2/25/04 Nuclear Energy Economics andPolicy Analysis1Capital Costs:Capitalization, Depreciation andTaxationFebruary 23. 2004(Rev. Feb. 25, 2004)2/25/04 Nuclear Energy Economics andPolicy Analysis2From an accounting perspective, there are twocategories of costs:• ‘Expensed’ costs– Items that are used up quickly; costs recovered out ofcurrent revenues• ‘Capitalized’ costs– Long lifetime items; costs recovered progressivelythroughout the expected lifetime2/25/04 Nuclear Energy Economics andPolicy Analysis3Depreciation Example: Pizza Delivery BusinessSales: $20,000/yrCar purchase: $6,000Operating expenses: $10,000Car lifetime: 4 yrsNet salvage value: $02/25/04 Nuclear Energy Economics andPolicy Analysis4DefinitionsOperating Revenues: revenues that a company receives as a result of its operation (sales for instance.)Operating Expenses: labor expenses, supply purchases, utility costs etc.Operating Income: Operating Revenues - Operating Expenses.Net Cash Flow: Total Cash Inflow - Total Cash Outflow = Operating Income – Capital expendituresNet Income: Operating Income – Depreciation Allowance2/25/04 Nuclear Energy Economics andPolicy Analysis5Income StatementsYear 1 Year 2 Year 3Year 4Operating Revenues 20,000 20,000 20,00020,000Operating Expenses 10,000 10,000 10,00010,000Car Purchase 6,000 -- ----Operating Income(=operating revenues –operating expenses)4,000 10,000 10,00010,000Net Cash Flow 4,000 10,000 10,00010,000I: Expensing the car purchaseYear 1 Year 2 Year 3Year 4Operating Revenues 20,000 20,000 20,00020,000Operating Expenses 10,000 10,000 10,00010,000Operating Income 10,000 10,000 10,00010,000Depreciation allowance 1500 1500 15001500Net income (beforetaxes) = Operatingincome – depreciationallowance8,500 8,500 8,5008,500Net cash flow 4000 10,000 10,00010,000II: Capitalizing the car purchase & straight-line depreciation2/25/04 Nuclear Energy Economics andPolicy Analysis6Income statements (III): Expensing the car purchase; taxes includedYear 1 Year 2 Year 3 Year 4Op. Revenues (OR) 20000 20,000 20,000 20,000Op. Expenses (OE) 10000 10,000 10,000 10,000Car Purchase 6000Op. Income (OI) 4000 10000 10000 10000Taxable Income (TI)(= OR-OE-‘otherdeductible items’)4000 10000 10000 10000Taxes (T= TI*t)(t = 30%)1200 3000 3000 3000Net Income AfterTaxes(=TI – T)2800 7000 7000 7000Net Cash Flow(= Total cash in –total cash out)2800 7000 7000 70002/25/04 Nuclear Energy Economics andPolicy Analysis7Income Statements (IV): Capitalizing and depreciating thecar purchase; taxes included(Straight-line depreciation assumed)Year 1 Year 2 Year 3 Year 4Op. Revenues (OR) 20000 20,000 20,000 20,000Op. Expenses (OE) 10000 10,000 10,000 10,000Op. Income (OI) 10000 10000 10000 10000DepreciationAllowance (D)1500 1500 1500 1500Taxable Income(TI = OR-OE-D)8500 8500 8500 8500Taxes (T= TI*t)(t = 30%)2550 2550 2550 2550Net Income AfterTaxes(ATNI =TI – T)5950 5950 5950 5950Net Cash Flow(NCF = Total cash in– total cash out)1450 7450 7450 74502/25/04 Nuclear Energy Economics andPolicy Analysis8Year 1 Year 2 Year 3 Year 4Op. Revenues (OR) 20000 20,000 20,000 20,000Op. Expenses (OE) 10000 10,000 10,000 10,000Car Purchase 6000Op. Income (OI) 4000 10000 10000 10000Taxable Income (TI)(= OR-OE-‘otherdeductible items’)4000 10000 10000 10000Taxes (T= TI*t)(t = 30%)1200 3000 3000 3000Net Income AfterTaxes(=TI – T)2800 7000 7000 7000Net Cash Flow(= Total cash in –total cash out)2800 7000 7000 7000Year 1 Year 2 Year 3 Year 4Op. Revenues (OR) 20000 20,000 20,000 20,000Op. Expenses (OE) 10000 10,000 10,000 10,000Op. Income (OI) 10000 10000 10000 10000DepreciationAllowance (D)1500 1500 1500 1500Taxable Income(TI = OR-OE-D)8500 8500 8500 8500Taxes (T= TI*t)(t = 30%)2550 2550 2550 2550Net Income AfterTaxes(ATNI =TI – T)5950 5950 5950 5950Net Cash Flow(NCF = Total cash in– total cash out)1450 7450 7450 7450Expensing the car cost Depreciating the car costTotal taxes = $10200 Total taxes = $102002/25/04 Nuclear Energy Economics andPolicy Analysis9Year 1 Year 2 Year 3 Year 4Op. Revenues (OR) 20000 20,000 20,000 20,000Op. Expenses (OE) 10000 10,000 10,000 10,000Car Purchase 6000Op. Income (OI) 4000 10000 10000 10000Taxable Income (TI)(= OR-OE-‘otherdeductible items’)4000 10000 10000 10000Taxes (T= TI*t)(t = 30%)1200 3000 3000 3000Net Income AfterTaxes(=TI – T)2800 7000 7000 7000Net Cash Flow(= Total cash in –total cash out)2800 7000 7000 7000Year 1 Year 2 Year 3 Year 4Op. Revenues (OR) 20000 20,000 20,000 20,000Op. Expenses (OE) 10000 10,000 10,000 10,000Op. Income (OI) 10000 10000 10000 10000DepreciationAllowance (D)1500 1500 1500 1500Taxable Income(TI = OR-OE-D)8500 8500 8500 8500Taxes (T= TI*t)(t = 30%)2550 2550 2550 2550Net Income AfterTaxes(ATNI =TI – T)5950 5950 5950 5950Net Cash Flow(NCF = Total cash in– total cash out)1450 7450 7450 7450Expensing the car cost Depreciating the car costNPV(@10%/yr) = -6000 + 8800/1.1 + 7000/1.12+ 7000/1.13+7000/1.14= $17,825NPV(@0%/yr) = -6000 + 7450/1.1 + 7450/1.12+ 7450/1.13 +7450/1.14= $17,615Conclusion: On an after-tax NPV basis, the business would prefer to expense the carcost. But this is not permitted by the IRS!2/25/04 Nuclear Energy Economics andPolicy Analysis10Example: Capitalizing and depreciating the car; debtfinancingSales: $20,000/yrCar purchase: $6,000Operating expenses: $10,000Car lifetime: 4 yrsNet salvage value: $0Car loan: $4000Loan term: 4 yearsRepayment: Equal principalrepaymentsat end of year2/25/04 Nuclear Energy Economics andPolicy Analysis11Income Statement: Capitalization and (straight line) depreciation of thecar + debt financingT=0 End of Year 1 End of Year 2 End of Year 3 End of Year 4Operating Revenue(OR)20000 20000 20000 20000Operating Costs (OC) 10000 10000 10000 10000Operating Income(OI = OR-OC)10000 10000 10000 10000Depreciationallowance (D)1500 1500 1500 1500Interest payment (IP) 400 300 200 100Taxable income(TI = OI – D – IP)8100 8200 8300 8400Taxes (@ 30% of TI) 2430 2460 2490 2520After-tax net income 5670 5700 5730 5760Principal repayment(PR)1000 1000 1000 1000Net cash flow(NCF = OR – OC – IP– PR)-2000 6170 6240 6310 63802/25/0412Nuclear Energy Economics andPolicy AnalysisSunset Inc.INCOME STATEMENT & RETAINED EARNINGS(For Year Ended December 31, 20xx)Income statementNet salesSales & other operating revenueLess sales return & allowancesCost of goods soldLaborMaterialsOverheadDepreciationTotalGross profitOperating expensesSellingGeneral administrationLease paymentsTotalNet operating