Taxation

Taxation

 Income tax
 Value added Tax(VAT)
 Excise Tax …..(What do u think of the current situation?)
 Turnover Tax
 Taxation
 Gross income (GI):- is the total income realized from all
revenue
 Income tax:- is the amount of taxes based on some form of
income or profit that must be delivered to a federal (or lower-
level) government agency.
 Operating expenses E :- include all corporate costs
incurred in the transaction of business.
 Taxable income (TI) :- is the amount upon which taxes are
 Taxation
 Tax rate T :- is a percentage, or decimal equivalent, of TI
owed in taxes.
Taxes = (taxable income) X (applicable tax rate)
= (TI)(T )
 Net profit after taxes (NPAT):- is the amount remaining
each year when income taxes are subtracted from taxable
income.
NPAT = taxable income - taxes = TI - (TI)(D
= (TI)(l - T)
Income tax
Income tax
Income tax
 Income tax

..\tax\Federal Income Tax Proc. 979-2008

-english.pdf
Depreciation
 Objective
 Understand and use the basic terminology of depreciation
 Apply the straight line model of depreciation.
 Apply the declining balance and double declining balance
models of depreciation .
 Apply the unit production method of depreciation.
 Apply the sum year digit method.

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 Terminology
 Depreciation :- decrease in an asset's value because of
age, wear, and obsolescence.
 Book depreciation:- Intended for Financial report such
as balance sheet, income statement.
 Tax depreciation :- intended for internal revenue service
for the purpose of calculating taxes.
 First cost or unadjusted basis:- is the delivered and
installed cost of the asset.
 Book value : - represents the remaining, undepreciated
capital investment on the books after the total amount of
depreciation charges to date have been subtracted from
the basis.
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 Terminology
 Recovery period :- is the depreciable life n of the asset
in years.
 Market value:- is the estimated amount realizable if the
asset were sold on the open market.
 Salvage value :- is the estimated trade-in or market
value at the end of the asset's useful life.
 Depreciation rate or recovery rate:- is the fraction of
the first cost removed by depreciation each year.
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 Objective of Depreciation

 To calculate proper profits

 To show the asset at its reasonable value
 To maintain the original monetary investment of the asset
intact.
 To provide for replacement of an asset.
 Depreciation is permitted to be deducted from profits for
tax purposes

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 Depreciation

 Depreciation is a book method (noncash)

 Decreasing value of the asset to the owner

 Represent the diminishing value (amount) of the capital

funds invested in it.

 The annual depreciation amount is not an actual cash flow

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 Types of depreciation

 In order to calculate depreciation by any depreciation method,

Estimates of three impotent items are required
1) Estimate the purchasing price or cost when new.
2) Estimate the economical life
3) Estimate the resale or salvage value.

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 Types of depreciation
 Consider a machine purchased for $10,000 with an
estimated life of five years and estimated salvage value of
$2.000.
 Charge $8,000 over the five year period of time

 How to Charge :-…………..Type of depreciation

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 Type of depreciation
There are different type of depreciation that can be used to
calculate the periodic depreciation allowance in financial
reporting.
1. Straight line method(SL)
2. The decline balance method
3. The unit of production method
4. Sum of year digit method

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 Straight line method (SL)
 Asset provides an equal amount of service in each year of
its useful life.
 The depreciation rate is 1/N, where N is the depreciable life.
 For book depreciation purpose.

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 Example
Consider the following data on an automobile:
 Cost basis of the asset (I) = $10.000;
 Useful life (N) = 5 years:
 Estimated salvage value (S) = $2,000.

Compute the annual depreciation allowances and the resulting

book values, using the straight-line depreciation method.

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 Solution
Given: B = $10,000, S = $2.000, and N = 5 years.
Find: D, and BV, for n = 1 to 5.
The straight-line depreciation rate is 1/5. or 20%. Therefore.
the annual depreciation charge is
D, = (0.20)($10,000 - $2,000) = $1.600.
Then the book values during its useful life?
BV = B - (D1+ D2 + D3+ .+ D, )

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 Declining Balance method (DL)
 The annual depreciation is determined by multiplying the
book value at the beginning of a year by a fixed (uniform)
percentage d, expressed in decimal form.
 Therefore, the depreciation amount decreases each year.
 The maximum annual depreciation rate for the DB method
is twice the straight line rate, that is,

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 Declining Balance method (DL)
 The depreciation for year t is the fixed rate d times the
book value at the end of the previous year.

 The actual depreciation rate for each year t, relative to

the first cost B, is

 If BV is not known, the depreciation in year t can be

calculated using B and d,

 Book value in year t

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Declining Balance method (DL)
 The book value for the DB method never goes to zero,

 If the fixed percentage d is not stated,

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Declining Balance method (DL)
 The book value for the DB method never goes to zero,

 If the fixed percentage d is not stated,

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25
Example
 A fiber optics testing device is to be DDB
depreciated. It has a first cost of $25,000 and an
estimated salvage of $2500 after 12 years.
(a) Calculate the depreciation and book value for years 1
and 4. Write the Excel functions to display depreciation
for years 1 and4.
(b) Calculate the implied salvage value after 12 years.

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Example
 A fiber optics testing device is to be DDB
depreciated. It has a first cost of $25,000 and an
estimated salvage of $2500 after 12 years.
(a) Calculate the depreciation and book value for years 1
and 4. Write the Excel functions to display depreciation
for years 1 and4.
(b) Calculate the implied salvage value after 12 years.

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Unit of production method
 The cost of each service unit is the net cost of the asset
divided by the total number of such units.

 The depreciation charge for a period is then related to the

number of service units consumed in that period.
 Advantages of using this method include the fact that
depreciation varies with production volume. and therefore
the method gives a more accurate picture of machine
usage. 28
Unit of production method
 A disadvantage of the units-of-production method is that
the collection of data on machine use and the accounting
methods are somewhat tedious.
 This method can be useful for depreciating equipment
used to exploit natural resources.

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 Example
 A truck for hauling coal has an estimated net cost of $55,000
and is expected to give service for 250,000 miles, resulting in
a $5,000 salvage value. Compute the allowed depreciation
amount for truck usage of 30,000 miles.
Given: I = $55,000, S = $5,000, total service units = 250,000
miles, and usage for this year = 30,000 miles.
Find: Depreciation amount in this year.

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 MACRS Recovery Periods
 Modified Accelerated Cost Recovery System

Reading Assignment.

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 Sum of year digit method
 Multiplying the basis of the asset, less any salvage value,
by the ratio of the number of years remaining in the
recovery period to the sum of the year's digits SUM.

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 Sum of year digit method

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 Example
 A manufacturing company has new equipment with a first

cost of 12,000 euro, an estimated salvage value of 2000

euro, and a recovery period of 8 years. Use the SYD method

to tabulate annual depreciation and book value.

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Example
 Freeport-McMoRan Mining Company has purchased a
computer-controlled gold ore grading unit for $80,000.
The unit has an anticipated life of 10 years and a salvage
value of $10,000. Use the SL,DB,DDB and SYD methods
to compare the schedule of depreciation and book values
for each year. Solve by hand and by computer.

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Replacement analysis and
Sensitivity Analysis

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 Basics of The Replacement
The need for a replacement study can develop from several sources:
 Reduced performance
 Increased costs of operation, higher scrap and rework costs, lost sales, reduced quality,
diminished safety, and larger maintenance expenses.

 Altered requirements.
 New requirements of accuracy, speed, or other specifications

 Obsolescence.
 International competition and rapidly changing technology

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 Terminology
 Defender and challenger
 The defender is the currently installed asset, and the challenger is the
potential
 Economic service life (ESL)
 The number of years at which the lowest AW of cost occurs.
 Defender first cost
 initial investment, current market value (MV)
 Challenger first cost
 is the amount of capital that must be recovered (amortized) when replacing a
defender with a challenger. This amount is almost always equal to P, the first
cost of the challenger.

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 Sunk cost refers to money that has already been spent; no
present action can recover it.
Terminology
 A sunk cost:- are capital losses and cannot be recovered in a
replacement study

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 Economic Service Life
 Until now the estimated life n of an alternative or asset has been stated.
 In reality, the best life estimate to use in the economic analysis is not
known initially.

The economic service life (ESL) is the number of years n at

which the equivalent uniform annual worth (AW) of costs is
the minimum, considering the most current cost estimates
over all possible years that the asset may provide a needed
service.
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 Economic Service Life
 The ESL is determined by calculating the total A W of costs if the asset is
in service 1 year, 2 years, 3 years, and so on, up to the last year.

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Economic Service Life

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Economic Service Life

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Economic Service Life

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 Example
 Consider a new electric forklift truck that would cost
$18,000, have operating costs of $1,000 in the first year,
and have a salvage value of $10,000 at the end of the first
year. For the remaining years, operating costs increase each
year by 15% over the previous year's operating costs.
Similarly, the salvage value declines each year by 25% from
the previous year's salvage value. The truck has a maximum
life of seven years. Overhauls costing $3,000 and $4,500 will
be required during the fifth and seventh year of service,
respectively. The firm's required rate of return is 15%. Find
the economic service life of this new machine. 45
Performing A Replacement Study

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 Performing A Replacement Study(Example)
 Purchasing cost two years ago $20,000 with a five-year life and a salvage
value of $5,000. Operating cost 1st year was $ 5000 and now $ 8,000. The
anticipated salvage value has now been reduced to $2,500. The current
market value is $10,000
 Option :- to purchase another machine for $15.000. Over its three-year
useful life, the machine will reduce labor and raw-materials usage
sufficiently to cut operating costs from $8,000 to $6,000.This reduction in
costs will allow after-tax profits to rise by $2.000 per year. It is estimated
that the new machine can be sold for $5,500 at the end of year three.
 Assuming that the firm's interest rate is 12%, decide whether replacement
is justified now.

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 Solution(Cash flow approach)
 Option 1: Keep the defender
PW(12%)D = $2,500(P/F, 12%, 3) - $8,000(P/A, 12%, 3)= - $17,434.90

AW(12%)D = PW(12%)D (A/P, 12%, 3)= - $7,259.1

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 Solution
 Option 2: Replace the defender with challenger
PW(12%)C = $5,500(P/F, 12%, 3) - $5000 - $6,000(P/A, 12%, 3)
= - $15,495.50
AW(12%)C = PW(12%)C (A/P, 12%, 3)= - $6,451.9

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 Opportunity cost approach
 Option 1: Keep the defender
PW(12%)D = -$10,000 - $2,500(P/F, 12%, 3) - $8,000(P/A, 12%, 3)
= - $27,434.90

AW(12%)D = PW(12%)D (A/P, 12%, 3)= - $11,422.64

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 Solution
 Option 2: Replace the defender with challenger

PW(12%)C = $5,500(P/F, 12%, 3) - $10,000 - $6,000(P/A, 12%, 3)

= - $25,495.50

AW(12%)C = PW(12%)C (A/P, 12%, 3)= - $10,615.33

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 Example
 Two years ago, Geo-Sphere Spatial, Inc. (GSSI) purchased a new GPS
tracker system for $1,500,000. The estimated salvage value was $50,000
after 9 years. Currently the expected remaining life is 7 years with an AOC
of $75,000 per year. A French corporation, La Aramis, has developed a
challenger that costs $400,000 and has an estimated 12-year life, $35,000
salvage value, and AOC of $50,000 per year. If the MARR = 12% per year,
(a) find the minimum trade-in value necessary now to make the challenger
economically advantageous, and (b) determine the number of years to
retain the defender to just break even if the trade-in offer is $150,000.
Assume the $50,000 salvage value can be realized for all retention periods
up to 7 years. 52
 Sensitivity analysis
 Sensitivity analysis determines how a measure of worth—PW, AW,
ROR, or B/C—and the alternative may be altered if a particular parameter
varies over a stated range of values.

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 Sensitivity analysis
 There are three types of sensitivity analyses

 Variation of one parameter at a time for a single project or for selecting

between mutually exclusive alternatives

 Variation of more than one parameter for a single project

 Sensitivity of mutually exclusive alternative selection to variation of more than

one parameter

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 Sensitivity analysis
 A general procedure to conduct a sensitivity analysis follows
these steps:
1. Determine which parameter(s) of interest might vary from the most likely estimated
value.

2. Select the probable range (numerical or percentage) and an increment of variation

for each parameter.
3. Select the measure of worth.

4. Compute the results for each parameter using the measure of worth.
5. To better interpret the sensitivity, graphically display the parameter versus the
measure of worth.
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 Example
 Wild Rice, Inc. expects to purchase a new asset for automated rice handling.
Most likely estimates are a first cost of $80,000, zero salvage value, and a cash
flow before taxes (CFBT) per year t that follows the relation $27,000 – 2000t. The
MARR for the company varies over a wide range from 10% to 25% per year for
different types of investments. The economic life of similar machinery varies from
8 to 12 years. Evaluate the sensitivity of PW by varying.

1. MARR, while assuming a constant n value of 10 years, and

2. n, while MARR is constant at 15% per year. Perform the analysis by hand and
by spreadsheet.
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Project Risk and Uncertainties

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 Project Risk and Uncertainties
 Risk is exposure to the consequences of uncertainty.
 A risk is defined as the potential for complications and problems with
respect to the completion of a project and the achievement of a project
goal.
 Risk assessment is a technique that aims to identify and estimate risks
impacted upon by a project.
 Uncertainty can be defined as a lack of certainty involving variability
and/or ambiguity.
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 Project Risk and Uncertainties
Construction project risks are related:

 to the nature of the production processes,

 products themselves,

 time its takes to produce, etc

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 Project Risk and Uncertainties
construction projects are said to be risky businesses, generally the nature of

construction works entail susceptibility to changing situations such as

 weather conditions change,

 subsurface conditions change, etc

while the long duration of project works is susceptible to

 market [price] changes,

 as well as change in demand of the facility delivered

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Major project Risk

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 Project Risk and Uncertainties
Risk
management

Identify Respond Controlling

Identify Quantify risk
risk to risk risk
objective
1. Sensitivity
analysis Options
2. Decision 1. Avoid
tree
2. Transfer
3.Expected
3. Mitigate
monetary
value 4. accept

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