Engineering Economic Analysis

Income Tax Rates

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During a 3-year period, a finn had the following results (in millions of dollars):

Gross income from sales

Purchase of special tooling

(useful life: 3 years)

All other expenditures

After-Tax Cash Flows for the Challenger

Year 1

$200

-60

Year 2

$200

o

Year 3

$200

o

-140

$ 0

-140

$ 60

-140

$ 60

Compute the taxable income for each of the 3 years.

.SOl~TlON'

The cash results for each year would suggest that Year 1 was a poor one, while Years 2 and 3

were very profitable. A closer look reveals that the finn's cash results were adversely affected in

Year 1 by the purchase of special tooling. Since the special tooling has a 3-year useful life, it is a

capital expenditure with its cost allocated over the useful life. For straight-line depreciation and

no salvage value, we use Equation 11-2 to find the annual charge:

B-S 60-0

Annualdepreciationcharge=- N = 3 =$20million

Applying Equation 12-2, we write

Taxable income= 200 - 140 - 20 =$40 million

In each of the 3 years, the taxable income is $40 million.

An examination of the cash results and the taxable income in Example 12-1 indicates th~t

taxable income is a better indicator of the annual perfonnance of the finn.

INCOME TAX RATES

Income tax rates for individualschangedmanytimesbetween 1960and 1995,as illustratedin

Figure 12-1. Recent movementshave been less dramatic. From 1995to 2000 the maximum

rate was 39.6%; it fell to 39.1% in 2001 and was 38.6% in 2002 and 2003.

Individual Tax Rates

There are four schedulesof federal income tax rates forindividuals. Single taxpayersuse the

Table 12-1schedule.Married taxpayers filingajointretum use the Table 12-2schedule.1\vo

other schedules (not shown here) are applicable to unmarriea individuals with dependent

relatives ("head of household"), and married taxpayers filing separately.