1. CTC 475 Review Taxes Taxes Types of taxes Types of taxes Income tax is graduated Income tax is graduated ATCF ATCF Calculate Depreciation Calculate Depreciation BTCF-Depreciation=TI BTCF-Depreciation=TI Tax=TI*tax rate Tax=TI*tax rate ATCF=BTCF-Tax 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 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 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 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) Can finance a project with equity (owner’s funds) or debt (borrowed funds) If money is borrowed principle and interest must be repaid If money is borrowed principle and interest must be repaid Interest is a cash flow and affects taxable income Interest is a cash flow and affects taxable income Principle is a cash flow but does not affect taxable income Principle is a cash flow but does not affect taxable income

6. Methods for borrowing money 1. Periodic payment of interest with all principle being repaid at end of repayment period. 2. Uniform payment of principle. 3. Uniform payment of (principle and interest). 4. Pay nothing until end of repayment period.

7. Example Problem-Method 1-4 Borrowed amount = $40K Borrowed amount = $40K $40K borrowed at 18% per year over 5 years; equal payments $40K borrowed at 18% per year over 5 years; equal payments 18% per year compounded annually 18% per year compounded annually Repayment period-5 years Repayment period-5 years

8. Method 1-Pay Interest Periodically EOY Interest Payment Principle Payment Total Payment 0 1 18%*40K= $7,200 0$7,200 2$7,2000$7,200 3$7,2000$7,200 4$7,2000$7,200 5$7,200$40,000$47,200

9. Method 2-Pay Principal Periodically EOY Interest Payment Principle Payment Remaining Principle Total Payment 0$40,000 1$7,200$8,000$32,000$15,200 2$5,760$8,000$24,000$13,760 3$4,320$8,000$16,000$12,320 4$2,880$8,000$8,000$10,880 5$1,440$8,000$0$9,440

10. Method 3-Uniform Payment EOY Interest Payment Principle Payment Remaining Principle Total Payment 0$40,000 1$7,200$5,591$34,409$12,791 2$6,194$6,598$27,811$12,791 3$5,006$7,785$20,026$12,791 4$3,605$9,186$10,840$12,791 5$1,951$10,840$0$12,791

11. Method 4-Pay All at End EOY Interest Payment Principle Payment Total Payment 0 1$0$0$7,200 2$0$0$7,200 3$0$0$7,200 4$0$0$7,200 5$51,510$40,000 40K(F/P18,5)= $91,510

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

13. PW of BTCF PW=$17,649 (BTCF) PW=$17,649 (BTCF) PW=$3,010 (BTCF-depreciation only and all equity) PW=$3,010 (BTCF-depreciation only and all equity)

14. ATCF-Calculate Depreciation EOYCalculation Depreciation (MACRS) 120%*$82K=$16,400 232%*$82K=$26,240 319.2%*$82K=$15,744 411.52%*$82K=$9,446 511.52%*$82K=$9,446 65.76%*$82K=$4,723

15. Calculate Payment Size Assume method 3 (uniform payment) Assume method 3 (uniform payment) Payment Size, A=$40,000(A/P 18,5 ) Payment Size, A=$40,000(A/P 18,5 ) Payment size = $12,792 Payment size = $12,792

16. Calculate Interest & Principle EOYInterestPrinciple Remaining Principle 0$40,000 1 $7,200 (40K*.18) $5,592 (12,792-7,200) $34,408 2 $6,193 ($34,408*.18) $6,599 (12,792-6193) $27,809 3$5,006$7,786$20,023 4$3,604$9,188$10,835 5$1,950$10,842~$0

17. ABCDEFGH (B-D-E)(F*.34)(B-C-D-G) EOYBTCFPRINCINT DEPRE C TITAXESATCF 0-42K-42,000 123.5K5,5917,20016,400-100-3410,743 223.5K6,5986,19426,240-8,934-3,03813,746 323.5K7,7855,00615,7442,7509359,774 423.5K9,1863,6059,44610,4493,5537,156 523.5K10,8391,9519,44612,1034,1156,595 623.5K4,72318,7776,38417,116 723.5K23,5007,99015,510 75K5,0001,7003,300

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

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

20. Next lecture Sensitivity Analyses Sensitivity Analyses Optimistic-Pessimistic Optimistic-Pessimistic