Graw Hill: 17.1 Income Tax Terminology and Relations For Corporations and Individuals

Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
ENGINEERING ECONOMY Fifth Edition

Mc
Blank and Tarquin Graw
Hill
CHAPTER 17
17.1
INCOME TAX TERMINOLOGY AND
RELATIONS FOR CORPORATIONS
AND INDIVIDUALS
Blank & Tarquin: 5th edition. Ch.17 Authored by Dr. Don Smith, Texas A&M University 1
17.1 Important Terms: Gross Income
Gross Income
 Total income for the tax year from all
revenue-producing sources of the
corporation.
 Sales revenues,
 Fees,
 Rent,
 Royalties,
 Sale of assets
17.1 Income Tax
The total amount of money transferred

from the enterprise to the various
taxing agencies for a given tax year.
 Federal Corporate Taxes are normally paid
at the end of every quarter, and a final
adjusting payment is submitted with the tax
return at the end of the fiscal year.
 This tax is based upon the income-
producing power of the firm.
 Taxes are actual cash flows.
17.1 Operating Expenses (E)
All legally recognized costs associated

with doing business for the tax year.
 Real Cash Flows,
 These are Tax deductible for corporations,
 AOC
 M & O costs
 utilities
 Material expenses,
 Etc.
17.1 Taxable Income (TI)
Calculated amount of money for a

specified time period from which the tax
liability is determined.
Calculated as:
 TI = Gross Income – expenses –
depreciation
 TI = GI – E – D [17.1]
17.1 Tax Rate T
A percentage or decimal equivalent of

TI.
For Federal corporate income tax T is
represented by a series of tax rates.
The applicable tax rate depends upon
the total amount of TI.
Taxes owed equals:
 Taxes = (taxable income) x (applicable rate)
= (TI)(T). [17.2]
17.1 Net Profit After Tax (NPAT)
Amount of money remaining each year

when income taxes are subtracted from
taxable income.
NPAT = Taxable Income – Taxes
= TI – {(TI)(T)},
= (TI)(1-T). [17.3]
17.1 NPAT
Net profits (if positive) represent funds

that are the claim of the owners of the
firm – NOT the firm!
NPAT can be:
 “Saved” by the firm,
 Reinvested within the firm,
 Paid out as dividends to the stockholders,
 Some combination of paying dividends and
reinvesting.
17.1 Federal Corporate Tax Rates
Corporate Tax Rates:

 No one single rate;
 Series of “graduated” rates;
 TI is partitioned into up to 8 brackets of
taxable income;
 A tax rate is then applied to each bracket of
taxable income and then summed across all
applicable brackets.
17.1 The Eight Federal Tax Brackets (2002)

Taxable Income
Bracket Bracket Min Bracket Max
1 $0 $50,000
2 $50,000 $75,000
3 $75,000 $100,000
4 $100,000 $335,000
5 $335,000 $10,000,000
6 $10,000,000 $15,000,000
7 $15,000,000 $18,333,333
8 $18,333,333 Sky's the limit!
17.1 Bracket Tax Rates
Taxable Income T - (%)

Braket Braket Min Bracket Max Brkt. Rate
1 $0 $50,000 0.15
2 $50,000 $75,000 0.25
3 $75,000 $100,000 0.34
4 $100,000 $335,000 0.39
5 $335,000 $10,000,000 0.34
6 $10,000,000 $15,000,000 0.35
7 $15,000,000 $18,333,333 0.38
8 $18,333,333 Sky's the limit! 0.35
17.1 Example:
Assume TI = $200,000.
Determine the Federal tax liability.
 1st $50,000 (0.15) = $7,500 ($150,000 left)
 Next $25,000 (0.25) = $6,250 ($125,000 left)
 Next $25,000 (0.34) = $8,500 ($100,000 left)
Now we are in the 4th bracket
Tax all monies between $100,000 to
$335,000 at 39%
 Last $100,000 (0.39) = $39,000.
 Done!
17.1 Total Tax on TI = $200,000
Add the bracket tax amounts:

 $7,500
 $6,250
 $8,500
 $39,000
 $61,250
Tax as a % of TI:
 $61,250/$200,000 = 28.13%
17.1 Observations
Each bracket rate is termed a
“marginal” rate.
Note the bracket rates are:
1. 15%
2. 25%
3. 34%
4. 39%
5. 34%
6. 35%
7. 38%
8. 35%
17.1 Marginal Tax Rates
The first $50,000 of TI is taxed at the

bracket rate of 15%.
Any additional TI over $50,000 flows
into the next bracket.
The next $25,000 or part thereof, is
taxed at the marginal bracket rate of
25%.
Each additional $ that moves a firm into
a higher bracket is taxed at the higher
bracket’s tax rate.
17.1 Tax Bracket Description
A “tax bracket” system is termed a

“graduated tax system.”
Additional amounts of taxable income
are taxed at the associated bracket tax
rate.
The max bracket rate is 39% and the
minimum bracket rate is 15%.
17.1 Combined Tax Rate
Assume a known state tax rate, then:

Compute:
 Effective Tax rate – Te as:
 Te = state rate + (1 – state rate) (Federal
Rate)
State income taxes are deductible
expenses for federal income tax
purposes.
17.1 Personal vs. Corporate
Individuals report total income;

Gross earned income;
However, individuals may not deduct
most of their day-to-day living and
working expenses.
Individuals must apply the various
standard or itemized deductions
permitted by current law.
Corporations deduct actual cash-flow
expenses.
17.1 Personal vs. Corporate
Individuals have to file as either:

 Single,
 Married,
 Head of household.
Corporations have no such filing status
other than filing as a corporation.
17.1 Individual Tax Rates
See Table 17-2 on page 547;

Similar bracket design with 5 brackets;
1. 15%
2. 28%
See Example 17.2
3. 31%
4. 36%
5. 39.6%
The bracket amounts depend upon
filing status (Single, Married, Head of
Household).
ENGINEERING ECONOMY Fifth Edition

M c
Blank and Tarquin Graw
Hill
CHAPTER 17
17.2
BEFORE-TAX AND AFTER-TAX CASH
FLOW
17.2 NET CASH FLOW – NCF
NCF represents:
 Cash Inflow – Cash Outflows for a given
time period.
From economy studies the engineer will
estimate the future net cash flows
associated with the project over its
estimated life.
Now, we define Cash Flow Before Tax
(CFBT).
17.2 Cash Flows Before Tax (CFBT)
CFBT:
 Actual real cash flows associated with an
investment BEFORE any income tax
considerations are applied.
 CFBT does not consider depreciation or
depletion amounts.
17.2 CFBT Defined
CFBT =
 Gross income – expenses – initial
investment + salvage value

 CFBT= GI – E – P + S [17.7]
 Note:
 Depreciation and depletion

amounts are not part of CFBT as
they are not real cash flows.
17.2 Cash Flow After Tax ( CFAT)
CFAT for a given time period is defined

as:
 CFAT = CFBT – Taxes.
 The “Taxes” component must be expanded
to include the impacts of depreciation and
or depletion.
 Depreciation is a noncash flow, but is
deductible from GI and serves to moderate
(lessen) the TI amount.
17.2 Expanding the CFAT Amount
Specifically:
 CFAT = GI – E – P + S –(GI-E-D)(T )
E
 Note the (GI-E-D)(T ) term.
e
 (GI – E – D) represent the taxable
income component;
 Multiplying (GI – E – D) by T
e
computes the tax on the taxable
income part.
 Then the tax is subtracted from the
CFBT to yield the CFAT amounts.
17.2 Some Observations
Focus on: (GI – E - D).

For some time periods this term could
be negative.
 Operating “loss,” which can generate
a “negative” tax.
 If this is the case, then “so be it.”
 Let the sign take care of itself!
17.2 CFBT: Format
A tabular approach is suggested.

Numerous formats exist and no
one single format or design is “the
best.”
See Table 17-3 and Example 17.3
Suggested tabular format follows.
17.2 BTCF Format with Example 17.3

Life 6
Discount Rate 15.00%
(Signed) (+) (+) or (-) Calculated
Time Gross Operating Investment CFBT
Period Income Expenses or Salvage
0 -$550,000 -$550,000
1 $200,000 $90,000 $110,000
2 $200,000 $90,000 $110,000
3 $200,000 $90,000 $110,000
4 $200,000 $90,000 $110,000
5 $200,000 $90,000 $110,000
6 $200,000 $90,000 $150,000 $260,000
$1,200,000 $540,000 -$400,000 $260,000
NPV Amt ($68,857.76)
IROR 10.751%
17.2 ATCF Format: Example 17.3

Tax Rate: 35.00% Discount Rate Atax 10.00%
(1) (2) (3) (4)
CF(Signed) CF(+) CF(+) or (-) Non-CF
Time Gross Operating Investment Depreciation
Period Income Expenses or Salvage Amt (+) values
0 $0 $0 -$550,000
1 $200,000 $90,000 $0 $110,000
2 $200,000 $90,000 $0 $176,000
3 $200,000 $90,000 $0 $105,600
4 $200,000 $90,000 $0 $63,360
5 $200,000 $90,000 $0 $63,360
6 $200,000 $90,000 $150,000 $31,680
$1,200,000 $540,000 -$400,000 $550,000
First four columns are presented…..
17.2 ATCF Format: Example 17.3

(5) (6) (7)
Intermed. Cal. (-) C.F Calculated CF
Taxable Taxes CFAT t
Income (TI)
-$550,000 0
$0 $0 $110,000 1
-$66,000 -$23,100 $133,100 2
$4,400 $1,540 $108,460 3
$46,640 $16,324 $93,676 4
$46,640 $16,324 $93,676 5
$78,320 $27,412 $232,588 6
$38,500 $221,500
NPV -$5,075.14
IROR 9.708%
Last four columns are presented…..
17.2 ATCF Amounts from Column 7

(7)
Calculated CF These amounts represent
the after-tax cash flow
CFAT t
values for years 0–6.
-$550,000 0 The analyst can calculate
$110,000 1 PW, FW, AW, IROR, etc.
$133,100 2 using the methods in the
$108,460 3 previous chapters.
$93,676 4 The Goal: Is this
$93,676 5 investment acceptable?
$232,588 6
$221,500
17.2 ATCF Calculations
Best performed with a spreadsheet

model as shown.
Depreciation amounts can be calculated
in another spreadsheet and copied
(values only) into the ATCF worksheet.
User inputs besides the CF values are
the discount rate and the tax rate.

Graw Hill: 17.1 Income Tax Terminology and Relations For Corporations and Individuals

Uploaded by

Copyright:

Available Formats

Graw Hill: 17.1 Income Tax Terminology and Relations For Corporations and Individuals

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Graw Hill: 17.1 Income Tax Terminology and Relations For Corporations and Individuals

Uploaded by

Copyright:

Available Formats

Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

ENGINEERING ECONOMY Fifth Edition

17.1 Important Terms: Gross Income

17.1 Income Tax

The total amount of money transferred

17.1 Operating Expenses (E)

All legally recognized costs associated

17.1 Taxable Income (TI)

Calculated amount of money for a

17.1 Tax Rate T

A percentage or decimal equivalent of

17.1 Net Profit After Tax (NPAT)

Amount of money remaining each year

Net profits (if positive) represent funds

17.1 Federal Corporate Tax Rates

Corporate Tax Rates:

17.1 The Eight Federal Tax Brackets (2002)

17.1 Bracket Tax Rates

Taxable Income T - (%)

17.1 Total Tax on TI = $200,000

Add the bracket tax amounts:

17.1 Marginal Tax Rates

The first $50,000 of TI is taxed at the

17.1 Tax Bracket Description

A “tax bracket” system is termed a

17.1 Combined Tax Rate

Assume a known state tax rate, then:

17.1 Personal vs. Corporate

Individuals report total income;

17.1 Personal vs. Corporate

Individuals have to file as either:

17.1 Individual Tax Rates

See Table 17-2 on page 547;

ENGINEERING ECONOMY Fifth Edition

17.2 NET CASH FLOW – NCF

17.2 Cash Flows Before Tax (CFBT)

17.2 CFBT Defined

investment + salvage value

 Depreciation and depletion

17.2 Cash Flow After Tax ( CFAT)

CFAT for a given time period is defined

17.2 Expanding the CFAT Amount

CFBT to yield the CFAT amounts.

17.2 Some Observations

Focus on: (GI – E - D).

 Let the sign take care of itself!

17.2 CFBT: Format

A tabular approach is suggested.

17.2 BTCF Format with Example 17.3

17.2 ATCF Format: Example 17.3

First four columns are presented…..

17.2 ATCF Format: Example 17.3

17.2 ATCF Amounts from Column 7

17.2 ATCF Calculations

Best performed with a spreadsheet

You might also like