Time Value of Money, Construction Equipment and Methods

Transcription

1 Time Value of Money, Depreciation, and Average Investment Construction Equipment and Methods Dr. K. C. Williamson III TVM Time value of money ( TVM ) is the process of calculating the value of an asset in the past, present or future. It is based on the premise that the original principal will increase in value over time by interest. What are the key concepts in the property value and money? Asset Principal Interest Payments 1

2 Asset and Principal An asset is something that represents value. Machinery Principal is the amount of money borrowed or invested today. You buy a lift today for $10,000 of which you borrow $8, from the bank and pay $2, of your own money: the $8, is the principal of the loan. You invest $2, of company assets today, the $2, is the principal. Interest The value of money increases with time because of an interest rate, which is the cost of money. Contractors must perform a cash flow analysis which recognizes differing economic values depending on when money is received or paid in order to make the best decisions. 2

3 Equivalence This concept means that payments that differ in magnitude, but made at different time periods, may be equivalent to one another. Contractors wishing to purchase or lease a truck in 5 years may need to determine an investment value today to meet the cash demand in 5 years. To compare two payment values the contractor must determine an equivalent cost value. For a comparative analysis to be meaningful all compared values must be calculated for the same point in time. Asset Components Present value ( PV ) is the principal. p You deposit $5, today in a mutual fund. The $5, is the present value. Future value ( FV ) is principal and interest. You deposited $5, in a mutual fund for 5 years at 10% interest and you will receive $8, in 5 years, $8, is the future value. Payment ( Pmt ) is either principal or principal plus interest. You invest $50.00 per month, $50.00 is the payment. Your monthly machine payment is $750.00; the $ is made up of principal and interest. 3

4 Payments Period Period is the point in time when interest is paid or earned. Periods per year Periods per year is the frequency of which interest is calculated in a calendar year. Common periods per year are; 1-annually, 2-semiannually, 4- quarterly, 12-monthly, 365-daily. The interest on a investment account which is paid quarterly the growth in value is calculated four times a year. Payments Total Number of Periods Total periods are the sum of all the periods. It is conveniently calculated by multiplying the number of periods in one calendar year times the total number of years. For example, total periods for a investment account that pays interest quarterly for a 5 year period is 20 periods (5 years x 4 payments a year). Total periods for a 3 year monthly equipment loan payment are 36 periods (3 years x 12 payments a year). 4

5 Single Payment Single payments may occur either today or at some time in the future. P is used to indicate a sum paid or received today, F is used to indicate a future sum, i is the interest, and n represents the number of periods. To determine the future value of $100 invested at 6% for one year one would use the following formula. Single Payment where or $100 * ( ) = $ F = future value P = present value i = interest rate 5

6 Single Payment Future Worth Money held in an account will increase with time if interest payments remain on deposit (compounded). The value of this money can be calculated for any period of time using the following compound amount factor. ( 1 or n i) (( )^5 ) = 1.34 Future Worth To determine the future value of $100 invested at 6% compounded for 5 years, the equation becomes? F P( 1 i) n or $100 * (( )^5 ) = $

7 Present Worth Factor Future values may be devalued to determine the present value today using the following factor. 1/(1 i) n or (1 / ( )^5 ) = 0.75 Present Worth To determine the present value today when the needed future value is $100 invested at 6% for 5 years, the equation becomes? P or F ( 1 i) n $100 / (( )^5 ) = $

8 Depreciation The decrease in market value due to age Straight line Method Declining Balance Method Double-Declining Balance Method IRS-Prescribed Method Sum-of-the-Year s-digits Method * * Course Method Patterns of Expiration Costs Recognizing the expiration of the cost as an asset need not be linear. There are many other patterns each with some advantages and disadvantages. Length determined by useful life. Depreciation Patterns 8

9 Depreciation Terms Depreciation Value of equipment depreciation at periodof-interest Accumulated Depreciation Value of equipment depreciation from start of ownership to period-of-interest Book Value Value of equipment depreciation remaining at period-of-interest Purpose of Depreciation Allocation of cost Determining hourly equipment cost Determining replacement decision Return of capital Determining tax liability Depreciation is not a decline/reduction in physical value but is a reduction in fiscal value 9

10 Depreciation Factors Cost is the value of the delivered asset Salvage is the estimated salvage value, at end of economic life or is the value of accountable replacement Estimated Useful Life (economic not physical) is how long the asset can be used by the business for its intended use Service Hours is the annual hours the equipment is used What is Gain? Appreciating Assets (real estate, collectables): Purchase Price $ 300,000 Sales Price $ 600,000 CAPITAL GAIN $ 300,000 Capital Gain Tax Rate 20% CASH PAID IN TAXES $ 60,000 10

11 What is Gain? Depreciating Assets (equipment, trucks, etc.): Sales Price $ 200,000 Tax Basis $ 0 ORDINARY INCOME $ 200,000 Income Tax Rate 40% CASH PAID IN TAXES $ 80,000 IRC Section 1031 No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment. Internal Revenue Code Section 1031, P. (a) (1) 11

12 About 1031 History Included in the Federal tax code since 1921 Volume Over $1.2 Billion per week (based on 2004 figures) Inclusions Real Property Personal Property Exclusions Inventory or stock in trade Stocks, bonds or notes Partnership interests Beneficiaries Individuals, C corps, S corps, Partnerships, LLC s, Trusts Safe Harbor Regulations AGREEMENTS Single Exchange Agreement Master Exchange Agreement NOTIFICATION Buyers and Sellers must be notified QUAIFIED INTERMEDIARY Disinterested party Fund facilitation (protection from constructive receipt) Secure protection of sales proceeds TIMELINE 45 day replace or identify 180 day completion 12

13 What is Like-Kind? ASSET CLASSIFICATION Same nature, character or class General Asset Class or Manufacturing Code PRACTICAL IMPLICATIONS New or used One-to-many, many-to-one Sell and buy private party, at auction or through dealers EXAMPLE Construction Machinery or Equipment Backhoes Dozers Buckets Excavators Graders Scrapers Cranes Aerial Platforms Skid Steers Type of Exchanges SIMULTANEOUS EXCHANGES Trade-ins can qualify if they meet specific rules FORWARD EXCHANGES Sell first, Buy later REVERSE EXCHANGES Buy first, Sell later 13

14 Exchange Benefit Equipment Sold Asset Put in Service Purchase Price Tax Basis Sales Price Gain on Sale CAT Skid Steer 2005 $40,000 $11,520 $30,000 $18,480 CAT Excavator ,000 17,280 57,500 40,220 Grove Crane , , ,000 Loader , ,000 55,000 TOTALS $28,800 $272,500 $243,700 LIKE BENEFIT ($272,500 - $28,800) * 38% = $92,606 SYD Depreciation Costs Depreciation (Sub Total): Depreciation Yearly = (((Delivered Cost - Salvage Value) -Tire Cost) * SYD) Year Depreciation = ((Depreciation for Year) / Yearly Service Hours) - Hour 14

15 Investment Costs Capital Investment Rate Borrowed funds interest charged OR Company assets interest rate equal to the return on company investments Average Investment Investment cost can easily be calculated using the value of the average annual investment over the life of the equipment. However, this is not the actual cost for a specific year-ofinterest. Cost Salvage Average Investment Life 15

16 Average Investment True investment cost is best calculated as an average value of the machine during the year-of-interest Delivered cost = $35,000 Salvage Value = $5,000 Tire Cost = $1,000 Estimated Life (Years) = 5 Year-of-Interest = 3 Average Investment Table Year Depreciation Year End Year Average 1 $9, $25, $30, $7, $17, $21, $5, $11, $14, $3, $7, $9, $1, $6, $6, $ $ $

17 SYD Year 1 deprecated value is the delivered cost minus the salvage value minus tire cost if wheeled = $29,000 SYD is the sum of the year digits for the depreciation period (Machine s Estimated Economic Life) divided into the year-of-interest s digit in reverse order SYD Year 1-5/15 x $29,000 = $9, Year Year Year Year Year Year 1 $9, Year 2 $7, Year 3 $5, Year 4 $3, Year 5 $1,

18 First year s Year-end Value Delivered cost minus the year one depreciation $35,000 - $9, = $25, First year s Year Average Value Delivered cost plus the year-end end value divided by two (35, ,333.33)/2 = $30,

19 Second year s Year-end Value Previous year s Year-end end value minus the current year s depreciation $25, $7, = $17, Continues until the end of the estimated life Second year s Year Average Value Previous year s year-end end value plus the current year s year-end value divided by two (25, ,600.00)/2 = $21, Continues until the end of the estimated life 19