Engineering Economic Analysis

382 INCOMETAXES

*Sign convention for income taxes: a minus (-) represents a disbursement of money to pay

income taxes; a plus (+) represents the receipt of money by a.decrease in the tax liability.

tThe after-tax cash flow is the before-tax cash flow minus income taxes. Based on the income

tax sign convention, this is accomplished byaddingcolumns (a) and (d).

The calculations required to compute the after-tax rate of return in Example 12-5 were

certainly more elaborate than those for the before-tax rate of return. It must be emphasized,

however, that often the after-tax rate of return is the key value, since income taxes are a

major disbursement that cannot be ignored.

An analysis of a firm's sales activitiesindicates that a number of profitable sales are lost each year

because the firm cannot deliver some of its products quickly enough. By investing an additional

$20,000 in inventoryit is believed that the firm will realize $1000 more in before-tax profits in the

first year. In the second year, before-tax extra profit will be $1500. Profits for subsequent years

are expected to continue to increase on a $500-per-yeargradient. The investment in the additional

inventory may be recovered at the end of a 4-year analysis period simply by selling it and not

replenishing the inventory.Compute:

(a) The before-tax rate of return.

(b) The after-tax rate of return assuming an incremental tax rate of 39%.

Inventory is not considered to be a depreciable asset. Therefore, the investment in additional

Itlinventory is not depreciated. The cash flow table for the problem is presented in Table 12-4.CI!~

---

JABLE 12-3 Cash Flow Table for Example 12-5

(c) (d) (e)

(a) (b) A(Taxable 34% Income After-Tax

Before-Tax Straight-Line Income) Taxes Cash Flow

Year Cash Flow Depreciation (a)-(b) -0.34(c)* (a)+(d)t

0 -$3000 -$3000

1 800 $450 $350 -$119^681

2 800 450 350 -119 681

3 800 450 350 -119^681

4 800 450 350 -119 681

5

{800

450 350 -119

(^750) { 681 750