AFTER-TAX

ECONOMIC ANALYSIS

Monday, March 7, 2022

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Income Tax Terminology

and Basic Relations
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INCOME TAX - amount of payment (taxes) on income or

profit that must be delivered to a government unit.

NET OPERATING INCOME

= REVENUE – OPERATING EXPENSES
= GROSS INCOME – OPERATING EXPENSES
- Often called EBIT (Earnings Before Income Tax)
- Earnings before interest and income taxes

NET OPERATING INCOME = EBIT = GI – OE

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TAXABLE INCOME (TI)

= amount of income upon which taxes are based
TAXABLE INCOME
= REVENUE – OPERATING EXPENSES – DEPRECIATION
= GI – OE – D
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OPERATING REVENUE (R) – also known as GROSS INCOME (GI)

- Total income realized from all revenue-producing sources

NON-OPERATING REVENUE – sale of assets, license fee income,

and royalties are considered separately for tax purposes

OPERATING EXPENSES (OE) – all costs incurred in the transaction

of business
- tax-deductible for corporation
- Include annual operating cost, maintenance and operating costs (M & O)

DEPRECIATION – a reduction in the value of an asset with the

passage of time, due in particular to wear and tear
- not an operating expense
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TAX RATE (T) – is a percentage, or decimal equivalent, of taxable income (TI)

that is owed in taxes

GRADUATED OR PROGRESSIVE TAX RATE – higher rate apply as

the TI increases

MARGINAL TAX RATE – percentage paid on the last dollar of income

INCOME TAXES = APPLICABLE TAX RATE X TAXABLE INCOME

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NET OPERATING PROFIT AFTER TAXES (NOPAT)

= Taxable Income – Tax
= TI – T(TI)
= TI (1 – T)
- Also known as Net Profit After Tax (NPAT)
- Represents the money remaining in the
corporation as a result of the capital invested
during the year
8 US Corporate Income Tax Rate Schedules
(Graduated Tax Rate)
If Taxable Income ($) is:
Of the
Over But Not Over Tax is
Amount Over
0 50,000 15% 0
50,000 75,000 7,500 + 25% 50,000
75,000 100,000 13,750 + 34% 75,000
100,000 335,000 22,250 + 39% 100,000
335,000 10,000,000 113,900 + 34% 335,000
10,000,000 15,000,000 3,400,000 + 35% 10,000,000
15,000,000 18,333,333 5,150,000 + 38% 15,000,000
18,333,333 - 35% 0
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EXAMPLE: Assume a company is expected to generate a

taxable income of $500,000 in year 1

Taxes = 113,900 + 0.34(500,000 – 335,000) = $170,000

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𝑻𝒐𝒕𝒂𝒍 𝑻𝒂𝒙𝒆𝒔 𝑷𝒂𝒊𝒅 𝑻𝒂𝒙𝒆𝒔

Average tax rate = =
𝑻𝒂𝒙𝒂𝒃𝒍𝒆 𝑰𝒏𝒄𝒐𝒎𝒆 𝑻𝑰
Effective Tax Rate
(𝑻𝒆 ) = 𝒔𝒕𝒂𝒕𝒆 𝒓𝒂𝒕𝒆 + 𝟏 − 𝒔𝒕𝒂𝒕𝒆 𝒓𝒂𝒕𝒆 𝒇𝒆𝒅𝒆𝒓𝒂𝒍 𝒓𝒂𝒕𝒆
Taxes = (𝑻𝒆 ) (TI)
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Calculation of Cash
Flow After Taxes
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Cash Flow Before Taxes:

CFBT = Gross Income – Operating Expenses - Initial
Investment + Salvage Value
= GI – OE – P + S
Cash Flow After Taxes:
CFAT = CFBT – taxes
= GI – OE – P + S – (GI – OE – P + S ) (𝑻𝒆 )
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Calculation of CFAT
Gross Operating Investment Taxable
Depreciation
Year Income Expense and Salvage CFBT Income Taxes CFAT
D
GI OE P and S TI

(1) (2) (3) (4) = (5) (6) = (7) = (8) =

(1) + (2) + (3) (1) + (2) – (5) 𝑻𝒆 (6) (4) – (7)

P = Principal or Investment
CFBT = Cash Flow Before Tax
𝐓𝐞 = Effective Tax Rate
CFAT = Cash Flow After Tax
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EXAMPLE: Wilson Security has received a contract to provide

additional security for corporate and government personnel along the
international border between the two countries in South America.
Wilson plans to purchase listening and detection equipment for use in
the 6-year contract. The equipment is expected to cost $550,000 and
have a resale value of $150,000 after 6 years. Based on the incentive
clause in the contract, Wilson estimates that the equipment will
increase contract revenue by $200,000 per year and require an
additional M&O expense of $90,000 per year. MACRS depreciation
allows recovery in 5 years, and the effective corporate tax rate is 35%.
Tabulate and plot the CFBT and CFAT series
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EXAMPLE: Wilson Security has received 150,000

a contract to provide additional security for
corporate and government personnel along 200,000
the international border between the two
countries in South America. Wilson plans to
purchase listening and detection equipment
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for use in the 6-year contract. The
equipment is expected to cost $550,000 and
have a resale value of $150,000 after 6 years.
Based on the incentive clause in the 90,000
contract, Wilson estimates that the 550,000
equipment will increase contract revenue by
$200,000 per year and require an additional
M&O expense of $90,000 per year. MACRS
depreciation allows recovery in 5 years, and
the effective corporate tax rate is 35%.
Tabulate and plot the CFBT and CFAT series
 Depreciation Rate (%) for Each MACRS Recovery Periods
Year in Years for Personal Property
n=3 n=5 n=7 n=10 n=15 n=20
1 33.33 20.00 14.29 10.00 5.00 3.75
2 44.45 32.00 24.49 18.00 9.50 7.22
3 14.81 19.20 17.49 14.40 8.55 6.68
4 7.41 11.52 12.49 11.52 7.70 6.18
5 11.52 8.93 9.22 6.93 5.71
6 5.76 8.92 7.37 6.23 5.29
7 8.93 6.55 5.90 4.89
8 4.46 6.55 5.90 4.52
9 6.56 5.91 4.46
10 6.56 5.90 4.46
11 3.28 5.91 4.46
12 5.90 4.46

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13 5.91 4.46
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Calculation of CFAT
Gross Operating Investment Taxable
Depreciation
Year Income Expense and Salvage CFBT Income Taxes CFAT
D
GI OE P and S TI

(1) (2) (3) (4) = (5) (6) = (7) = (8) =

(1) + (2) + (3) (1) + (2) – (5) 𝑻𝒆 (6) (4) – (7)

P = Principal or Investment
CFBT = Cash Flow Before Tax
𝐓𝐞 = Effective Tax Rate
CFAT = Cash Flow After Tax
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Year GI OE P and S CFBT D TI Taxes CFAT

(1) (2) (3) (4) (5) (6) (7) (8)
0 - 550,000 - 550,000 0 0 -550,000

1 200,000 - 90,000 110,000 110,000 0 0 110,000

2 200,000 - 90,000 110,000 176,000 --66,000 -23,100 133,000

3 200,000 - 90,000 110,000 105,600 4,400 1,540 108,460

4 200,000 - 90,000 110,000 63,360 46,640 16,324 93,676

5 200,000 - 90,000 110,000 63,360 46,640 16,324 93,676

6 200,000 - 90,000 150,000 260,000 31,680 78,320 27,412 232,588

Totals 550,000
At n = 1, D= P x 20%
 AFTER-TAX ECONOMIC
ANALYSIS

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Fill
21 in the missing values for CFBT, D, TI, Taxes, and CFAT
in the following table. Depreciation amounts are based on
the 3-year MACRS method and 𝑻𝒆 is 35%
Year GI OE P and S CFBT D TI Taxes CFAT
0 -1,900 -1,900 - - - -1,900
1 800 -100 0 700 633 67 23 677
2 950 -150 0 - - -45 - 816
3 600 -200 0 400 281 - 42 -
4 300 -250 700 750 - -91 -32 782
 AFTER-TAX ECONOMIC EVALUATION
One Project:
PW or AW≥ 𝟎 , 𝒕𝒉𝒆 𝒑𝒓𝒐𝒋𝒆𝒄𝒕 𝒊𝒔 𝒇𝒊𝒏𝒂𝒏𝒄𝒊𝒂𝒍𝒍𝒚 𝒗𝒊𝒂𝒃𝒍𝒆 𝒃𝒆𝒄𝒂𝒖𝒔𝒆 𝒕𝒉𝒆 𝒂𝒇𝒕𝒆𝒓 −
𝒕𝒂𝒙 𝑴𝑨𝑹𝑹 𝒊𝒔 𝒎𝒆𝒕 𝒐𝒓 𝒆𝒙𝒄𝒆𝒆𝒅𝒆𝒅

Financial viability - ability to generate sufficient income to meet

operating payments, debt commitments and, where applicable, to allow
for growth, while maintaining service levels.

Two or more alternatives:

Select the alternative with the best (numerically largest) PW or AW
value
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 EXAMPLE
Paul is designing the interior walls of an industrial building.
In some places,, it is important to reduce noise transmission
across the wall, Two construction options – stucco on
metal lath (S) and bricks (B) – each has about the same
transmission loss, approximately 33 decibels. This will
reduce noise attenuation costs in adjacent office areas. Paul
has estimated the first costs and after-tax savings each year
for both designs.

Use the CFAT values and an after-tax MARR of 7% per year

to determine which is economically better.
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24 Stucco Texture Bricks Texture
 Plan S Plan B
Year CFAT, $ Year CFAT, $

0 -28,800 0 -50,000

1-6 5,400 1 14,200

7-10 2,040 2 13,300

10 2,792 3 12,400

4 11,500

5 10,600

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 MARR of 7% per year

6 10

3 5

(a) 𝑨𝑾𝑺 = [-28,800 + 5,400 (P/A, 7%, 6) + 2,040 (P/A, 7%, 4) (P/F, 7%, 6) +
2,792 (P/F, 7%, 10)] (A/P, 7%,10)
= $422
(b) 𝑨𝑾𝑩 = [-50,000 + 14,200 (P/F, 7%, 1) + 13,300 (P/F, 7%, 2) +
12,400 (P/F, 7%, 3) + 11,500 (P/F, 7%, 4) + 10,600 (P/F, 7%, 5)] (A/P, 7%,5)
= $327
Both plans are financially viable; select plan S because 𝑨𝑾𝑺 is larger.
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 For the PW analysis, the LCM is 10 years. Use the
AW values and the P/A factor for the LCM of 10
years to select stucco on metal lath, plan S

𝑷
𝑷𝑾𝑺 = 𝑨𝑾𝑺 𝑨 , 𝟕%, 𝟏𝟎 = 𝟒𝟐𝟐(𝟕. 𝟎𝟐𝟑𝟔) = $2,964

𝑷
𝑷𝑾𝑩 = 𝑨𝑾𝑩 , 𝟕%, 𝟏𝟎 = 𝟑𝟐𝟕(𝟕. 𝟎𝟐𝟑𝟔) = $2,297
𝑨

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 AFTER-TAX ECONOMIC EVALUATION

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 When JJ and Sons was awarded a contract to pour a skyscraper’s foundation,
the father had to choose between two pieces of equipment needed to
supplement pumping of concrete into foundation settings. Estimates are
below. Both machines have an estimated 7-year useful life; however, MACRS
depreciation is over a 5-year recovery period. The effective tax rate is 40%,
and the after-tax MARR is 7% per year. Your father had asked you, one of the
sons, to recommend one machine. Perform the after-tax PW analysis.

Crete-Helper
Machine Hoister (H)
(CH)
First Cost, $ - 50,000 - 40,000
Salvage value, $ 4,000 3,000
CFBT, $ per year 10,000 8,500
Life, years 7 7
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Calculation of CFAT
Gross Operating Investment Taxable
Depreciation
Year Income Expense and Salvage CFBT Income Taxes CFAT
D
GI OE P and S TI

(1) (2) (3) (4) = (5) (6) = (7) = (8) =

(1) + (2) + (3) (1) + (2) – (5) 𝑻𝒆 (6) (4) – (7)

P = Principal or Investment
CFBT = Cash Flow Before Tax
𝐓𝐞 = Effective Tax Rate
CFAT = Cash Flow After Tax
 Depreciation Rate (%) for Each MACRS Recovery Periods in Years
Year for Personal Property
n=3 n=5 n=7 n=10 n=15 n=20
1 33.33 20.00 14.29 10.00 5.00 3.75
2 44.45 32.00 24.49 18.00 9.50 7.22
3 14.81 19.20 17.49 14.40 8.55 6.68
4 7.41 11.52 12.49 11.52 7.70 6.18
5 11.52 8.93 9.22 6.93 5.71
6 5.76 8.92 7.37 6.23 5.29
7 8.93 6.55 5.90 4.89
8 4.46 6.55 5.90 4.52
9 6.56 5.91 4.46
10 6.56 5.90 4.46
11 3.28 5.91 4.46
12 5.90 4.46
13 5.91 4.46
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 Perform a PW-based evaluation of the two alternatives
below. The after-tax MARR is 8% per year, MACRS
depreciation applies, and 𝑻𝒆 = 40%. The (GI – OE) estimate
is made for the first three years; it is zero in year 4 when
each asset is sold.
Alternative X Y

First Cost. $ -8,000 -13,000

Salvage value, year 4, $ 0 0

GI – OE, $ per year 3,500 5,000

Recovery period, years 3 3

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