204 Energy Project Financing: Resources and Strategies for Success
- Taxable Income = BTCF – Loan Interest – Bond Interest – Depreca-
tion - Taxes = Taxable Income * Tax Rate
- ATCF = BTCF – Total Loan Payments – Total Bond Payments – Taxes
An important observation is that depreciation reduces taxable in-
come (hence, taxes) but does not directly enter into the calculation of
ATCF since it is not a true cash flow. It is not a true cash flow because no
cash changes hands. Depreciation is an accounting concept designed to
stimulate business by reducing taxes over the life of an asset. The next
section provides additional information about depreciation.A.5.2 Depreciation
Most assets used in the course of a business decrease in value over
time. U.S. federal income tax law permits reasonable deductions from tax-
able income to allow for this. These deductions are called depreciation al-
lowances. To be depreciable, an asset must meet three primary conditions:
(1) it must be held by the business for the purpose of producing income,
(2) it must wear out or be consumed in the course of its use, and (3) it must
have a life longer than a year.
Many methods of depreciation have been allowed under U.S. tax
law over the years. Among these methods are straight line, sum-of-the-
years digits, declining balance, and the accelerated cost recovery system.
Descriptions of these methods can be found in many references, including
economic analysis text books [White, et al., 1998]. The method currently
used for depreciation of assets placed in service after 1986 is the Modified
Accelerated Cost Recovery System (MACRS). Determination of the al-
lowable MACRS depreciation deduction for an asset is a function of (1)
the asset’s property class, (2) the asset’s basis, and (3) the year within the
asset’s recovery period for which the deduction is calculated.
Eight property classes are defined for assets which are depreciable
under MACRS. The property classes and several examples of property
that fall into each class are shown in Table A-2. Professional tax guidance
is recommended to determine the MACRS property class for a specific
asset.
The basis of an asset is the cost of placing the asset in service. In
most cases, the basis includes the purchase cost of the asset plus the costs