Present Worth of After Tax Cash Flows of an Investment - Engineering Economics Lightboard

[@pksd9909]

Thank you for this amazing video, it is really a big help in my preparation for my final exam for this course but I have a small question. If annual savings were instead annual costs in the question, will it still be taxed? even if it is costs and not savings? Would really appreciate your answer. Thanks

[@EngineeringEconomicsGuy]

Excellent question! Surprisingly, even if the annual savings are a 'cost' - i.e. a negative number (a 'net' down arrow on the cash flow diagram), you still multiply them by (1-t) to convert them to an after-tax cash flow. This makes no sense if you view the project in "isolation"! However, two assumptions justify this: 1) the company has 'many' projects, and 2) overall the company is profitable (i.e.-the company will need to pay tax). Hope this clarifies! Thanks for watching, and thanks for the nice comment! Good luck with your exam!!

[@elmerbadillo9666]

Good video. I have to solve this example : FrostCo is considering the purchase of a robotic icemaker. It costs $95,000 and saves $40,000 per year. FrostCo’s after tax MARR is 12% annual compounded annually. Assume the device will be sold for $3500 salvage value at the end of its 6 year life. Assume the ice maker falls under CCA Class 8. The corporate income tax rate is 54%. Calculate the after tax present worth of the ice maker. It's possible some help?

[@EngineeringEconomicsGuy]

The best way to solve the problem is with the CTF and CSF (Capital Tax Factor and Capital Salvage Factor). I solve a nearly identical problem in this video: kzbin.info/www/bejne/rKOlq5iCqpaCbbM This video will give you step-by-step instructions. Sorry for the delayed response!!

[@elmerbadillo9666]

That was awesome help. Thank you so much. By the way do you have any approximate after tax IRR and exact after IRR examples? @@EngineeringEconomicsGuy

[@EngineeringEconomicsGuy]

Sorry, I didn't see your reply until now! I don't have any videos on approximate or exact after-tax IRR, although I know exactly what you are asking. I should probably make videos on these topics. Any tax videos I have are in my 'Tax' Playlist on my main channel page. kzbin.info/aero/PLcfz9wmNxKqh9l2vzJIOcr8qHW_IAm2QA have a look. Maybe this will help with your question: If determining the after-tax cash flows is difficult, you can find the IRR using the before-tax cash flows and then multiply the IRR by (1-t)... this is the 'approximate' after-tax IRR. The good thing about the 'approximate' after-tax IRR is that it gives you a number that is almost always a 'conservative' estimate - meaning, the exact after-tax IRR will be a bit higher! The actual 'exact' after-tax IRR is just the IRR calculated when using all after-tax cash flows. This is a long complicated explanation - I hope it makes sense! Good luck!

[@praveenmahajan8304]

Hello sir, I want to know why the salvage value are not taken in to account while calculating the depreciation expenses. Depreciation expenses =(First cost-salvage value)/no. of year

[@EngineeringEconomicsGuy]

Good question. For the purpose of this example I stated that I was making the assumption that the salvage value was zero when I calculated the yearly depreciation expense. Then I treated the salvage value as a discrete cash flow 'on its own'. In the video, I think I said something like, let's pretend we're in a world that works this way. For a PROPER treatment of this topic, look at my videos on Capital Tax Factor and Capital Salvage Factor. Your question is a good question.

[@praveenmahajan8304]

But sir I think, salvage value is needs to be undertaken while calculating depreciation. Since the depreciation leads to increase the positive cash flow. By considering the salvage value, the same amount will not increase the cash flow. Salvage value is nothing but the remaining book value at the end of life of good

[@praveenmahajan8304]

Thanks sir, I understand one thing. If we include the salvage value in depreciation equation, then no needs to tax rate reduction in salvage value. Otherwise if we don't include the salvage value in depreciation then we need to calculate after tax salvage value. Your approach is second one. Thanks sir

[@EngineeringEconomicsGuy]

So... what is shown in this video, AND what you are saying about using the salvage value in the depreciation calculation is for 'academic purposes' ONLY. It is not how the real world works! Think of it this way: How do you know what the salvage value will be - it is an unknown future value - what do you use as your depreciation expense in each year? I would encourage you to visit my main KZbin Channel page and click on the 'Tax' playlist. There are more videos there.

[@lakshmisravanthi4303]

Very useful thank you

[@EngineeringEconomicsGuy]

You're very welcome! Thanks for watching!

[@sydfarrukh]

Why you didnt consider salvage value for calculating Straight line Depreciation?

[@EngineeringEconomicsGuy]

Excellent question. The problem assumes the asset will have a 5-year 'life' so I assumed its value would be zero at the end of 5-years. You need to assume something otherwise straight line depreciation can't be applied. The actual salvage value is treated like a kind of 'bonus' cash flow at the end of the 5-years. In the real world, you would need to 'give back' $5000 of depreciation expense on your income statement for that year to acknowledge the fact that you claimed too much depreciation. Please treat the example as fictitious! It is just trying to illustrate how to treat after-tax cash flows...but your question is a good one. Have a look at some of my other videos on after-tax calculations. Thanks for watching!

[@gordonhenderson149]

Isn't the salvage value incorporated into the PW fc

[@EngineeringEconomicsGuy]

Good question. I've simplified things in this example. I separated the PWfc, PWannuity, and PWsalvage into 3 separate items. I used Straight-Line depreciation assuming a salvage value of zero at the end of year 5 - then I treated the actual cash received for the salvage as a kind-of bonus cash flow at t=5. This video is meant to introduce the concept of the present worth of future tax savings as a result of depreciation, and this is most easily done in a SL Depreciation example. In 'real-life' we would use a method such as: kzbin.info/www/bejne/rKOlq5iCqpaCbbM Hope this helps.

[@hasanfahad5292]

Is savings equal to positive cash flow?

[@EngineeringEconomicsGuy]

Yes, please consider a "savings" as a positive cash flow. Sometimes the hardest part of Engineering Economics is the language; not the math!

[@dogansahutoglu2073]

why did not you multiplywith (1-t) when calculated after tax-first cost?

[@EngineeringEconomicsGuy]

The first cost is a 'capital expense' it does not directly affect the income statement (tax) in the year of purchase. The depreciation amounts DO affect the income statement (as expenses) for all years the asset is owned.

[@EngineeringEconomicsGuy]

Good question!

[@dogansahutoglu2073]

@@EngineeringEconomicsGuy I appreciate it. Thanks, I was watching same video again and about to ask same question:)

[@stefansenic8472]

Hey, I have a similar task on my assignment. I have 6 years period and the depreciation period is given to be just for the first 3 years. How can I simply calculate that using your method of formulas? Regards

[@EngineeringEconomicsGuy]

I'm not sure exactly what your question intends. If the depreciation only happens over the first 3 years it is difficult to find a simple way to do the calculations. My suggestion would be to set it up in a spreadsheet! Look at each year's income statement as an individual column.

[@stefansenic8472]

@@EngineeringEconomicsGuy Yes, the depreciation was given just for the first 3 years.. Then I will make this spreadsheet and then hopefully manage to find PW. But in general, if depreciation is given for all periods then your method is good to use, right?

[@EngineeringEconomicsGuy]

It should be...

[@genaroamion2387]

what is you use DB method? what would happen?

[@genaroamion2387]

what if*

[@EngineeringEconomicsGuy]

For declining balance depreciation have a look at this video: kzbin.info/www/bejne/imfZdGeKmNSCpsk AND, you might also find the concept of the 'Capital Tax Factor' useful - it is a derived formula that takes the declining balance depreciation into account: kzbin.info/www/bejne/rKOlq5iCqpaCbbM