Engineering Economic Analysis

380 INCOME TAXES

Selecting an Income Tax Rate for Economy Studies

Since income tax rates vary with the level of taxable income for both individuals and

corporations, one must decide which tax rate to use in a particular situation. The simple

answer is that the tax rate to use is the incremental tax rate that applies to the change in

taxable income projected in the economic analysis. If a married couple filingjointly has a

taxable income of $40,000 and can increase their income by $2000, what tax rate shouldbe

used for the $2000 of incremental income? From Table 12-2, we see the $2000 falls within

the 15% tax bracket.

Now suppose this couple could increase their $40,000 income by $10,000. In this

situation, Table 12-2 shows that the 15% incremental tax rate should be applied to the

first $7,450 and a 27% incremental tax rate to the last $2,550 of extra income. The ap-

propriate incremental tax rate for corporations is equally easy to determine. For larger

corporations, the federal incremental tax rate is 35%. In addition, there may be up to a

12-15% state tax.

Economic Analysis Taking Income Taxes into Account

An importantstep in economicanalysis has been to resolve the consequencesof alternatives

into a cash flow.Because income taxes have been ignored, the result has been abefore-tax

cashflow.This before-tax cash flowis an essential componentin economic analysisthat also

considers the consequences of income tax. The principal elements in anafter-tax analysis

are as follows:

· Before-tax cash flow

·Depreciation

· Taxableincome(Before-taxcashflow- Depreciation)

·Income taxes (Taxable income x Incremental tax rate)

·After-tax cash flow (Before-tax cash flow - Income taxes)

These elements are usually arranged to form acash flow table. This is illustrated by

Example 12-5.

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A IDedium-sizedprofitable corporation is considering the purchase of a $3000 used pickup truck

for use by the shipping and .receiving department. puring the trucJ<:'s5-year useful life, it is

estimated the .finn will save $800 per year after all the costs of oWniJ:J.gand operati.ngthe truck

have been paid. Truck salvage value is estimated at$750.

:I (a) Wbatistfie befo~e-ta:~;~te ~lretOtn?~ = =:=: =- ~;; =~ ~=: = = =:e ;;;;;:;;; '=

(b) What is th~after-taxrate ofretutIl 911tb,is capit<l! expellaitur~? AssuIDe straight4ine

::I Ii _ ~..,..depreciation.,:.,... ..e>-' ,..,..,',',,';; =;11: t!tiI =tI!!I:.:=: =;;'~ == ;:; a::IICIiI:!i f!I i!i

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