Construction management, Lecture notes of Construction management

Download Construction management and more Lecture notes Construction management in PDF only on Docsity! Construction Management ENCE4331: Engineering Economy Cont’d Construction Management Lecture 4 1 Abdulhamid Mimi • Revisit previous lecture • Depreciation and Tax Effects • Price Level Changes: Inflation and Deflation • Examples Construction Management Lecture 4 2 Today’s Presentation Outline Depreciation and Tax Effects Cont’d • Let P be the cost of an asset, S its estimated salvage value, and N the estimated useful life (depreciable life) in years. Furthermore, let Dt denote the depreciation amount in year t, Tt denote the accumulated depreciation up to year t, and Bt denote the book value of the asset at the end of year t, where t=1,2,..., or n refers to the particular year under consideration. Then, • What about year 2 in the previous example? Construction Management Lecture 4 5 Depreciation and Tax Effects Cont’d • To consider tax effects in project evaluation, the most direct approach is to estimate the after-tax cash flow and then apply an evaluation method such as the net present value method • For specific project financing from internal funds, let after tax cash flow in year t be Yt. Then, for t=0,1,2,...,n, • At is the net revenue before tax in year t, Dt is the depreciation allowable for year t and Xt is the marginal corporate income tax rate in year t. Construction Management Lecture 4 6 Example 3 Construction Management Lecture 4 7 A company plans to invest $55,000 in a piece of equipment which is expected to produce a uniform annual net revenue before tax of $15,000 over the next five years. The equipment has a salvage value of $5,000 at the end of 5 years and the depreciation allowance is computed on the basis of the straight line depreciation method. The marginal income tax rate for this company is 34%, and there is no expectation of inflation. If the after-tax MARR specified by the company is 8%, determine whether the proposed investment is worthwhile, assuming that the investment will be financed by internal funds. Price Level Changes: Inflation and Deflation Cont’d Construction Management Lecture 4 10 Let i be the discount rate excluding inflation, i' be the discount rate including inflation, and j be the annual inflation rate. Then, Price Level Changes: Inflation and Deflation Cont’d Construction Management Lecture 4 11 If At denotes the cash flow in year t expressed in terms of constant (base year) dollars, and A't denotes the cash flow in year t expressed in terms of inflated (then- current) dollars, then Example 4 Construction Management Lecture 4 12 Suppose that, in the previous example, the inflation expectation is 5% per year, and the after-tax MARR specified by the company is 8% excluding inflation. Determine whether the investment is worthwhile.