Energy Project Financing : Resources and Strategies for Success

202 Energy Project Financing: Resources and Strategies for Success

Example 1

Determine the weighted average cost of capital for financing, which

is composed of:

25% loans with a before tax cost of capital of 12%/yr and

75% retained earnings with a cost of capital of 10%/yr.

The company’s effective tax rate is 34%.

Cost of CapitalLOANS = 12% * (1 – 0.34) = 7.92%

Cost of CapitalRETAINEDEARNINGS = 10%

Weighted Average Cost of Capital = (0.25)*7.92% + (0.75)*10.00% = 9.48%

A.5 TAX CONSIDERATIONS

A.5.1 After Tax Cash Flows

Taxes are a fact of life in both personal and business decision-mak-

ing. Taxes occur in many forms and are primarily designed to generate

revenues for governmental entities ranging from local authorities to the

federal government. A few of the most common forms of taxes are in-

come taxes, ad valorem taxes, sales taxes, and excise taxes. Cash flows

used for economic analysis should always be adjusted for the combined

impact of all relevant taxes. To do otherwise ignores the significant impact

that taxes have on economic decision-making. Tax laws and regulations

are complex and intricate. A detailed treatment of tax considerations as

they apply to economic analysis is beyond the scope of this appendix and

generally requires the assistance of a professional with specialized train-

ing in the subject. A high level summary of concepts and techniques that

concentrate on federal income taxes is presented in the material which

follows. The focus is on federal income taxes, since they impact most deci-

sions and have relatively wide and general application.

The amount of federal taxes due are determined based on a tax rate

multiplied by a taxable income. The rates (as of April 2000) are determined

based on tables of rates published under the Omnibus Reconciliation Act

of 1993 as shown in Table A-1. Depending on income range, the margin-

al tax rates vary from 15% of taxable income to 39% of taxable income.

Taxable income is calculated by subtracting allowable deductions from

gross income. Gross income is generated when a company sells its prod-