Tax Analysisi

YO. THEORETICAL FUNDAMENT

I.1 The Tribute paid to the State. Basics

Taxes are the source that provides the necessary resources to the State. This
situation requires strengthening the economic activity of companies and regulating the
economy, with reforms that transform production and internal demand into the engine
of growth.
The tax is based on the security that the state provides to people and their
property. The theory of the tax maintains that the tax by its nature is not exclusively an
insurance premium or the price of the services provided, but a social debt, whose
debtors are the citizens for the sole fact of being part of the social community, whose
most highest expression is the State.

I.2 The tax system

The generic term tax includes the following three concepts:

Tax
TributeRate
Special Contributions

a) Tax
The tax explains the basic treatment of capital gains and losses. In general,
companies are taxed on the income generated in the process of doing business, while
individuals pay taxes on wages, salaries, royalties, and investment proceeds.

b) Special Contribution
It is the tax whose obligation is to generate benefits derived from the
performance of public works or state activities that are executed with the contribution.

c) Rate
It is the tax whose obligation has as its generating event the effective provision
by the State of a public service individualized to the taxpayer. Within the rate concept,
there is the following subclassification:
c.1 Arbitrations . They are a fee paid for the provision or maintenance of a
public service. Example: payment of taxes for maintenance of parks and gardens.
c.2 Rights . They are fees paid for the provision of a public administrative
service or for the use or exploitation of public goods. Example: the amount paid for a
birth certificate.
c.3 Licenses . These are fees that are levied on obtaining specific authorizations
to carry out activities of private benefit subject to control or supervision.

I.3 Types of Taxes

In general, taxes are levied on income, property, sales and consumption. These
different tax rates are expressed in:
  Tax on the Production of Services and Imports
 Tax on Economic Activities
 Real Estate Tax
 Tax on motor vehicles
 Tax on Constructions and Works
 Taxes on the Increase in Value of Urban Land

I.4 The tax system in the national economy

The government, through the Central Reserve Bank (BCRP) and the Ministry of
Economy and Finance (MEF), controls the nation's monetary and fiscal policies to
influence the level of economic activity.

Monetary policy influences the availability and cost of credit, and fiscal policy
manages the income and expenditure of the State.

The Framework Law of the National Tax System is Legislative Decree No. 771,
effective as of January 1, 1994. The law indicates the current taxes and indicates who the tax
creditors are: the Central Government, Local Governments and some entities with specific
purposes.

I.5 List of some taxes in Peru

I.5.1 Consumption tax:

a) VAT applies 18% to the goods produced, and highly perishable products and
basic necessities are exempt.
b) ISC , taxes luxury items. There are differentiated ad-Valoren rates. Thus we
have the following affected products: Fuels, liquors, soft drinks, cigarettes and
imported foods.

I.5.2 Income Taxes

Taxes natural and legal persons (companies)

I.5.2.1 Income Tax on Legal Entities

a) Income tax 3rd category, taxes services, marketing, productivity and

educational services.
b) Income tax 2nd category, taxes intangibles (Royalties, patents, licenses,
trademarks, directors' allowances).

I.5.2.2 Income Taxes on Natural Persons

a) 1st Category, Income Tax.

b) 2nd Category, income recipient.
c) 4th Category, independent professional work.
d) 5th Category, dependent personal work.

I.5.3 Tax on international business or tariffs.

 It is the tax applied to imports and exports, currently the national tariff on
imports is on average 15% (5% - 25%).

Tax Basics1

The concepts that support the different types of taxes established by the tax
system in each country are presented below:

1) Tax on the sales . They are allocated based on purchases of goods and/or
services , and are independent of income or gross profits. It is collected by: state,
municipal or local governments. These taxes are added to the cost of the items
purchased.
2) Consumption tax . They are taxes that are assigned as a function of the sale of
certain goods or services that are often considered superfluous and are therefore
independent of the income or profits of a company. Although they are usually
charged to the original manufacturer or supplier of the goods or services, the
cost is passed on to the buyer.
3) Profits Tax . They are generally the most significant type of taxes. They are
assigned as a function of gross receipts less legal deductions . They are
collected by: regional governments, most state governments.
4) Property tax . They are assigned as a function of the value of the asset owned ,
such as land, buildings, equipment, etc. These are independent of the income or
profit of a company. They are collected by: municipal, local and/or state
governments.

Types of taxes

a) INDIVIDUAL TAXES, for 1992

Taxpayer's marital status Taxable on:

a.1. MARRIED (joint return)

Of 0 --- 35 800 15%
35 801 --- 86 500 28%
86 501 --- onwards 31%

a.2. SINGLE
Of 0 --- 21 450 15%
21 451 --- 51 900 28%
51 901 --- onwards 31%

b) CORPORATE TAXES, for 1993.

1
It should be noted that the following analysis is based on North American legislation; because they try to
encourage business activity.
i
 From 0 Taxable Income 50,000 15%
50 001 “ 75 000 25%
75 001 “ 100 000 34%
100 001 “ 335 000 39% (0.34 + 0.05)
335 001 “ 10´000 000 34%
10´000 001 “ 15´000 000 35%
15´000 001 “ 18´333 333 38% (0.35 + 0.03)
18´333 334 “ onwards 35%

The income tax is levied as follows:

15% 50 000 = 7 500
25% 25 000 = 6 250
34% 25 000 = 8 500
39% 235 000 = 91 650
34% 203 000 = 69 020

Basic tax terminology

a) Gross Income (BI), is the total income from sources that produce income. For
companies it produces income from the main activity it carries out; For individuals,
gross income consists primarily of salaries, wages, interest, dividends, royalties, and
capital gains.

b) Operating Expenses (GO), include all costs incurred in business transactions.

c) Taxable Income (IG), is the amount in nuevos soles (S/.) on which taxes are
calculated, thus we have:
IG = Gross Income – Expenses – Depreciation

d) Tax Rate (T) , is a percentage (%) or decimal equivalent of the taxable income due
to the tax. That is to say:

Tax = (IG) x T

e) Net Profit or Net Income , generally results from subtracting taxes on corporate
income from taxable income.

CALCULATING TAXES

IG = IB - Expenses - Interest on Debt - Depreciation - Other Deductions

IN = IG * (1 - T)

THE DEDUCTIONS
Salary, wages, income, employee benefits;
 Repairs, materials;
Interest, taxes;
Advertising, etc.

SPECIAL CASES
Losses due to fire and theft;
Contributions;
Depreciation and depletion;
Bond interest;
Research and development expenses;
Pollution control.

Balance Analysis
Costs

Fixed Costs , Those costs that are used regardless of the level of production.

Example: Worker payroll, electricity, water, telephone. Rent, operating costs.

Variable costs,

Example: raw materials in production, inputs.

Costs

Costs
CT = CF + CV

CV
C.F.

0 Quantity Produced

Production Representation
 P.T.

P.T.

Labor or
variable factor
0 1 2 3 4 5 6 7 8

Income Representation:

AND

Price : Value of the product on the market

Cost : Production Expenses.

AND
C.T.
P.T.
AND

c P.T.
C.T.

b
d
TO

Factor

Point a:
PT = CT
 Point B and C, represents greater utility

PT = Y

Problem

Historically, a plant works at 80% of its capacity with a production of 14,000 units per
month, the current demand is decreasing, use the following information to determine the
place (the quantity), to which it can reduce production;

CF = S/ 75,000 per month

CV = 2.5 per unit
Y = S/ 12.00 per unit

1.- Determine the number of units that must be produced at the equilibrium point.
2.- Estimate the total profit when production is 14,000 units?
3.- Estimate the variable cost per unit by relating it to fixed costs at a level of 8,000
products, if income and fixed costs remain constant?

1.- PT = CT PT = Y(x)
CT = CF +CV(x)
X(12.00) = CF + CV
12.00(X) = 75,000 + 2.5(X)
9.5(X) = 75,000
X = 7,894.74 (minimum production)

14,000 _______________ 80%

X _______________ 100%

X = 17,500

Amount to which production can be reduced

7,894.74 = 45.11%
17,500

2.- Y-CT

12.00 (14,000) – [75,000 + 2.5 (14,000)]

= 168,000 – (110,000)
= 58,000

3.- PT = X(Y) = 12(8,000) = 96,000

PT = CF + CV
96,000 = 75,000 + X(8,000)
21,000 = 8,000 (X)
2.625 =
 Balance Point Between Two Alternatives

Problem

An aerospace company is evaluating 2 alternatives:

1st : The company of an automatic feeding machine has an initial cost (B) of S /. 23,000
soles, salvage value of S /. 2,500 soles and a projected life of 10 years. One person will
operate the machine at a cost of and a projected life of S /. 12 soles an hour. The expected
production is 8 tons/hour. The annual maintenance and operation cost is expected to be S
/. 3,500 soles.

2nd : The alternative annual feeding machine has an initial cost equal to S /. 8,000 soles,
it has no expected salvage value, a life of 5 years and a production of 6 tons/hour.
However, 3 workers will be required at S /. 8 soles per hour each. The machine will have
an annual maintenance and operation cost of S /. 1,500 soles. All capital invested is
expected to generate a market return of 10% per year before taxes.

1. How many tons/year must be finished in order to justify the higher purchase cost of
the automatic feeding machine?

2. If a requirement to finish 2,000 tons/year is anticipated, which machine should be

purchased?
Data:

Automatic Feed

B = S /. 23,000
2,500
VS = S /. 2,500

CAM = S /. 3,500
0 1 2 3 4 5 6 7 8 9 10
n = 10

t i = 10%

Production cost:
23,000
S
/. 12 x 1 Hour x X Ton = 1.5
Hour 8 Ton year

Manual feeding
B = S /. 8,000

VS = 0

CAM = S /. 1,500

n=5

t i = 10%
0 1 2 3 4 5
Production cost:
S
/. 12 x 3 x 1 Hour x
Hour 6 Ton year 8,000

1. VA a = -23000 (A/P, i, 10) + 2500 (A/F, i, 10) -3500 – 1.5

= - 23000 (0.16275) + 2500 (0.06275) – 3500 – 1.5

= -7086.375 – 1.5

VA m = -8000 (A/P, i, 10) -1500 – 4

= - 8000 (0.26380) – 1500 – 4

= -3610.4 – 4

Matching:

-7086.375 – 1.5X = -3610.4 – 4X

2.5 X = 3475.975

X = 1390.39 Ton/year

2. Machine A a = -7086.375 – 1.5

Machine A m = -3610.4 – 4 X = -3610.4 – 4 (2000) = -11,610.4

The Automatic Feeding Machine must be purchased.

Project Financing Methods

If a company does not have enough cash to make an investment, there are two general
options to finance its project:

YO. Through financing equity (or equity). It can be presented in two ways: (1) using
retained earnings or (2) issuing shares.

II. Debt Financing. This type of financing includes short-term loans and the sale of
long-term bonds from which money is borrowed from investors on a fixed term.

YO. Equity Financing

The company must decide how much money to raise, the type of securities it will issue
(common or preferred shares) and the basis for allocating the price of the issue.

Once the company has decided on the type of shares to issue, it will need to estimate the
issuance costs , the expenses it will incur in connection with the issuance, such as:
investment bankers' fees, attorneys' fees, accountants' costs, and printing costs. and
engraved.

Typically the investment banker will purchase the shares from the company at a
discount price lower than the price at which it will be offered to the public (the discount
usually represents issuance costs). If the company is already public, the offer price is
usually based on the existing stock price on the market. If the company is first opened to
the public, there will be no set price and investment bankers will have to estimate the
expected market price for sales of the shares.

Example 1. The company hopes to gain considerable market penetration with the new
product; To produce it, it requires new facilities, which will cost 10 million soles.
The company has decided to raise this amount by issuing common shares. The
investment bankers have informed management that they must assign a price of 28 soles
to the new issue.
The issuance costs will be 6% of the sale price. How many shares must the company
sell to obtain 10 million new soles after issuance expenses?

(0.06) (28) (X) = S /. 1.68X

To obtain 10 million net new soles, the following relationship is established:

28X – 1.68X = 10,000,000

26.32 X = 10,000,000
X = 379,940 shares

The issuance costs of all shares would be:

 1.68 (379,940) = S /. 638 300

II Debt Financing

When using the debt financing option, it is necessary in our analyzes to separate interest
payments from loan replacement. There are two common methods of debt financing.

1. Financing with bonds. There is no payment of principal; Only interest is paid

annually (or semi-annually), and the principal is paid at once when the bond matures.
Bond financing is similar to bond financing by selling bonds.

2. Term loan. There is equal replacement, in which the sum of payments and principal
payments is uniform; Interest payments decrease while principal payments increase over
the life of the loan.

Example 2.
Financing with bonds. The issuance cost is 1,407% of the amount of 10 million new
soles. Investment bankers have indicated the 5-year issue with a face value of 1,000
soles can be sold at 995 soles per unit. The bond would require annual interest payments
at 12%.

Term loan. A bank loan can be obtained for 10 million new soles with an annual interest
rate of 11%, for 5 years (with 5 annual payments)

a) How many bonds with a par value of 1,000 soles would you have to sell to obtain 10
million new soles?

b) What are the annual payments (principal and interest) of the bond?

c) What are the annual payments (principal and interest) on the term loan?

to) (0.01407) (1000) X = 14.07

1000 X – 14.07 X = 10,000,000

X = 10 142.71 = 10 143 Bonds.

b) I = Vb V = 1,000
c b = 12%
C=1

I = 1000(0.12) = S /.120 that you pay each year.

1
c) P (A/P, i, 5)

A = P i(1+i) n
(1+i) n -1

A = 10 000000 0.11(1+0.11) 5
(1+0.11) 5 -1

A = 10 000000 0.185356
0.685058

A = 10 000000 (0.27057)

A = 2' 705 700

 Analysis of Current Monetary Units

Problem

A small manufacturer plans to invest in the production of sensors and control systems
that have been requested by a fruit dehydrating company. This contract will be carried
out under the terms of a proprietary contract, which would conclude within 5 years. The
project is expected to generate the following cash flows in current soles:

n Net cash flows in soles ( S /.) Current

0 -75 000
1 32 000
2 35 700
3 32 800
4 29 000
5 58 000

1. How much are the equivalent soles of year zero (constant soles), if the general
inflation rate (f) is 5% annually?

2. Calculate the present value of these cash flows if the interest rate is 12%?

1.

–75,000 + 32,000 (P/F, i, 1) + 35,700 (P/F, i, 2) + 32,800 (P/F, i, 3) + 29,000 ((P/F, i, 4)

+ 58,000 (P/F, i, 5)

-75000 + 32 000 (0.9524) + 35 700 (0.9070) + 32 800 (0.8638) + 29 000 (0.8227) +

58 000 (0.7835)

-75 000 + 160 490.64

= 85 490.64

2.
d = 12%
j = 5%
i = d + j + dj
i = 0.12 + 0.05 + (0.12x0.05)
i = 0.176 = 17.6%

1
P = 32,000 = 27,210.88
(1+0.176)1

1
 P = 35,700 = 25,813.90
(1+0.176)2

1
P = 32,800 = 20,167.49
(1+0.176)3

1
P = 29,000 = 15,162.43
(1+0.176)4

1
P = 58,000 = 25,786.44
(1+0.176)5

= -75 000 + 27 210.88 + 25 813.90 + 20 167.49 + 15 162.43 + 25 786.44

= 39 141.14
 Project Analysis Based on Cost-Effectiveness

The preferred alternative will be the one that produces maximum effectiveness, at a
certain level of cost, or the minimum cost for a fixed level of effectiveness, at which
competing alternatives have the same objectives.

General Procedure for a Cost-Effectiveness Study

A typical analysis procedure includes the following steps:

Step 1 : Set the objectives.

Step 2 : Identify the restrictions imposed on the scope of the objectives Ex. Budget or
Weight.

Step 3 : Identify all feasible alternatives.

Step 4 : Identify the social interest rate.

Step 5 : Determine the equivalent life cycle cost of each alternative.

Step 6 : Establish the basis for the development of a cost-effectiveness index. For this
there are 2 strategies:
1. The Fixed Cost method.
2. The Fixed Effectiveness method.
In the fixed cost method, the amount of efficiency achieved with a given cost is
determined; In the fixed effectiveness method, the cost to reach a predetermined place
of effectiveness is determined.

Step 7 : Calculate the cost-effectiveness index for each alternative based on the criteria
chosen in step 6.

Step 8 : Select the alternative with the highest cost-effectiveness index.

 Evaluation of Multiple Investment Alternatives

Project relationship forms:

to) : Projects C and D are independent

c d

b) : The Projects. A and B are mutually exclusive

T b
O

c) : Projects F is contingent on project E

A F
N

Accept (1)
Reject (0)

Alternative FO XB
R
1 1 0
2 0 1
3 0 0

Problem

Consider the following 5 investment projects: With estimated cash flows. Assume that
projects A and B are mutually exclusive, project C is independent, project D is
contingent on project C, project E is contingent on project B.

Project 0 1 2 3
TO -100 50 50 50
b -200 50 100 200
c -100 30 80 120
d -300 100 100 100
AND -200 100 100 150

Use the present value measurement to select the best alternative with a minimum
attractive rate of return of 12%.
 T b
O
T b A
O N
c D

d c

d c

A b
N

Group 1 Group 2

Alternative FO XB XBE Alternative XC XCD

R
1 0 1 0 1 1 0
2 1 0 0 2 0 1
3 0 0 1 3 0 0
4 0 0 0

Alternative Project 0 1 2 3 Vp (12%)

1 TO -100 50 50 50 20.095
2 c -100 30 80 170 111.569
3 b -200 50 100 200 66.725
4 A,C -200 80 130 170 96.074
5 B,C -300 80 180 220 71.524
6 B,E -400 150 200 350 142.505
7 C,D -400 130 180 220 16.169
8 B,E,C -500 180 280 470 218.484
9 C,D,B -400 180 280 420 282.994
10 C, D, A -500 180 270 76.124
11 b. E,C,D -800 280 380 570 158.674
12 0 0 0 0 0

V A = -100 + 50 (P/F, 12%,1) + 50 (P/F, 12%,2) + 50 (P/F, 12%,3)

V A = -100 + 50 (0.8929) + 50 (0.7972) + 50 (0.7118)

V A = 20,095
V C = -100 + 30 (P/F, 12%,1) + 80 (P/F, 12%,2) + 170 (P/F, 12%,3)

V C = -100 + 30 (0.8929) + 80 (0.7972) + 170 (0.7118)

V C = 111,569

V B = -200 + 50 (P/F, 12%,1) + 100 (P/F, 12%,2) + 200 (P/F, 12%,3)

V B = -200 + 50 (0.8929) + 100 (0.7972) + 200 (0.7118)

VB = 66,725

V A,C = -200 + 80 (P/F, 12%,1) + 130 (P/F, 12%,2) + 170 (P/F, 12%,3)

V A,C = -200 + 80 (0.8929) + 130 (0.7972) + 170 (0.7118)

V A,C =96.074

V B,C = -300 + 80 (P/F, 12%,1) + 180 (P/F, 12%,2) + 220 (P/F, 12%,3)

V B,C = -300 + 80 (0.8929) + 180 (0.7972) + 220 (0.7118)

V B,C = 71,524

V B,E = -400 + 150 (P/F, 12%,1) + 200 (P/F, 12%,2) + 350 (P/F, 12%,3)

V B,E = -400 + 150 (0.8929) + 200 (0.7972) + 350 (0.7118)

V B,E = 142,505

V C,D = -400 + 130 (P/F, 12%,1) + 180 (P/F, 12%,2) + 220 (P/F, 12%,3)

V C,D = -400 + 130 (0.8929) + 180 (0.7972) + 220 (0.7118)

V C,D = 16,169

V B,E,C = -500 + 180 (P/F, 12%,1) + 280 (P/F, 12%,2) + 470 (P/F, 12%,3)
V B,E,C = -500 + 180 (0.8929) + 280 (0.7972) + 470 (0.7118)

V B,E,C = 218,484

V C,D,B = -400 + 180 (P/F, 12%,1) + 280 (P/F, 12%,2) + 420 (P/F, 12%,3)

V C,D,B = -400 + 180 (0.8929) + 280 (0.7972) + 420 (0.7118)

V C,D,B =282,894

V C,D,A = -500 + 180 (P/F, 12%,1) + 280 (P/F, 12%,2) + 270 (P/F, 12%,3)

V C,D,A = -500 + 180 (0.8929) + 280 (0.7972) + 270 (0.7118)

V C,D,A = 76,124

V B,E,C,D = -800 + 280 (P/F, 12%,1) + 380 (P/F, 12%,2) + 570 (P/F, 12%,3)

V B,E,C,D = -800 + 280 (0.8929) + 380 (0.7972) + 570 (0.7118)

V B,E,C,D = 158,674

Alternative 9 of project C, D, B is chosen

BIBLIOGRAPHY:

1. ANDÍA VALENCIA, Walter (1999) Problems of Economic Engineering.

Lima Peru.
2. ALIAGA VALDEZ, Carlos (2002) Financial mathematics. Ed. Prentice
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3. ÁLVAREZ ARANGO, Alberto (2005) Financial mathematics. Third

Edition, by Mc Graw-Hill Interamericana, SA, Bogitá, DC, Colombia.

4. BACA URBINA, Gabriel (2003) Fundamentals of Economic Engineering.

Third edition. Mc Graw Hill, Mexico City

5. BLANK, L. T. and Tarquin (1995) Economic engineering. Ed.

McGraw-Hill.
6. CHAN S. Park (1997) Contemporary Economic Engineering. Ed.
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7. CHÚ RUBIO, Manuel (2002) Fundamentals of Finance, a Peruvian

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