PowerPoint Authors:Susan Coomer Galbreath, Ph.D., CPACharles W. Caldwell, D.B.A., CMAJon A. Booker, Ph.D., CPA, CIACynthia J. Rooney, Ph.D., CPA

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Income Taxes in Capital Budgeting DecisionsAppendix 13C

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Learning Objective 8

(Appendix 13C)

Include income taxes in a net present value

analysis.

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Simplifying Assumptions

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Simplifying Assumptions

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Key Concepts

To calculate the amount of income tax expense associated with a capital budgeting project, we’ll be using a two-step process:

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Key Concepts

A capital budgeting project’s incremental net income computations include:

1. Annual revenues.2. Annual cash operating expenses.3. Annual depreciation expense.4. One-time expenses related to repairs and

maintenance.

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Key Concepts

A capital budgeting project’s incremental net income computations exclude:

1. Immediate investments in equipment, other assets, and installation costs.

2. Investments in working capital.3. The release of working capital.4. The proceeds from selling a noncurrent asset

when no gain or loss is realized on the sale.

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Holland Company – An Example

Holland Company owns the mineral rights to land that has a deposit of

ore. The company is deciding whether to purchase equipment and open a mine on the property. The

mine would be depleted and closed in 5 years and the equipment would

be sold for its salvage value.

More information is provided on the next slide.

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Holland Company – An Example

Should Holland

open a mine on the

property?

Initial investment in equipment

$ 275,000

Initial investment in working capital

$ 50,000

Estimated annual sales of ore $ 250,000 Estimated annual cash operating expenses $ 150,000 Cost of road repairs needed in 3 years $ 30,000 Salvage value of the equipment in 5 years $ - After-tax cost of capital 12%Tax rate 30%

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Holland Company – An Example

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Holland Company – An Example

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Holland Company – An ExampleThe net present value computations include the

following:

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Holland Company – An ExampleEach year’s total cash flows are multiplied by the appropriate discount factor for 12% to compute their lesser present value.

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Holland Company – An ExampleThe present values in cells B22 through G22 are combined to

determine the project’s net present value of $231.

The positive net present value indicates that Holland Company should proceed with the mining project.

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End of Appendix 13C