing as Prentice Hall

20 18-20 Other Applications of Investment Models Current Salary vs. Deferred Comp (3 of 4) Employers point of view Current salary Immediate tax benefit Salary less tax benefit is employers after-tax salary expense Deferred salary Have after-tax salary expense available for investment until time n when deferred compensation is paid ©2009 Pearson Education, Inc. Publishing as Prentice Hall

21 18-21 Other Applications of Investment Models Current Salary vs. Deferred Comp (4 of 4) Employers point of view (continued) CSE = BT$ x (1 + t co ) x (1-r c ) n DCE = BT$ x (D n ) x (1-t cn ) CSE – Current salary expense DCE – Deferred compensation expense t co – Employers marginal tax rate in yr 0 t cn – Employers marginal tax rate in yr n ©2009 Pearson Education, Inc. Publishing as Prentice Hall

22 18-22 Implicit Taxes and Clienteles Implicit taxes Market adjustments for tax-favored investments Difference in before tax rates of return between a nontax-favored investment and a tax-favored investment Assumes similar risk and duration ©2009 Pearson Education, Inc. Publishing as Prentice Hall

23 Comments or questions about PowerPoint Slides? Contact Dr. Richard Newmark at University of Northern Colorados Kenneth W. Monfort College of Business ©2009 Pearson Education, Inc. Publishing as Prentice Hall


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