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b12 Income Taxes and Capital Budgeting
b12 Income Taxes and Capital Budgeting
12
Income taxes
Marginal Income Tax Rate
• In capital budgeting, the relevant tax rate
is the marginal income tax rate.
• This is the tax rate paid on additional
amounts of pretax income.
Effects of
Depreciation Deductions
• For tax purposes, accelerated depreciation
is generally allowed.
• The focus is on the tax reporting rules, not
those for public financial reporting.
• The number of years over which an asset
is depreciated for tax purposes is called
the recovery period.
Depreciation Deductions for
Capital Budgeting
• Depreciating a fixed asset creates future
tax deductions.
• The present value of this deduction
depends directly on its specific yearly
effects on future income tax payments.
Depreciation Deductions for
Capital Budgeting
Recovery period
Discount rate
Tax rate
Tax Effect on Cash Inflows from
Depreciation Deductions
TAX
Learning Objective 3
What is inflation?
It is the decline in general
purchasing power of the monetary unit.
The key in capital
budgeting is consistent
treatment of the minimum
desired rate of return and the
predicted cash inflows and outflows.
Watch for Consistency
P= I ÷ O
Payback Model Example
• Assume that $12,000 is spent for a
machine with an estimated useful life of 8
years.
• Annual savings of $4,000 in cash outflows
are expected from operations.
• What is the payback period?