Chapter 2

INTEREST AND INVESTMENT COSTS

Cash Flow in Chemical Project: Relationships Analysis Different Factors: 1. Discount Factors to give present worths for cash flows which occur in an instant at a point in time after the reference point 2. Discount Factors to give present worths for cash flows which occur uniformly over 1 year periods after the reference point 3. Discount Factors to give present worths for cash flows which occur uniformly over a period of years 4. Compounding Factors to give future worths for cash flows which occur in an instant at a point in time before the reference point for Continuous Cash flow and Continuous interest of importance for Profitability

Compiled by Prof. Prasad Parulekar

5. Compounding Factors to give future worths for cash flows which occur uniformly before reference point Taxes and Insurance: Both are important for determining economic situation of industry Taxes----amounts major portion of concerns earnings; Supply funds to meet public needs of government Insurance----costs small part of total expenditure for any industrial operation; Adequate insurance coverage is necessary wherever large investment exist; Protects against emergencies, occurring, causing great damages Both of them vary for business concern and individual person Taxes: Types of Taxes: Taxes---imposed by central, state as well as local government
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1. Property Taxes: Decided by local government Special property taxes by individual cities / towns for industries located within city limit Varies from one to other locality; on average---1 to 4% of assessed valuation Referred as Direct Taxes (directly paid by particular concern or property owner and cant be passed to one who consumes that property) 2. Excise Taxes: Imposed by central as well as state government Central excise taxes---charges for import excise duties, transfer of stocks and bonds, and similar things

Compiled by Prof. Prasad Parulekar

 Both

central

and

state

excise

taxes---for

manufacturers and retailers on sale of products like gasoline, alcoholic beverages etc. Referred as Indirect Taxes (can be passed to consumer) Business units have to pay it for privilege of carrying on a business or manufacturing firm in particular localities 3. Income Taxes: Based on gross earnings Gross earning---difference between

Total

Income and Total Product Cost

Act as important source of capital for central and state government Applicable as per national and State laws which may change from year to year State income taxes---varies from state to state; function of gross earnings fro individual 0 to 5% or more of gross earnings depending on particular state and existing laws
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Central Income Taxes: Central income tax system----for business establishments---complex to any extent Complexity--- depends on existing laws (varying often, difficult to interpret in few pages) Income tax payments---better to take help of legal and accounting tax experts Varies due to ---national emergencies, prevailing economic situations, desires of law makers in office at particular time Special tax exemptions for industries---producing particular type of product, market or service involved in the business; government wishes to offer support and inducement to particular concerns High profit making concerns---overall tax rate varies yearly based on size of available tax deductions, carryback or carry-forward provisions Variations in income tax ---influences financial transactions
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Normal tax: Imposed by government on earnings of corporations Rates are set by national law makers Gross earning may be divided in various parts and tax rate may vary from part to part Sur tax: Have to be paid by corporations (in addition to normal tax) on gross earnings above certain limit Capital Gain Tax: Imposed on profits made from sale of capital assets like, buildings, land, equipments Referred as--- Long Term Capital gain----if asset is hold for more than 1 year and Short Term Capital

Gain---if it is held for period less than that indicated

for long term capital gain

Compiled by Prof. Prasad Parulekar

 Net Capital gain=Long term + Short term capital gain; taxed at same rate as ordinary income in the year, gain occurred Many special tax regulations for capital gain----carryback and carry-forward of net capital losses, alternative tax calculation methods, minimum tax requirements

Tax Exemptions for dividends Received: Partial tax exemption for dividends received by corporations 15% of such dividends---considered as taxable income; remaining 85%---tax exempted Contributions: Corporate contributions to appropriate organizations, as defined by income tax laws---deducted as expenses up to 10% of taxable income figured
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Carry-back and Carry-forward of Losses: Situations may arrive where corporation suffers losses (income---Negative taxable income) In such cases, other methods of tax accounting should be used Tax regulations permit corporations---to use loss to offset profits in other years by carry-back or carryforward of losses Can carry the losses back as charges against profits for as many as 3 years before loss or carry forward the losses as charges against profits for as many as 5 years after loss Taxes and Depreciation: Depreciation costs----represents deductions from taxable gross earnings If d = depreciation cost for year = fractional tax rate Then,
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Tax credit for depreciation = d If S = total annual income / revenue C = total annual cost with exception of depreciation and taxes Then, Net annual cash flow to company after taxes = (S C d) (1 ) + d = (S C) (1 ) + d Excess Profit Tax: High income and profit can be earned by certain concerns during national emergency time e.g. concerns producing military necessities during war time Government impose excess profit tax on such concerns Unpopular among businessmen Tax Returns: Reported either on cash basis or accrual basis
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 Cash basis---only money actually received or paid out during year is reported Accrual basis----income and expenses are included as of time they were incurred, even though final payment has not been made Returns--- may be based on standard calendar year or fiscal year; any date may be chosen as end of fiscal year; payments are made in installment

Insurance: Annual insurance cost (for ordinary industrial projects)----costs 1% of fixed capital investment Different known Legal Responsibility: Any no. of insurances for any no. of causes---to protect against loss of property (by corporation)
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types

of

insurance

and

legal

responsibilities of corporation---should be well

 Protection against unpredictable emergencies other than direct property loss----can also be obtained through insurance Impossible to insure against every possible incidence, but necessary to consider results for potential emergency and understand legal responsibility for various types of events Payments required for settling a case in which legal responsibility is proved can be greater than costs due to direct property damage Design engineer should be aware about laws and regulations governing the type of plant or process Types of Insurance: Major insurance requirements for manufacturing concerns are--1. Fire Insurance: fire and similar emergency coverage on buildings, equipments and all other owned or used property; also includes losses caused by lightning, flood, wind storms, automobile accidents, explosions, earthquakes, and similar occurrences
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2. Public Liability Insurance: includes body injury, property loss / damage, on all operations involving automobiles, elevators, certain act which is harmful to public, aviation products, or any corporate functions carried out at a location away from plant premises 3. Business Interruption Insurance: loss of income due to business interruptions caused by fire or other emergency; extremely important insurance 4. Insurance against power plant, machinery and special operation hazards 5. Workers Compensation Insurance 6. Marine and Transportation Insurance---for all property in transit 7. Comprehensive Crime Coverage 8. Employee pension plans 9. Product Liability Self Insurance:
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Benefit

Insurance:

including

life,

hospitalization, accident, health, personal property and

 Used to reduce the cost of insurance Decision whether to purchase or self-insure, requires balancing the possible savings v/s changes of large losses Tax implications must be considered insurance premium for standard insurance are tax deductible while funds paid into self insurance reserve are not.

13

Compiled by Prof. Prasad Parulekar