Engineering Economic Analysis After-Tax

Bab 10
Analisa
Economi
Setelah-Pajak
Principles of Engineering Economic Analysis, 5th edition
Teknik Analisa Economi

1. Identidikasi alternatip investasi
2. Tetapkan planning horizon
3. Tentukan discount rate
4. Estimasi cash flows
5. Bandingkan antar alternatip
6. Lakukan Analisa Tambahan
7. Pilih investasi yang diinginkan
Pesan Utama #1
Lakukan analisa setelahpajak/after-tax, jangan
analisa sebelumpajak/beore-tax, kecuali
dalam situasi tidak umum.
Corporate Income Tax Rates for Tax Years

Beginning January 1, 1993 and Beyond
Selama hukum pajak penghasilan

berbeda dengan buku, pelajari
sistem hukum perpajakan di
Indonesia
Contoh 10.1
A small business is forecasting a taxable income
of $50,000 for the year. The owner is considering
making an investment that will increase taxable
income by $45,000. If the investment is pursued
and the anticipated return occurs, what will be
the magnitude of the increase in income taxes
caused by the new investment? What would be
the magnitude of the increase in income taxes if
the company forecasts a taxable income of
$400,000 for the year?
Contoh 10.1 (Lanjutan)

With a base taxable income of $50,000, the
federal income tax will be 0.15($50,000), or $7500.
The income tax for a taxable income of $95,000
will be $13,750 + 0.34($20,000) = $20,550.
With a base taxable income of $400,000, the
federal income tax will be $113,900 +
0.34($65,000) = $136,000 or 34% of $400,000.
Because every dollar of the additional $45,000 in
taxable income will be taxed at 34%, the increase
in taxable income will be 0.34($45,000) = $15,300
for a total tax of $151,300.
effective tax rate = income tax

divided by taxable income;
incremental tax rate = average
rate charged to incremental
investment; and
marginal tax rate = tax rate that
applies to the last dollar included in
taxable income.
Fiscal Year 2007 Effective Tax Rates

Company
Effective Company
Tax Rate
Effective
Tax Rate
ABB
27.0%
Federal Express
37.3%
Abbott Laboratories
19.3% Harley-Davidson
35.5%
BP
37.0%
Hewlett-Packard
20.8%
Canon
33.2%
Home Depot
36.4%
Caterpillar
30.0%
Intel
23.9%
Coca-Cola
24.0%
J.B. Hunt Transport Services
34.4%
ConocoPhillips
48.9%
Motorola
26.0%
Eli Lilly
23.8%
Wal-Mart
33.6%
Contoh 10.2
For Example 10.1, the effective tax
rate, when base taxable income is
$50,000 and an additional $45,000 in
taxable income will occur, is
$20,550/($50,000 + $45,000), or 21.63%.
The incremental tax rate is
($20,550 - $7500)/$45,000, or 29%.
The marginal tax rate is 34%.
In performing engineering
economic analyses, use
the marginal tax rate.
Let
BTCF
DWO
TI
str
ftr
itr
T
ATCF
=
=
=
=
=
=
=
=
before-tax cash flow

depreciation write-off, allowance or charge
taxable income
state income tax rate
federal income tax rate
income tax rate
income tax
after-tax cash flow
ATCF = BTCF(1 - itr) + itr(DWO)

itr = str + ftr(1 - str)
If ftr = 35% and str = 7%, then
itr = 0.07 + 0.35(0.93)
itr = 0.3955 or 39.55%
Analisa After-Tax
Alternatip Single
Contoh 10.3
A $500,000 investment in a surface mount
placement machine produces after-tax net
revenue of $92,500/yr for 10 years, at which
time the SMP machine has a salvage value
of $50,000. Based on a 40% income tax
rate, a 10% ATMARR, & SLN depreciation,
what will be the ATPW, ATFW, ATAW,
ATIRR, and ATERR for the SMP
investment? What will be the BTCF, BTPW,
BTFW, BTAW, BTIRR, and BTERR if the
BTMARR is 0.10/(1.0 0.4) = 16.667%?
BT & AT Analysis of the SMP Investment with SLN

EOY
0
1
2
3
4
5
6
7
8
9
10
MARRBT =
$31,666.67
$31,666.67
$31,666.67
$31,666.67
$31,666.67
$31,666.67
$31,666.67
$31,666.67
$31,666.67
$31,666.67
MARRAT =
ATCF
-$500,000.00
$92,500.00
$92,500.00
$92,500.00
$92,500.00
$92,500.00
$92,500.00
$92,500.00
$92,500.00
$92,500.00
$142,500.00
10%
PW AT =
$87,649.62
FW BT = $449,547.99
FW AT =
$227,340.55
AW BT =
AW AT =
$14,264.57
PW BT =
BTCF
-$500,000.00
$124,166.67
$124,166.67
$124,166.67
$124,166.67
$124,166.67
$124,166.67
$124,166.67
$124,166.67
$124,166.67
$174,166.67
16.667%
DWO
$45,000.00
$45,000.00
$45,000.00
$45,000.00
$45,000.00
$45,000.00
$45,000.00
$45,000.00
$45,000.00
$45,000.00
TI
$79,166.67
$79,166.67
$79,166.67
$79,166.67
$79,166.67
$79,166.67
$79,166.67
$79,166.67
$79,166.67
$79,166.67
$96,229.49
$20,406.41
IRR BT =
21.64%
IRR AT =
13.80%
ERR BT =
18.74%
ERR AT =
11.79%
Example 10.4
placement machine produces before-tax
net revenue of $124,166.67/yr for 10 years,
at which time the SMP machine has a
salvage value of $50,000. Based on a 40%
income tax rate, a 10% ATMARR, & 5-yr
MACRS depreciation, what will be the
ATPW, ATFW, ATAW, ATIRR, and ATERR
for the SMP investment?
AT Analysis of the SMP Investment with MACRS

EOY
0
1
2
3
4
5
6
7
8
9
10
BTCF
DWO
TI
T
ATCF
-$500,000.00
-$500,000.00
$124,166.67 $100,000.00 $24,166.67
$9,666.67 $114,500.00
$124,166.67 $160,000.00 -$35,833.33 -$14,333.33 $138,500.00
$124,166.67 $96,000.00 $28,166.67 $11,266.67 $112,900.00
$124,166.67 $57,600.00 $66,566.67 $26,626.67
$97,540.00
$124,166.67 $57,600.00 $66,566.67 $26,626.67
$97,540.00
$124,166.67 $28,800.00 $95,366.67 $38,146.67
$86,020.00
$124,166.67
$0.00 $124,166.67 $49,666.67
$74,500.00
$124,166.67
$0.00 $124,166.67 $49,666.67
$74,500.00
$124,166.67
$0.00 $124,166.67 $49,666.67
$74,500.00
$174,166.67
$0.00 $174,166.67 $69,666.67 $104,500.00
PW AT = $123,988.64
FW AT =
$321,594.61
AW AT =
$20,178.58
IRR AT =
16.12%
ERR AT =
12.46%
SMP Investment
Measure of Economic Worth
With SLN
With MACRS
PWAT
$87,649.62
$123,988.64
FWAT
$227,340.55 $321,594.61
AWAT
$14,264.57
$20,178.58
IRRAT
13.80%
16.12%
ERRAT
11.79%
12.46%
Main Message #2
In general, the faster
an investment is
depreciated, the
greater its after-tax
present worth.
Example 10.5
placement machine produces BTCF of
$124,166.67/yr for 10 years, at which time the
SMP machine is sold for $50,000. If DDB
depreciation is used, based on a 40% income tax
rate, a 10% ATMARR, & 5-yr MACRS
depreciation, what will be the ATPW, ATFW,
ATAW, ATIRR, and ATERR for the SMP
investment?
TIn = BTCFn(incl Fn) - DWOn - Bn

Taxable income in the year of property disposal (EOY = n) is equal to the
before-tax cash flow in the year of property disposal, including salvage
value realized, less the depreciation write-off in the year of property
disposal, less the book value at the time of property disposal.
Recall, if depreciable property is disposed of before the end of the
recovery period, when using MACRS depreciation, a half-year allowance
(in the case of personal property) or mid-month allowance (in the case of
real property) is permitted in the year of disposal.
AT Analysis of the SMP Investment with DDB

EOY
0
1
2
3
4
5
6
7
8
9
10
BTCF
-$500,000.00
$124,166.67
$124,166.67
$124,166.67
$124,166.67
$124,166.67
$124,166.67
$124,166.67
$124,166.67
$124,166.67
$174,166.67
B 10 =
DWO
TI
$100,000.00 $24,166.67 $9,666.67

$80,000.00 $44,166.67 $17,666.67
$64,000.00 $60,166.67 $24,066.67
$51,200.00 $72,966.67 $29,186.67
$40,960.00 $83,206.67 $33,282.67
$32,768.00 $91,398.67 $36,559.47
$26,214.40 $97,952.27 $39,180.91
$20,971.52 $103,195.15 $41,278.06
$16,777.22 $107,389.45 $42,955.78
$13,421.77 $107,057.81 $42,823.12
$53,687.09
ATCF
-$500,000.00
$114,500.00
$106,500.00
$100,100.00
$94,980.00
$90,884.00
$87,607.20
$84,985.76
$82,888.61
$81,210.89
$131,343.55
PW AT =
$105,429.72
FW AT =
$273,457.54
AW AT =
$17,158.20
IRR AT =
14.88%
ERR AT =
12.12%
Example 10.6
A $500,000 investment is made in a consulting
study that produces BTCF of $124,166.67/yr for
10 years, plus an additional $50,000 in the 10th
year. Based on a 40% income tax rate and a 10%
ATMARR, what will be the ATPW, ATFW, ATAW,
ATIRR, and ATERR for the investment in the
consultant?
AT Analysis of a $500,000 Investment in a Consultant

EOY
0
1
2
3
4
5
6
7
8
9
10
BTCF
-$500,000.00
$124,166.67
$124,166.67
$124,166.67
$124,166.67
$124,166.67
$124,166.67
$124,166.67
$124,166.67
$124,166.67
$174,166.67
TI
T
ATCF
-$500,000.00 -$200,000.00 -$300,000.00
$124,166.67 $49,666.67 $74,500.00
$124,166.67 $49,666.67 $74,500.00
$124,166.67 $49,666.67 $74,500.00
$124,166.67 $49,666.67 $74,500.00
$124,166.67 $49,666.67 $74,500.00
$124,166.67 $49,666.67 $74,500.00
$124,166.67 $49,666.67 $74,500.00
$124,166.67 $49,666.67 $74,500.00
$124,166.67 $49,666.67 $74,500.00
$174,166.67 $69,666.67 $104,500.00
PW AT = $169,336.56
FW AT =
$439,215.43
AW AT =
$27,558.75
IRR AT =
21.64%
ERR AT =
15.03%
Expensing vs Capitalizing
Measure of Economic Worth
Expensing
Capitalizing
PWAT
$169,336.56 $123,988.64
FWAT
$439,215.43 $321,594.61
AWAT
$27,558.75
$20,178.58
IRRAT
21.64%
16.12%
ERRAT
15.03%
12.46%
After-Tax Analysis
Multiple Alternatives
Example 10.7
Recall the two design alternatives for the Scream
Machine considered previously. Now, we perform
an after-tax analysis, based on: design A having
an initial investment of $300,000 and producing
before-tax net annual revenue of $71,666.67; and
design B having an initial investment of $450,000
and producing before-tax net annual revenue of
$103,333.33. Based on a 40% income tax rate, a
10% ATMARR, and 7-yr MACRS depreciation,
perform an after-tax comparison of the two
alternatives.
AT Analysis of the Scream Machine Design Alternatives

EOY
0
1
2
3
4
5
6
7
8
9
10
BTCF(A)
-$300,000.00
$71,666.67
$71,666.67
$71,666.67
$71,666.67
$71,666.67
$71,666.67
$71,666.67
$71,666.67
$71,666.67
$71,666.67
DWO(A)
EOY
0
1
2
3
4
5
6
7
8
9
10
BTCF(B)
-$450,000.00
$103,333.33
$103,333.33
$103,333.33
$103,333.33
$103,333.33
$103,333.33
$103,333.33
$103,333.33
$103,333.33
$103,333.33
DWO(B)
$42,870.00
$73,470.00
$52,470.00
$37,470.00
$26,790.00
$26,760.00
$26,790.00
$13,380.00
$0.00
$0.00
$64,305.00
$110,205.00
$78,705.00
$56,205.00
$40,185.00
$40,140.00
$40,185.00
$20,070.00
$0.00
$0.00
TI(A)
$28,796.67
-$1,803.33
$19,196.67
$34,196.67
$44,876.67
$44,906.67
$44,876.67
$58,286.67
$71,666.67
$71,666.67
TI(B)
$39,028.33
-$6,871.67
$24,628.33
$47,128.33
$63,148.33
$63,193.33
$63,148.33
$83,263.33
$103,333.33
$103,333.33
T(A)
$11,518.67
-$721.33
$7,678.67
$13,678.67
$17,950.67
$17,962.67
$17,950.67
$23,314.67
$28,666.67
$28,666.67
PW(A) =
T(B)
$15,611.33
-$2,748.67
$9,851.33
$18,851.33
$25,259.33
$25,277.33
$25,259.33
$33,305.33
$41,333.33
$41,333.33
PW(B) =
ATCF(A)
-$300,000.00
$60,148.00
$72,388.00
$63,988.00
$57,988.00
$53,716.00
$53,704.00
$53,716.00
$48,352.00
$43,000.00
$43,000.00
$50,790.36
ATCF(B)
-$450,000.00
$87,722.00
$106,082.00
$93,482.00
$84,482.00
$78,074.00
$78,056.00
$78,074.00
$70,028.00
$62,000.00
$62,000.00
$60,824.10
Example 10.8
In the previous example, suppose alternative A
qualifies as 3-yr property and alternative B
qualifies as 7-yr property. Based on a 40%
income tax rate and a 10% ATMARR, perform an
after-tax comparison of the two alternatives.
AT Analysis of Alternatives with Different Property Classes

EOY
0
1
2
3
4
5
6
7
8
9
10
EOY
0
1
2
3
4
5
6
7
8
9
10
BTCF(A)
DWO(A)
TI(A)
T(A)
ATCF(A)
-$300,000.00
-$300,000.00
$71,666.67
$99,990.00 -$28,323.33 -$11,329.33
$82,996.00
$71,666.67 $133,350.00 -$61,683.33 -$24,673.33
$96,340.00
$71,666.67
$44,430.00 $27,236.67 $10,894.67
$60,772.00
$71,666.67
$22,230.00 $49,436.67 $19,774.67
$51,892.00
$71,666.67
$0.00 $71,666.67 $28,666.67
$43,000.00
$71,666.67
$0.00 $71,666.67 $28,666.67
$43,000.00
$71,666.67
$0.00 $71,666.67 $28,666.67
$43,000.00
$71,666.67
$0.00 $71,666.67 $28,666.67
$43,000.00
$71,666.67
$0.00 $71,666.67 $28,666.67
$43,000.00
$71,666.67
$0.00 $71,666.67 $28,666.67
$43,000.00
PW(A) = $64,084.76
BTCF(B)
DWO(B)
TI(B)
T(B)
ATCF(B)
-$450,000.00
-$450,000.00
$103,333.33
$64,305.00 $39,028.33 $15,611.33
$87,722.00
$103,333.33 $110,205.00 -$6,871.67 -$2,748.67 $106,082.00
$103,333.33
$78,705.00 $24,628.33
$9,851.33
$93,482.00
$103,333.33
$56,205.00 $47,128.33 $18,851.33
$84,482.00
$103,333.33
$40,185.00 $63,148.33 $25,259.33
$78,074.00
$103,333.33
$40,140.00 $63,193.33 $25,277.33
$78,056.00
$103,333.33
$40,185.00 $63,148.33 $25,259.33
$78,074.00
$103,333.33
$20,070.00 $83,263.33 $33,305.33
$70,028.00
$103,333.33
$0.00 $103,333.33 $41,333.33
$62,000.00
$103,333.33
$0.00 $103,333.33 $41,333.33
$62,000.00
PW(B) = $60,824.10
Example 10.9
A distribution center is considering using a robot
to perform palletizing. The robot has an initial
cost of $125,000; its annual O&M cost is $500; it
qualifies as 3-yr property; and it has a $25,000
salvage value after 5 yrs. Alternatively, 2 people
can perform the palletizing at an annual cost of
$50,000. Using a 5-yr planning horizon, a 40% tax
rate, a 10% ATMARR, and an AW analysis, should
the robot be purchased?
AT Analysis of Robotic versus Manual Palletizing

Since labor cost can be expensed in the year in which it
occurs, the ATEUAC of manually palletizing is
$50,000(0.60) = $30,000
As shown below, the EUAC of robotic palletizing is
$19,840.63. Therefore, the robot is justified economically.
EOY
0
1
2
3
4
5
BTCF
-$125,000.00
-$500.00
-$500.00
-$500.00
-$500.00
$24,500.00
DWO
$41,662.50
$55,562.50
$18,512.50
$9,262.50
$0.00
TI
-$42,162.50 -$16,865.00
-$56,062.50 -$22,425.00
-$19,012.50 -$7,605.00
-$9,762.50 -$3,905.00
$24,500.00
$9,800.00
AW =
ATCF
-$125,000.00
$16,365.00
$21,925.00
$7,105.00
$3,405.00
$14,700.00
-$19,840.63
Example 10.10
Acme Brick is considering adding 5 lift trucks to its fleet. It
can either purchase or lease the trucks. If purchased, each
truck has a first cost of $18,000; annual O&M costs of
$3750; and a salvage value of $3000. Lift trucks qualify as
3-yr property.
If the lift trucks are leased, beginning-of-year payments of
$5900/truck, plus operating costs of $1800/truck, will be
incurred.
Using a 5-yr planning horizon, a 40% tax rate, a 10%
ATMARR, and an AW analysis, should the trucks be
purchased or leased?
AT Analysis of Purchasing versus Leasing Lift Trucks

EOY
BTCF(P)
0
-$90,000.00
1
-$18,750.00
2
-$18,750.00
3
-$18,750.00
4
-$18,750.00
5
-$3,750.00
PW(P) = -$140,045.81
EOY
BTCF(L)
0
-$29,500.00
1
-$38,500.00
2
-$38,500.00
3
-$38,500.00
4
-$38,500.00
5
-$9,000.00
PW(L) = -$132,783.18
DWO(P)
TI(P)
$29,997.00
$40,005.00
$13,329.00
$6,669.00
$0.00
-$48,747.00
-$58,755.00
-$32,079.00
-$25,419.00
-$3,750.00
DWO(L)
TI(L)
-$29,500.00
-$38,500.00
-$38,500.00
-$38,500.00
-$38,500.00
-$9,000.00
$0.00
$0.00
$0.00
$0.00
$0.00
Lease the lift trucks!

T(P)
-$19,498.80
-$23,502.00
-$12,831.60
-$10,167.60
-$1,500.00
PW(P) =
T(L)
-$11,800.00
-$15,400.00
-$15,400.00
-$15,400.00
-$15,400.00
-$3,600.00
PW(L) =
ATCF(P)
-$90,000.00
$748.80
$4,752.00
-$5,918.40
-$8,582.40
-$2,250.00
-$96,486.74
ATCF(L)
-$17,700.00
-$23,100.00
-$23,100.00
-$23,100.00
-$23,100.00
-$5,400.00
-$90,926.87
After-Tax Analysis
Borrowing Investment Capital
ATCF = BT&LCF(1 - itr) - LCF + itr(DWO + IPMT)

After-tax cash flow equals before-tax-and-loan cash flow times one minus
the income tax rate, less the loan cash flow, plus the product of the income
tax rate and the sum of the depreciation write-off and the interest payment
made on the loan.
TIn = BT&LCFn(incl Fn) - IPMTn DWOn - Bn

Taxable income in the year of property disposal equals before-tax-andloan cash flow in the year of property disposal, including salvage value
realized, less the interest payment made in the year of property disposal,
less depreciation write-off in the year of property disposal, less the book
value at the time of disposal.
Four Loan Repayment Plans

1. Pay interest each period, but make no
principal payment until the end of the
loan period
2. Make equal end-of-period principal
payments and pay interest each period
on the unpaid balance at the beginning
of the period
3. Make equal end-of-period payments
over the loan period
4. Make no payment until the end of the
loan period
Because interest can be deducted from taxable income, the

effective after-tax interest rate paid on borrowed funds is
ieff = i(1 - itr)
Similarly, ATMARR = BTMARR(1 itr)
With an interest rate of 12%, an income tax rate of 40%, and
an ATMARR of 10%, since the BTMARR = 0.10/0.60, or
16.667%, it costs less to borrow the money than to use
internal funds.
If the interest rate on the loan is greater than the BTMARR,
then one should borrow as little as possible and repay the
principal as quickly as possible. Likewise, if the interest rate
is less than the BTMARR, then one should borrow as much
as possible and delay repaying the principal as long as
possible.
Example 10.11
Now, we apply the four loan repayment methods to
the SMP investment. We assume $300,000 is
borrowed at 12% annual compound interest and
repaid in 10 yrs.
We will use a 10-yr planning horizon, a 40% tax
rate, a 10% ATMARR, and a PW analysis to
determine the preferred borrowing method.
2 roots: -18.62% and 41.54%

After-Tax Analysis of SMP Investment with $300,000 Borrowed & Repaid Using Method 2
EOY
0
1
2
3
4
5
6
7
8
9
10
income tax rate =

BT&LCF
PPMT
-$500,000.00 -$300,000.00
$124,166.67
$30,000.00
$124,166.67
$30,000.00
$124,166.67
$30,000.00
$124,166.67
$30,000.00
$124,166.67
$30,000.00
$124,166.67
$30,000.00
$124,166.67
$30,000.00
$124,166.67
$30,000.00
$124,166.67
$30,000.00
$174,166.67
$30,000.00
40%
IPMT
DWO
TI
$36,000.00 $100,000.00 -$11,833.33

$32,400.00 $160,000.00 -$68,233.33
$28,800.00 $96,000.00
-$633.33
$25,200.00 $57,600.00 $41,366.67
$21,600.00 $57,600.00 $44,966.67
$18,000.00 $28,800.00 $77,366.67
$14,400.00
$0.00 $109,766.67
$10,800.00
$0.00 $113,366.67
$7,200.00
$0.00 $116,966.67
$3,600.00
$0.00 $170,566.67
Tax
-$4,733.33
-$27,293.33
-$253.33
$16,546.67
$17,986.67
$30,946.67
$43,906.67
$45,346.67
$46,786.67
$68,226.67
PW AT =
ATCF
-$200,000.00
$62,900.00
$89,060.00
$65,620.00
$52,420.00
$54,580.00
$45,220.00
$35,860.00
$38,020.00
$40,180.00
$72,340.00
$156,374.28
FW AT = $405,594.61
AW AT =
$25,449.19
IRR AT =
28.51%
ERR AT =
16.54%
After-Tax Analysis of SMP Investment with $300,000 Borrowed & Repaid Using Method 3
MARR =
income tax rate =
EOY
BT&LCF
PPMT
0
-$500,000.00 -$300,000.00
1
$124,166.67 $17,095.25
2
$124,166.67 $19,146.68
3
$124,166.67 $21,444.28
4
$124,166.67 $24,017.59
5
$124,166.67 $26,899.71
6
$124,166.67 $30,127.67
7
$124,166.67 $33,742.99
8
$124,166.67 $37,792.15
9
$124,166.67 $42,327.21
10
$174,166.67 $47,406.47
10%
40%
IPMT
interest rate = 12%

DWO
TI
$36,000.00 $100,000.00 -$11,833.33

$33,948.57 $160,000.00 -$69,781.90
$31,650.97 $96,000.00
-$3,484.30
$29,077.65 $57,600.00 $37,489.02
$26,195.54 $57,600.00 $40,371.13
$22,967.58 $28,800.00 $72,399.09
$19,352.26
$0.00 $104,814.41
$15,303.10
$0.00 $108,863.57
$10,768.04
$0.00 $113,398.63
$5,688.78
$0.00 $168,477.89
Tax
-$4,733.33
-$27,912.76
-$1,393.72
$14,995.61
$16,148.45
$28,959.64
$41,925.76
$43,545.43
$45,359.45
$67,391.16
PW AT =
ATCF
-$200,000.00
$75,804.75
$98,984.18
$72,465.14
$56,075.81
$54,922.97
$42,111.78
$29,145.66
$27,525.99
$25,711.97
$53,680.26
$160,734.89
FW AT =
$416,904.92
AW AT =
$26,158.86
IRR AT =
31.65%
ERR AT =
16.68%
2 roots: -3.65% and 53.49%

ATPW maximized @
9.328% MARR
Method 1 is preferred
(Given the results, it is anticipated that
ATPW will increase with increased
borrowing. Lets see what happens if we
borrow 100% of the capital needed to
acquire the SMP machine and repay
using Method 1.)
SMP Investment
Measure
of Worth
PWAT
FWAT
AWAT
0% Debt*
Capitalizing
$123,988.64
$321,594.61
$20,178.58
60% Debt*
Capitalizing
$175,603.01
$455,468.98
$28,578.58
100% Debt*
Capitalizing
$210,012.58
$544,718.55
$34,178.58
* Financed at 12% annual compound interest rate, repaying loan

over a 10-year period using repayment method 1 (interest only loan)
How much can the interest rate increase and it still

be profitable to borrow money? We will find that it
depends on the repayment method used. With a
MARR of 10%, as long as the interest rate paid on
borrowed capital is less than 10%/(1 - 0.40), or
16.667%, there is a repayment method for which it
is economical to borrow investment capital.
Lets see what the effect is of borrowing $500,000
at an interest rate of 16.667%, using all four
repayment methods.
ATPW for a $500,000 Loan with an Interest Rate Equal to MARR/(1 itr).
MARR = 10%
income tax rate = 40%
BT&LCF
PPMT
IPMT
-$500,000.00 -$500,000.00
$124,166.67
$0.00
$83,333.33
$124,166.67
$0.00
$83,333.33
$124,166.67
$0.00
$83,333.33
$124,166.67
$0.00
$83,333.33
$124,166.67
$0.00
$83,333.33
$124,166.67
$0.00
$83,333.33
$124,166.67
$0.00
$83,333.33
$124,166.67
$0.00
$83,333.33
$124,166.67
$0.00
$83,333.33
$174,166.67 $500,000.00
$83,333.33
$100,000.00
$160,000.00
$96,000.00
$57,600.00
$57,600.00
$28,800.00
$0.00
$0.00
$0.00
$0.00
-$59,166.66
-$119,166.66
-$55,166.66
-$16,766.66
-$16,766.66
$12,033.34
$40,833.34
$40,833.34
$40,833.34
$90,833.34
-$23,666.67
-$47,666.67
-$22,066.67
-$6,706.67
-$6,706.67
$4,813.33
$16,333.33
$16,333.33
$16,333.33
$36,333.33
PW =
0
1
2
3
4
5
6
7
8
9
10
-$500,000.00 -$500,000.00
$124,166.67
$50,000.00
$124,166.67
$50,000.00
$124,166.67
$50,000.00
$124,166.67
$50,000.00
$124,166.67
$50,000.00
$124,166.67
$50,000.00
$124,166.67
$50,000.00
$124,166.67
$50,000.00
$124,166.67
$50,000.00
$174,166.67
$50,000.00
$83,333.33
$75,000.00
$66,666.67
$58,333.33
$50,000.00
$41,666.67
$33,333.33
$25,000.00
$16,666.67
$8,333.33
$100,000.00
$160,000.00
$96,000.00
$57,600.00
$57,600.00
$28,800.00
$0.00
$0.00
$0.00
$0.00
-$59,166.66
-$110,833.33
-$38,500.00
$8,233.34
$16,566.67
$53,700.00
$90,833.34
$99,166.67
$107,500.00
$165,833.34
-$23,666.67
-$44,333.33
-$15,400.00
$3,293.33
$6,626.67
$21,480.00
$36,333.33
$39,666.67
$43,000.00
$66,333.33
PW =
0
1
2
3
4
5
6
7
8
9
10
-$500,000.00 -$500,000.00
$124,166.67
$22,696.59
$124,166.67
$26,479.35
$124,166.67
$30,892.58
$124,166.67
$36,041.34
$124,166.67
$42,048.23
$124,166.67
$49,056.27
$124,166.67
$57,232.31
$124,166.67
$66,771.03
$124,166.67
$77,899.53
$174,166.67
$90,882.79
$83,333.33
$79,550.57
$75,137.34
$69,988.58
$63,981.69
$56,973.65
$48,797.61
$39,258.89
$28,130.39
$15,147.13
$100,000.00
$160,000.00
$96,000.00
$57,600.00
$57,600.00
$28,800.00
$0.00
$0.00
$0.00
$0.00
-$59,166.66
-$115,383.90
-$46,970.67
-$3,421.91
$2,584.98
$38,393.02
$75,369.06
$84,907.78
$96,036.28
$159,019.54
-$23,666.67
-$46,153.56
-$18,788.27
-$1,368.76
$1,033.99
$15,357.21
$30,147.62
$33,963.11
$38,414.51
$63,607.82
PW =
0
1
2
3
4
5
6
7
8
9
10
-$500,000.00 -$500,000.00
$124,166.67
$0.00
$124,166.67
$0.00
$124,166.67
$0.00
$124,166.67
$0.00
$124,166.67
$0.00
$124,166.67
$0.00
$124,166.67
$0.00
$124,166.67
$0.00
$124,166.67
$0.00
$174,166.67 $500,000.00
$0.00
$0.00
$0.00
$0.00
$0.00
$0.00
$0.00
$0.00
$0.00
$1,835,812.08
$100,000.00
$160,000.00
$96,000.00
$57,600.00
$57,600.00
$28,800.00
$0.00
$0.00
$0.00
$0.00
$24,166.67
-$35,833.33
$28,166.67
$66,566.67
$66,566.67
$95,366.67
$124,166.67
$124,166.67
$124,166.67
-$1,661,645.41
$9,666.67
-$14,333.33
$11,266.67
$26,626.67
$26,626.67
$38,146.67
$49,666.67
$49,666.67
$49,666.67
-$664,658.17
PW =
EOY
0
1
2
3
4
5
6
7
8
9
10
interest rate = 16.667%

DWO
TI
Tax
ATCF
$0.00
$64,500.00
$88,500.00
$62,900.00
$47,540.00
$47,540.00
$36,020.00
$24,500.00
$24,500.00
$24,500.00
-$445,500.00
$123,988.64
$0.00
$14,500.00
$43,500.00
$22,900.00
$12,540.00
$17,540.00
$11,020.00
$4,500.00
$9,500.00
$14,500.00
$49,500.00
$123,988.64
$0.00
$41,803.42
$64,290.31
$36,925.02
$19,505.52
$17,102.76
$2,779.54
-$12,010.87
-$15,826.36
-$20,277.76
$4,528.94
$123,988.64
$0.00
$114,500.00
$138,500.00
$112,900.00
$97,540.00
$97,540.00
$86,020.00
$74,500.00
$74,500.00
$74,500.00
-$1,496,987.25
$6,545.98
Notice, the after-tax present worth equals

$123,988.64 for Methods 1, 2, and 3, but $6,545.98
for Method 4. In fact, the ATPW for Methods 1, 2,
and 3 is identical to that obtained when no money
is borrowed (see Example 10.4). Hence, for interest
rates less than MARR/(1 - itr), it pays to borrow
money, as long as Method 1, 2, or 3 is used.
Example 10.12
A small business borrows $100,000 at 15%
compounded annually and repays the loan over a
5-yr period. Its income tax rate is 40%. If the
business has a 10% ATMARR, using an ATPW
analysis, which repayment method is preferred?
How does the preference change for various
interest rates?
After-Tax Analysis of Four Methods of Repaying a $100,000 Loan

EOY
0
1
2
3
4
5
PPMT
-$100,000.00
$0.00
$0.00
$0.00
$0.00
$100,000.00
IPMT
TI
$15,000.00
$15,000.00
$15,000.00
$15,000.00
$15,000.00
-$15,000.00
-$15,000.00
-$15,000.00
-$15,000.00
-$15,000.00
-$6,000.00
-$6,000.00
-$6,000.00
-$6,000.00
-$6,000.00
ATPW =
ATCF
$100,000.00
-$9,000.00
-$9,000.00
-$9,000.00
-$9,000.00
-$109,000.00
$3,790.79
0
1
2
3
4
5
-$100,000.00
$20,000.00
$20,000.00
$20,000.00
$20,000.00
$20,000.00
$15,000.00
$12,000.00
$9,000.00
$6,000.00
$3,000.00
-$15,000.00
-$12,000.00
-$9,000.00
-$6,000.00
-$3,000.00
-$6,000.00
-$4,800.00
-$3,600.00
-$2,400.00
-$1,200.00
ATPW =
$100,000.00
-$29,000.00
-$27,200.00
-$25,400.00
-$23,600.00
-$21,800.00
$2,418.43
0
1
2
3
4
5
$100,000.00
$14,831.56
$17,056.29
$19,614.73
$22,556.94
$25,940.48
$15,000.00
$12,775.27
$10,216.82
$7,274.61
$3,891.07
-$15,000.00
-$12,775.27
-$10,216.82
-$7,274.61
-$3,891.07
-$6,000.00
-$5,110.11
-$4,086.73
-$2,909.85
-$1,556.43
ATPW =
$100,000.00
-$23,831.56
-$24,721.45
-$25,744.83
-$26,921.71
-$28,275.13
$2,617.01
0
1
2
3
4
5
$100,000.00
$100,000.00
$0.00
$0.00
$0.00
$0.00
$0.00
$0.00
$0.00
$0.00
$0.00
$0.00
$0.00
$0.00
$0.00
$0.00
$0.00
$0.00
$0.00
$0.00
$0.00
$0.00
$100,000.00 $101,135.72 -$101,135.72 -$40,454.29 -$160,681.43
ATPW =
$229.47
$40,000
$30,000
ATMARR
= 10%
$20,000
$10,000
ATMARR /(1 - itr )

= 16.667%
$0
0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
10% 11% 12% 13% 14% 15% 16% 17% 18% 19% 20%
Method 4 is best
-$10,000
Method 1 is best
Interest Rate on Borrowed Capital
Method 2 is best
if borrowing is
required
-$20,000
Method 1
Method 2
Method 3
Method 4
ATPW for the $100,000 Loan for Each of Four Repayment Methods
Example 10.13
Recall Example 3.8, which involved choosing a mortgage for
a house purchase. Three alternative mortgages were
considered: 30-yr conventional; 30-yr ARM; and a 30-yr
balloon (interest only) loan. The ARM was eliminated due to
risk considerations.
If the professional couple is in a 33% income tax bracket
and their ATMARR is 6.5% per annum compounded monthly,
which mortgage is preferred?
ATPWballoon =PV(0.065/12,60,0.67*1848.48)
+PV(0.065/12,60,,350000*1.01753+7500)
= -$326,264.30
Month
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
BTLCF
-$2,338.87
-$2,338.87
-$2,338.87
-$2,338.87
-$2,338.87
-$2,338.87
-$2,338.87
-$2,338.87
-$2,338.87
-$2,338.87
-$2,338.87
-$2,338.87
-$2,338.87
-$2,338.87
-$2,338.87
-$2,338.87
-$2,338.87
-$2,338.87
-$2,338.87
-$2,338.87
-$2,338.87
-$2,338.87
-$2,338.87
-$2,338.87
-$2,338.87
-$2,338.87
-$2,338.87
-$2,338.87
-$2,338.87
-$2,338.87
IPMT
$2,039.04
$2,037.37
$2,035.69
$2,034.00
$2,032.29
$2,030.58
$2,028.86
$2,027.13
$2,025.39
$2,023.64
$2,021.88
$2,020.11
$2,018.33
$2,016.53
$2,014.73
$2,012.92
$2,011.09
$2,009.26
$2,007.41
$2,005.56
$2,003.69
$2,001.81
$1,999.93
$1,998.03
$1,996.12
$1,994.19
$1,992.26
$1,990.32
$1,988.36
$1,986.39
ATPW for the 30-Year Conventional Loan
TI
-$2,039.04
-$2,037.37
-$2,035.69
-$2,034.00
-$2,032.29
-$2,030.58
-$2,028.86
-$2,027.13
-$2,025.39
-$2,023.64
-$2,021.88
-$2,020.11
-$2,018.33
-$2,016.53
-$2,014.73
-$2,012.92
-$2,011.09
-$2,009.26
-$2,007.41
-$2,005.56
-$2,003.69
-$2,001.81
-$1,999.93
-$1,998.03
-$1,996.12
-$1,994.19
-$1,992.26
-$1,990.32
-$1,988.36
-$1,986.39
T
-$672.88
-$672.33
-$671.78
-$671.22
-$670.66
-$670.09
-$669.52
-$668.95
-$668.38
-$667.80
-$667.22
-$666.64
-$666.05
-$665.46
-$664.86
-$664.26
-$663.66
-$663.06
-$662.45
-$661.83
-$661.22
-$660.60
-$659.98
-$659.35
-$658.72
-$658.08
-$657.45
-$656.80
-$656.16
-$655.51
ATLCF
Month
BTLCF
-$1,665.98
31
-$2,338.87
-$1,666.54
32
-$2,338.87
-$1,667.09
33
-$2,338.87
-$1,667.65
34
-$2,338.87
-$1,668.21
35
-$2,338.87
-$1,668.77
36
-$2,338.87
-$1,669.34
37
-$2,338.87
-$1,669.91
38
-$2,338.87
-$1,670.49
39
-$2,338.87
-$1,671.07
40
-$2,338.87
-$1,671.65
41
-$2,338.87
-$1,672.23
42
-$2,338.87
-$1,672.82
43
-$2,338.87
-$1,673.41
44
-$2,338.87
-$1,674.01
45
-$2,338.87
-$1,674.60
46
-$2,338.87
-$1,675.21
47
-$2,338.87
-$1,675.81
48
-$2,338.87
-$1,676.42
49
-$2,338.87
-$1,677.03
50
-$2,338.87
-$1,677.65
51
-$2,338.87
-$1,678.27
52
-$2,338.87
-$1,678.89
53
-$2,338.87
-$1,679.52
54
-$2,338.87
-$1,680.15
55
-$2,338.87
-$1,680.78
56
-$2,338.87
-$1,681.42
57
-$2,338.87
-$1,682.06
58
-$2,338.87
-$1,682.71
59
-$2,338.87
-$1,683.36
60
-$333,258.00
BTPW = -$314,972.87
IPMT
$1,984.42
$1,982.43
$1,980.42
$1,978.41
$1,976.39
$1,974.35
$1,972.30
$1,970.24
$1,968.17
$1,966.08
$1,963.99
$1,961.88
$1,959.75
$1,957.62
$1,955.47
$1,953.32
$1,951.14
$1,948.96
$1,946.76
$1,944.55
$1,942.33
$1,940.10
$1,937.85
$1,935.59
$1,933.31
$1,931.02
$1,928.72
$1,926.41
$1,924.08
$1,921.74
TI
-$1,984.42
-$1,982.43
-$1,980.42
-$1,978.41
-$1,976.39
-$1,974.35
-$1,972.30
-$1,970.24
-$1,968.17
-$1,966.08
-$1,963.99
-$1,961.88
-$1,959.75
-$1,957.62
-$1,955.47
-$1,953.32
-$1,951.14
-$1,948.96
-$1,946.76
-$1,944.55
-$1,942.33
-$1,940.10
-$1,937.85
-$1,935.59
-$1,933.31
-$1,931.02
-$1,928.72
-$1,926.41
-$1,924.08
-$1,921.74
30-yr conventional loan is preferred; decision is reversed!

T
ATLCF
-$654.86
-$1,684.01
-$654.20
-$1,684.67
-$653.54
-$1,685.33
-$652.88
-$1,685.99
-$652.21
-$1,686.66
-$651.54
-$1,687.33
-$650.86
-$1,688.01
-$650.18
-$1,688.69
-$649.50
-$1,689.37
-$648.81
-$1,690.06
-$648.12
-$1,690.75
-$647.42
-$1,691.45
-$646.72
-$1,692.15
-$646.01
-$1,692.85
-$645.31
-$1,693.56
-$644.59
-$1,694.27
-$643.88
-$1,694.99
-$643.16
-$1,695.71
-$642.43
-$1,696.44
-$641.70
-$1,697.17
-$640.97
-$1,697.90
-$640.23
-$1,698.64
-$639.49
-$1,699.38
-$638.74
-$1,700.12
-$637.99
-$1,700.88
-$637.24
-$1,701.63
-$636.48
-$1,702.39
-$635.71
-$1,703.15
-$634.95
-$1,703.92
-$634.17 -$332,623.83
ATPW = -$325,333.87
How Much Money Should You Borrow?

The simple answer is no more than you can
repay.
Considering the four repayment methods,
except for Method 4, ATPW increases as the
percent of the investment capital borrowed
increases so long as the interest rate paid is
less than the ATMARR divided by one minus the
income tax rate.
Method 4 achieves a negative ATPW for interest
rates less than ATMARR/(1-itr), as the following
example illustrates.
Example
A company invests $100,000 and receives
$268,418.33 after 5 years. The ATMARR for the
business is 10%. The firm pays income taxes at a
marginal rate of 40%. If investment capital is
borrowed, an annual compound interest rate of 12%
must be paid.
Determine which repayment method is best if
a) $20,000 is borrowed?
b) $40,000 is borrowed?
c) $60,000 is borrowed?
d) $80,000 is borrowed?
e) $100,000 is borrowed?
Method
1
Method
2
Method
3
Method
4
EOY
0
1
2
3
4
5
ATMARR = 10%
income tax rate = 40%
BT&LCF
PPMT
IPMT
-$100,000.00
-$40,000.00
$0.00
$0.00
$4,800.00
$0.00
$0.00
$4,800.00
$0.00
$0.00
$4,800.00
$0.00
$0.00
$4,800.00
$268,418.33
$40,000.00
$4,800.00
EOY
0
1
2
3
4
5
IPMT
-$100,000.00
$0.00
$0.00
$0.00
$0.00
$268,418.33
PPMT
-$40,000.00
$8,000.00
$8,000.00
$8,000.00
$8,000.00
$8,000.00
EOY
0
1
2
3
4
5
IPMT
-$100,000.00
$0.00
$0.00
$0.00
$0.00
$268,418.33
PPMT
-$40,000.00
$6,296.39
$7,051.96
$7,898.19
$8,845.97
$9,907.49
EOY
0
1
2
3
4
10
PPMT
-$40,000.00
$0.00
$0.00
$0.00
$0.00
$40,000.00
IPMT
-$100,000.00
$0.00
$0.00
$0.00
$0.00
$268,418.33
$4,800.00
$3,840.00
$2,880.00
$1,920.00
$960.00
$4,800.00
$4,044.43
$3,198.20
$2,250.42
$1,188.90
$0.00
$0.00
$0.00
$0.00
$30,493.67
TI
-$4,800.00
-$4,800.00
-$4,800.00
-$4,800.00
$263,618.33
TI
-$4,800.00
-$3,840.00
-$2,880.00
-$1,920.00
$267,458.33
TI
-$4,800.00
-$4,044.43
-$3,198.20
-$2,250.42
$267,229.43
TI
$0.00
$0.00
$0.00
$0.00
$237,924.67
interest rate = 12%

% borrowed = 40%
Tax
ATCF
-$60,000.00
-$1,920.00
-$2,880.00
-$1,920.00
-$2,880.00
-$1,920.00
-$2,880.00
-$1,920.00
-$2,880.00
$105,447.33
$118,171.00
PW =
$4,245.68
Tax
ATCF
-$60,000.00
-$1,920.00
-$10,880.00
-$1,536.00
-$10,304.00
-$1,152.00
-$9,728.00
-$768.00
-$9,152.00
$106,983.33
$152,475.00
PW =
$2,708.64
Tax
ATCF
-$60,000.00
-$1,920.00
-$9,176.39
-$1,617.77
-$9,478.62
-$1,279.28
-$9,817.11
-$900.17
-$10,196.22
$106,891.77
$150,430.17
PW =
$2,889.66
Tax
ATCF
-$60,000.00
$0.00
$0.00
$0.00
$0.00
$0.00
$0.00
$0.00
$0.00
$95,169.87
$102,754.80
PW =
$3,802.65
Sensitivity of ATPW to % Capital Borrowed,

Interest Rate Paid & Payment Method

Interest Rate Paid & Payment Method
M4 ATPW = $0 with
15.07% interest rate

Interest Rate & Payment Method

M4 ATPW = $0 with
15.07% interest rate

In 1958, two Nobel-prize winning

economists, Franco Modigliani and Merton
Miller, published an investment theory that a
firm should focus on maximizing corporate
wealth and not worry about debt-to-equity
ratios. Their theorem stated that, under
certain conditions, the value of a firm is
unaffected by how the firm is financed. The
theorems basic premise is that corporate
wealth is maximized by minimizing income
taxes paid.
Main Message #3
It is profitable to borrow
investment capital as
long as the interest rate
is less than the ATMARR
divided by one minus the
income tax rate.
Additional Tax Considerations

Investment Tax Credit
Investment Tax Credit

Comes and goes; began in 1962
Repealed in 1985 when max tax rate
was decreased from 46% to 34%
If ITC returns, will probably vary
somewhat from our example
Last version: 10% tax credit in Yr 1;
reduce cost basis 5%
Example 10.14
For the SMP machine, suppose a 10% investment
tax credit is available. The cost basis is reduced
by 5%; hence, the cost basis is $475,000. What are
the measures of economic worth, given the 10%
investment tax credit and using a 10% ATMARR?
Applying the Investment Tax Credit to the SMP Investment

EOY
0
1
2
3
4
5
6
7
8
9
10
BTCF
DWO
TI
T
ITC
ATCF
-$500,000.00
-$500,000.00
$124,166.67 $95,000.00 $29,166.67 $11,666.67 $50,000.00 $162,500.00
$124,166.67 $152,000.00 -$27,833.33 -$11,133.33
$0.00 $135,300.00
$124,166.67 $91,200.00 $32,966.67 $13,186.67
$0.00 $110,980.00
$124,166.67 $54,720.00 $69,446.67 $27,778.67
$0.00
$96,388.00
$124,166.67 $54,720.00 $69,446.67 $27,778.67
$0.00
$96,388.00
$124,166.67 $27,360.00 $96,806.67 $38,722.67
$0.00
$85,444.00
$124,166.67
$0.00 $124,166.67 $49,666.67
$0.00
$74,500.00
$124,166.67
$0.00 $124,166.67 $49,666.67
$0.00
$74,500.00
$124,166.67
$0.00 $124,166.67 $49,666.67
$0.00
$74,500.00
$174,166.67
$0.00 $174,166.67 $69,666.67
$0.00 $104,500.00
PW = $161,710.59
FW = $419,435.61
AW = $26,317.65
=0.95*500000*0.32
IRR =
18.39%
ERR =
13.13%
Additional Tax Considerations

Section 179 Expense Deduction

Designed for small businesses, Section
179 expense deduction allows taxpayers to
elect, in the year certain tangible property
is placed in service, to treat the cost as an
expense rather than a capital expenditure.
Up to $250,000 can be deducted; the
balance becomes the cost basis for
depreciation. (The amount deducted is
reduced by the amount the aggregate cost
of qualifying property exceeds $800,000.)

Let $K
D179
= aggregate cost of qualifying property

= Section 179 expense deduction
If $K < $250,000, then D179 = $K

If $250,000 < $K < $800,000, then D179 = $250,000
If $800,000 < $K < $1,050,000, then D179 = $1,050,000 - $K
Example
If $K = a) $200,000, b) $500,000, c) $850,000, d) $1,200,000,
then D179 = a) $200,000, b) $250,000, c) $200,000, d) $0
Example 10.15
Assume two $500,000 SMP machines are the only
assets purchased and placed in service during the
tax year. Since the $1,000,000 investment exceeds
the $800,000 cap, the cost basis is reduced by
$1,050,000 - $1,000,000, or $50,000. What are the
measures of economic worth, given the Section
179 expense deduction?
Applying the Section 179 Expense Deduction to the SMP Investment

BTCF
-$1,000,000.00
$248,333.34
$248,333.34
$248,333.34
$248,333.34
$248,333.34
$248,333.34
$248,333.34
$248,333.34
$248,333.34
$298,333.34
Section 179
Deduction
$50,000.00
$0.00
$0.00
$0.00
$0.00
$0.00
$0.00
$0.00
$0.00
$0.00
DWO
TI
$190,000.00
$304,000.00
$182,400.00
$109,440.00
$109,440.00
$54,720.00
$0.00
$0.00
$0.00
$0.00
$8,333.34
$3,333.34
-$55,666.66 -$22,266.66
$65,933.34 $26,373.34
$138,893.34 $55,557.34
$138,893.34 $55,557.34
$193,613.34 $77,445.34
$248,333.34 $99,333.34
$248,333.34 $99,333.34
$248,333.34 $99,333.34
$298,333.34 $119,333.34
PW =
FW =
AW =
=(1000000-50000)*0.32
IRR =
ERR =
ATCF
-$1,000,000.00
$245,000.00
$270,600.00
$221,960.00
$192,776.00
$192,776.00
$170,888.00
$149,000.00
$149,000.00
$149,000.00
$179,000.00
$239,127.60
$620,235.41
$38,916.92
16.02%
12.38%
Reminder!
When using MACRS-GDS for property
years that include a half-year*
depreciation the first year and a halfyear depreciation the last year, we
assume a half-year depreciation charge
occurs regardless of when, during the
year, the acquisition or disposal of the
asset occurs
* The same principle applies when using property classes with a midmonth convention
Timing of the1st Year DWO

In general, the engineering economy
literature assumes the investment occurs at
the end of year zero and the first
depreciation charge is taken during the first
year, or at the end of year one.
In practice, companies typically take the first
years depreciation charge in the year in
which the investment is made.
The following example illustrates the impact
of delaying the depreciation charge one year
Example 10.16
Recall the two design alternatives for The Scream
Machine considered previously. Now, we perform
an after-tax analysis, based on: design A having
an initial investment of $300,000 and producing
before-tax net annual revenue of $71,666.67; and
design B having an initial investment of $450,000
and producing before-tax net annual revenue of
$103,333.33. Based on a 40% income tax rate, a
10% ATMARR, and 7-yr MACRS depreciation,
perform an after-tax comparison of the two
alternatives when the first year DWO occurs at the
end of zero.
EOY
0
1
2
3
4
5
6
7
8
9
10
BTCF(A)
-$300,000.00
$71,666.67
$71,666.67
$71,666.67
$71,666.67
$71,666.67
$71,666.67
$71,666.67
$71,666.67
$71,666.67
$71,666.67
DWO(A)
$42,870.00
$73,470.00
$52,470.00
$37,470.00
$26,790.00
$26,760.00
$26,790.00
$13,380.00
$0.00
$0.00
$0.00
TI(A)
-$42,870.00
-$1,803.33
$19,196.67
$34,196.67
$44,876.67
$44,906.67
$44,876.67
$58,286.67
$71,666.67
$71,666.67
$71,666.67
EOY
0
1
2
3
4
5
6
7
8
9
10
BTCF(B)
-$450,000.00
$103,333.33
$103,333.33
$103,333.33
$103,333.33
$103,333.33
$103,333.33
$103,333.33
$103,333.33
$103,333.33
$103,333.33
DWO(B)
$64,305.00
$110,205.00
$78,705.00
$56,205.00
$40,185.00
$40,140.00
$40,185.00
$20,070.00
$0.00
$0.00
$0.00
TI(B)
-$64,305.00
-$6,871.67
$24,628.33
$47,128.33
$63,148.33
$63,193.33
$63,148.33
$83,263.33
$103,333.33
$103,333.33
$103,333.33
T(A)
ATCF(A)
-$17,148.00 -$282,852.00
-$721.33
$72,388.00
$7,678.67
$63,988.00
$13,678.67
$57,988.00
$17,950.67
$53,716.00
$17,962.67
$53,704.00
$17,950.67
$53,716.00
$23,314.67
$48,352.00
$28,666.67
$43,000.00
$28,666.67
$43,000.00
$28,666.67
$43,000.00
$59,447.76
PW(A) =
T(B)
ATCF(B)
-$25,722.00 -$424,278.00
-$2,748.67 $106,082.00
$9,851.33
$93,482.00
$18,851.33
$84,482.00
$25,259.33
$78,074.00
$25,277.33
$78,056.00
$25,259.33
$78,074.00
$33,305.33
$70,028.00
$41,333.33
$62,000.00
$41,333.33
$62,000.00
$41,333.33
$62,000.00
$73,810.19
PW(B) =
Recall, with 1st DWO @ EOY = 1, ATPW(A) = $37,951.10 and ATPW(B) = $41,565.37,
a $3614.18 incremental difference. Here, with 1st DWO @ EOY = 0, ATPW(A) =
$59,447.76 and ATPW(B) = $73,810.19, a $14,362.43 incremental difference.
What We Learned in Chapter 10

1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
Income tax rates and regulations change rapidly

The definitions of effective income tax rate, incremental income tax rate, and marginal income tax rate
Marginal income tax rates should be used in performing engineering economic analyses
Consult an expert in income taxes if income taxes will play a major role in determining the economic
viability of an investment
Straight-line depreciation is the most commonly used depreciation method in financial reporting
The modified accelerated cost recovery system (MACRS) is the depreciation method allowed by the U.S.
Internal Revenue Service in performing income tax calculations
If an investment can be expensed, the after-tax cost equals the product of the investment and one minus
the income tax rate
If borrowed capital is used to fund an investment, each dollar of interest paid costs 60 cents after-taxes if
the income tax rate is 40%
Every dollar of depreciation increases ATCF by the product of the income tax rate and the depreciation
allowance (see Equation 10.4.)
When borrowing investment capital at interest rates less than the minimum attractive rate of return, delay
repaying principal and interest as long as possible, i.e., use Method 4
When borrowing investment capital at an interest rate greater than the minimum attractive rate of return,
but less than the minimum attractive rate of return divided by one minus the income tax rate, delay paying
principal as long as possible, i.e., use Method 1
When the interest rate is greater than the minimum attractive rate of return divided by one minus the
income tax rate, avoid borrowing investment capital; if borrowed capital is required, then repay as much of
the principal as possible as quickly as possible, i.e., Method 2
Income tax considerations can change the recommendation regarding the investment to be made
Research has shown that a firms cost of capital is not significantly influenced by its debt-to-equity ratio
and
Nobel Prizes in economics were awarded to two researchers who developed a theorem to the effect that
corporate wealth is maximized by minimizing income taxes paid
Pit Stop #10Its Been A Taxing Experience

1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
True or False: If an investment cannot be justified economically using a

before-tax analysis, it cannot be justified using an after-tax analysis.
True or False: After-tax present worth will be greater when using MACRS
than it will be when using SLN.
True or False: The faster an asset is depreciated, the greater will be its aftertax present worth.
True or False: If money can be borrowed for 20% compounded annually and
the marginal income tax rate is 40%, then it will be profitable to borrow the
investment capital if your after-tax MARR is greater than 12%.
True or False: If the same amount of money is invested in something that
can be expensed as in something that must be depreciated (and both
provide the same annual returns) then, to maximize after-tax present worth,
you should choose the investment that can be depreciated.
True or False: If investment capital is borrowed, the income tax rate equals
40%, the after-tax MARR is 12%, and the loan rate is 15%, then it is best to
repay the loan using Method 1.
True or False: The investment tax credit is not in force, currently.
True or False: Section 179 Expense Reduction is not in force, currently.
Pit Stop #10Its Been A Taxing Experience

1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
True or False: If an investment cannot be justified economically using a

before-tax analysis, it cannot be justified using an after-tax analysis. False
True or False: After-tax present worth will be greater when using MACRS
than it will be when using SLN. True
True or False: The faster an asset is depreciated, the greater will be its aftertax present worth. True
True or False: If money can be borrowed for 20% compounded annually and
the marginal income tax rate is 40%, then it will be profitable to borrow the
investment capital if your after-tax MARR is greater than 12%. True
True or False: If the same amount of money is invested in something that
can be expensed as in something that must be depreciated (and both
provide the same annual returns) then, to maximize after-tax present worth,
you should choose the investment that can be depreciated. False
repay the loan using Method 1. True
True or False: The investment tax credit is not in force, currently. True
True or False: Section 179 Expense Reduction is not in force, currently.
False

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Principles of Engineering Economic Analysis, 5th edition

Corporate Income Tax Rates for Tax Years

Principles of Engineering Economic Analysis, 5th edition

Selama hukum pajak penghasilan

Principles of Engineering Economic Analysis, 5th edition

Principles of Engineering Economic Analysis, 5th edition

Contoh 10.1 (Lanjutan)

effective tax rate = income tax

Principles of Engineering Economic Analysis, 5th edition

Fiscal Year 2007 Effective Tax Rates

J.B. Hunt Transport Services

Principles of Engineering Economic Analysis, 5th edition

Principles of Engineering Economic Analysis, 5th edition

Principles of Engineering Economic Analysis, 5th edition

Principles of Engineering Economic Analysis, 5th edition

before-tax cash flow

Principles of Engineering Economic Analysis, 5th edition

ATCF = BTCF(1 - itr) + itr(DWO)

Principles of Engineering Economic Analysis, 5th edition

Principles of Engineering Economic Analysis, 5th edition

BT & AT Analysis of the SMP Investment with SLN

Principles of Engineering Economic Analysis, 5th edition

Principles of Engineering Economic Analysis, 5th edition

AT Analysis of the SMP Investment with MACRS

Principles of Engineering Economic Analysis, 5th edition

Principles of Engineering Economic Analysis, 5th edition

Principles of Engineering Economic Analysis, 5th edition

TIn = BTCFn(incl Fn) - DWOn - Bn

Principles of Engineering Economic Analysis, 5th edition

AT Analysis of the SMP Investment with DDB

$100,000.00 $24,166.67 $9,666.67

Principles of Engineering Economic Analysis, 5th edition

Principles of Engineering Economic Analysis, 5th edition

AT Analysis of a $500,000 Investment in a Consultant

Principles of Engineering Economic Analysis, 5th edition

Principles of Engineering Economic Analysis, 5th edition

Principles of Engineering Economic Analysis, 5th edition

Principles of Engineering Economic Analysis, 5th edition

AT Analysis of the Scream Machine Design Alternatives

Principles of Engineering Economic Analysis, 5th edition

Principles of Engineering Economic Analysis, 5th edition

AT Analysis of Alternatives with Different Property Classes

Principles of Engineering Economic Analysis, 5th edition

Principles of Engineering Economic Analysis, 5th edition

AT Analysis of Robotic versus Manual Palletizing

Principles of Engineering Economic Analysis, 5th edition

AT Analysis of Purchasing versus Leasing Lift Trucks

Lease the lift trucks!

Principles of Engineering Economic Analysis, 5th edition

ATCF = BT&LCF(1 - itr) - LCF + itr(DWO + IPMT)

Principles of Engineering Economic Analysis, 5th edition

TIn = BT&LCFn(incl Fn) - IPMTn DWOn - Bn

Principles of Engineering Economic Analysis, 5th edition

Four Loan Repayment Plans

Because interest can be deducted from taxable income, the

Principles of Engineering Economic Analysis, 5th edition

2 roots: -18.62% and 41.54%

income tax rate =

$36,000.00 $100,000.00 -$11,833.33

Principles of Engineering Economic Analysis, 5th edition