After-tax Basis Research Articles

An Analysis Of Alternative Methods Of Calculating Tax-Adjusted Awards

Abstract No abstract available.

The discount rate for a power station

The British electricity supply industry evaluates investment proposals by discounting pre-tax cash flows at a specified required rate of return, currently 5% in real terms. After privatization, the industry will have to judge investments on an after-tax basis. In this paper we estimate a market-determined required rate of return for investment in new power stations, and conclude that the after-tax rate should be about 11%. The equivalent pre-tax rate is significantly higher than this. Use of such a discount rate increases the attractiveness of coal-fired stations, and British nuclear stations appear to be uneconomic.

A Model for Assessing Investments in Intensive Grazing Technology

The financial profitability of intensive grazing management techniques such as short duration grazing (SDG) and the Savory Grazing Management (SGM) has received very little attention in the range management or economics literature. Most research has emphasized variables which measure technical rather than economic efficiency. A conceptual economic model is presented which illustrates the importance of the management factor in determining the optimal stocking rate and profitability of cell grazing practices. Empirical results yield internal rates of return on an after-tax basis for a SlO,OOO grazing cell for 11-4095 assuming cow herd productivity is maintained at, or increased above, pre-adoption levels. As cell costs increase and stocking rates increase, ranch profitability declines and increases respectively in almost all cases. The principal determinant of long-run profits is found to be livestock productivity since this factor has a greater impact on profitability than stocking rate levels or cell investment costs. Increased stocking rates with intensive grazing technology do not insure Increased profits unless concurrent improvement in range, livestock, and business management practices are adopted.

The Effects of Inflation and Income Taxes on Interest Rates: Some New Evidence

This paper reexamines the empirical relation between inflation and interest rates concentrating on the tax effect proposed by Darby and Feldstein. Using the random walk intercept model, relative responses of taxable yields and tax-exempt yields to expected infla? tion are estimated. The results show that for the sample period 1953-1982, the nominal yields on Treasury bills rise at a rate greater than one-for-one with expected inflation, while the nominal yields on default-free municipal bonds rise approximately one-for-one with expected inflation. Thus, the tax-adjusted Fisher hypothesis by Darby and Feldstein is empirically supported. The components of Treasury bills are also extracted and their variances are compared. It is shown that variation of expected inflation is not overwhelmingly larger than that of the after-tax real rate. Therefore, on an after-tax basis, changes in the real rate explain a substantial portion of changes in the nominal rate of interest.

Inflation and the Capital Budgeting Process

Abstract Cash flow analysis under conditions of inflation is discussed by addressing the analysis and application of general and real price changes in forestry investment decisions. Terms required for understanding and undertaking such analyses are defined. Cash flow analyses can be conducted using the current or constant dollar approaches and on before- or after-tax bases. Inflation should be accounted for in analyses conducted on an after-tax basis which include depreciation expenses or depletion allowances. Tables of formulae are presented that modify the traditional, well-known valuation formulas by incorporating general and real price changes.

Efficient portfolio choice with differential taxation of dividends and capital gains

Abstract A simple, necessary and sufficient condition is derived under which portfolios that are mean-variance efficient on a before-tax basis are also efficient on an after-tax basis and vice-versa. Under this condition and the hypothesis that investors demand after-tax efficient portfolios, the ‘no-tax’ form of the Capital Asset Pricing Model provides an accurate description of equilibrium asset returns even though investors in the economy may be subject to a wide variety of tax rates on dividends and capital gains. Evidence reported by Black and Scholes (1974), however, makes the condition for equivalence of before and after-tax efficiency empirically implausible. The paper thus concludes with a characterization of some essential differences between before and after-tax efficient portfolios and of the after-tax efficiency losses associated with before-tax efficient portfolios. The relation of these results to the issue of corporate dividend policy choices is also discussed.

Optimizing the Profitability of Matrix Acidizing Treatments

Described here is a mathematical model for optimizing the profitability of matrix acidizing treatments for both oil and gas wells, with or without prorationing. The model allows its user to determine whether the economic prorationing. The model allows its user to determine whether the economic potential of an unstimulated well can be increased by acidizing and to potential of an unstimulated well can be increased by acidizing and to select the most profitable treatment design from a number of alternatives. Introduction Over the years, well stimulation research has concentrated mainly on developing advanced matrix acidizing, and fracturing techniques, with less attention given to economic optimization of such treatments. We describe here a mathematical model for optimizing profitability of matrix acidizing treatments for both oil and gas wells, with or without prorationing. This model, in essence, allows its user todetermine whether the economic potential of an unstimulated well can be increased by matrix acidizing andselect the most profitable treatment design from a number of alternatives. Maximum present worth (with the discount rate specified by the user) is the criterion for optimum treatment design. As an alternative, the user may, for instance, maximize the ratio of present worth to treatment cost. Either way, the model analyzes cash flow on an after-tax basis and takes into account all relevant costs, royalties, and depletion and timing effects, as well as the effect of wellbore damage or previous stimulation. Other advantages of this model are thatwell production rates can be increased as a result of more production rates can be increased as a result of more efficient treatment design,treatment costs can be reduced when acid reactivity is a limiting constraint on treatment size,the most profitable cases can be selected from among a number of wells that could be profitably treated,unprofitable treatments can be identified, andworkover budgets can be more easily formulated. General Scheme The profitability of matrix acidizing treatments is determined using relationship between stimulated well performance and treatment size (cost). The present worth for a given well can be calculated for present worth for a given well can be calculated for a given acid formulation as a function of acid volume. For hypothetical treatments using small volumes of acid, the predicted improvement in production capacity (and present worth) increases rapidly with small incremental increases in treatment volume. At some point, increasing the acid volume no longer provides sufficient improvement in well productivity and the present worth decreases from its maximum. The present worth decreases from its maximum. The optimum treatment represents a level of stimulation severity at which the last increment of cost earns a rate of return equal to the discount rate (Fig. 1). The model presented here equates maximum present worth with economic optimization; however, the economic indicators of the total project for example, discounted cash flow rate of return, incremental reserves due to stimulation, profit ratio, and payout are calculated to provide the basis for a decision on whether or not to stimulate the well. Assumptions Assumptions used as a basis for the model are listed below. These conditions do not limit the analytical scheme and can be modified by the user to accommodate the latest stimulation technology. 1. Acid penetrates the matrix uniformly and radially. JPT P. 1055

Analysis of Appalachian Basin Economics

With improved wellhead prices, substantial risk capital is now available for developing modest per-well reserves in the Appalachian Basin. The leasing of tangible well equipment can, in instances where wells are better than marginal, provide additional economic incentives by improving the discounted cash flow rate of return. Introduction The increase in oil and gas drilling activity in the Appalachian Basin continues unabated and shows signs of gaining strength. This can be attributed directly to the improvement in realized prices for oil and gas that has occurred during the past 18 to 36 months. Risk capital is being attracted to the Basin, particularly through drilling funds and other types of particularly through drilling funds and other types of joint ventures. The concept of direct leasing of tangible well equipment has also been introduced in an attempt to spread the risk capital over more wells and to enhance the total investment profitability. An analysis of average oil and gas well profitability, on both a before-tax and an after-tax basis, is generally very favorable. The leasing of tangible well equipment, however, is attractive principally on an after-tax basis and only in terms of improving the discounted cash flow rate of return. Considerations in Determining Appalachian Basin Investments and Profitability In undertaking an analysis of Appalachian Basin economics, several key factors must be recognized. It seems to have become fashionable in the literature of the industry to present somewhat academic dissertations on methods of profitability analysis that invariably get into the question of the ranking of investment opportunity. Certainly at the major-company level such rankings have validity. The fact remains, however, that the vast majority of wells drilled in this country are drilled by independents and many of those are small operators. The average company or individual considering drilling a well in Armstrong County, Pa., does not have, as a practical matter, the alternative of putting the same dollars in a North Sea or Gulf of Mexico or Indonesian venture. For many, this may not be all bad. Attractive factors in the Appalachian area include modest costs of acquiring oil and gas leases; reasonable drilling expenses; few drilling problems in terms of depth or pressures; rapid evaluation of a given prospect, especially if drilled by a rotary rig; unusually low dry-hole risk, although substantial small- or marginal-well risk exists; good wellhead price for both oil and gas; immediate access to markets; and few if any restrictions on rates of production. The matter to be considered here is not whether or not to invest in the Appalachian area, but rather what the profitability of the investment might turn out to be. Therefore, certain methods of measuring profitability for investment opportunity ranking are profitability for investment opportunity ranking are generally not applicable. For example, the concept of discounting profit at the average investment opportunity rate is an abstraction for the small operator in the Appalachian area since his only other investment opportunity may be a savings account at the local bank. Even the idea of measuring everything against his "cost of money" may not be entirely valid. JPT P. 717

Real Estate Investment and Portfolio Theory

This paper has shown that the models developed to select common stock port-folios can be adapted to the selection of real estate portfolios and mixed asset portfolios. The concepts are all identical, and as long as return and risk can be quantified, the problems are soluble.The portfolios identified using a small sample indicate that real estate portfolios can have more return and less risk than do common stock portfolios. When the two assets are combined, the real estate assets dominate the resultant portfolios. On an after-tax basis these results are more apparent. The local aspect of real estate versus the national aspect of common stocks is primarily responsible for these results.

A MARGINAL ANALYSIS OF THE BENEFIT-COST RELATIONSHIPS OF EXECUTIVE COMPENSATION PLANS*

CORPORATIONS typically employ a variety of devices to remunerate executive talent. The purpose of this study is to identify the reward and cost associated with each plan in the executive-compensation package and to compare pay plans in terms of their relative cost efficiency. All comparisons are made on an after-tax basis, to recognize explicitly the differences in tax treatment of the various plans and the progressive nature of personal taxes. In addition, comparisons involving differences in timing employ a discounted-cash-flow computational framework. Additional adjustments in the calculations recognize the possibility of the employee's death before receipt of deferred rewards and the uncertain nature of stock-based remuneration. The expected after-tax present value of the relevant monetary flows forms the basis for comparison on both the benefit and cost side of the transaction. The analysis is performed in two distinct phases. First, the benefit-cost relationship for each of a series of pay plans is expressed in equation form and analyzed in detail with a sensitivity analysis to identify the relative importance of parameters such as age, subjective opportunity rates, and marginal tax rates in each set of equations. A set of typical pay plans is then compared on the basis of their cost efficiency in rewarding a group of typical corporate executives. The analysis is extended to consider the possibility of allowing the executive to select his own benefit package from a set of equal-cost pay plans. In addition, the analysis considers the tax implications of executive pay by tracing the effect on federal tax revenues of an increment to the executive's reward under each pay plan. The study was conducted prior to the 1969 tax-reform legislation and hence is based on the prior tax law. The new tax treatment of many pay alternatives, while altering the absolute values of benefit and cost, changes the conclusions based on relative costs very little. The results of the analysis indicate that the lowest cost per dollar of reward in the compensation package is achieved by pay plans that provide for the deferral of payment until retirement. The advantage of such plans lies in their potential for tax savings either as a result of favorable tax treatment granted to a particular plan or the more-general tax savings promised by the lower tax rates expected to apply to income in the post-retirement years. In addition, since the firm normally has opportunities for investment which promise returns in excess of the returns available to individuals, deferral has a higher value to the firm than its corresponding cost to the employee. Salary and bonus, the traditional remuneration plans that predominate in realworld pay packages, are found to be generally inefficient in providing a low-cost package of rewards. Their importance in the pay package, therefore, appears to be primarily a function of such considerations as the practical need of the employee for current cash. Stock options and other equity-based pay plans are found to be very inefficient in economic terms. Since lower-cost compensation plans can be designed to provide

The Taxation of Capital Gains: Reply

I welcome the opportunity to amplify the purpose and details of my proposal. My purpose was to develop a simple approximative procedure for avoiding the taxation of inflationary gains and removing the lock-in effect. In the interests of brevity, I did not consider what marginal tax rate would be used nor whether the interest rate used to accumulate the tax liabilities ought to be on a before-tax or on an after-tax basis. Dr Shibata has suggested that separate marginal tax rates ought to be used for each year during which the asset is held, and that, if interest on money borrowed to pay taxes were tax-deductible, one ought to put the interest rate on an after-tax basis. If both marginal tax rates and the after-tax borrowing rates were given separate values for each year within the asset holder's period, the calculation formulae for my procedure would become more complicated, and the relevant taxable amount could no longer be read from a simple two-dimensional table. Dr Shibata is right to emphasize that whether or not his amendments to my procedure are worth making depends on the differences they would make to the amount of tax payable. These differences ought to be looked at in relation to the greater costs of calculation using his amended version of my proposal. In general, I would suppose that any tax system which was attempting to treat capital gains equivalently to other forms of income would also embody good income averaging procedures. If so, then there would be little inter-temporal variation in marginal tax rates to worry about. If there were not good income-averaging provisions, taxpayers would schedule their asset sales in order to help average out income fluctuations if the entire gain were put into taxable income of the year of sale. In order to avoid this undesirable trading purely for tax reasons, I would recommend that the marginal rate applicable to realized gains (as calculated by my procedure) should be the individual's average marginal rate over the holding period, or over a specified number of past years. This is very much a second-best procedure, however, as it would be much simpler and more appropriate to have good averaging provisions for all sorts of income. I agree with Dr Shibata that the interest rate assumed in my procedure should be on an after-tax basis if interest on money borrowed to pay taxes were tax-deductible. The arbitrary interest rate would just be equal to the assumed typical market rate times one minus a typical marginal tax rate. Whether it is worthwhile making Shibata's amendment making year-to-year changes in the marginal tax rate used in defining the after-tax borrowing rate depends, as before, on how good are the income-averaging provisions. Even though Dr Shibata's amendments would be unnecessary in a tax system with good income-averaging provisions, it is worthwhile to consider

Investment Decisions in Petroleum Exploration and Production

NORTHERN, IAN G., SOCONY MOBIL OIL CO., NEW YORK, N.Y. MEMBER AIME Abstract Economic evaluation in the exploration and production end of the petroleum industry is quite different because we are dealing with an industry in which both the diversity and extent of the technical and environmental risk is frequently greater than in most other forms of business enterprise. With this in mind, four profit indicators are discussed, with their short-comings and advantages. Payout time, undiscounted profit ratio, discounted cash flow rate of return and present value ratio or present value profit ratio are the four methods discussed with application to an actual development drilling case history. Allowances for the risk involved in development drilling and production are also discussed. Introduction A business historian writing a number of years from now might well look back to the middle years of the twentieth century and label them "the age of evaluation". Only a few years ago evaluation procedures that are in common use today were the somewhat mysterious preserve of financial institutions and theoretical economists. The process of translation from theory to business application has not always been easy, nor is the process of change complete. Though our industry has developed a broad base of evaluation know-how, I think it is a fair assumption that the application of economics and mathematics to the field of business management is still in an expanding phase, and that certain aids to judgment will become more effective with time. Greater effectiveness does not imply intricacy and involvement. A sound evaluation policy need not be complex. With a proper understanding of concepts, techniques and limitations, the extent to which individual evaluations should be carried and the particular characteristics that should be captured in profit indicator form become more a matter of common sense than of going by the book. Whatever form evaluation progress adopts, however, the underlying facts of life as far as the exploration and production business is concerned will remain essentially unchanged. We are dealing with a branch of the petroleum industry in which both the diversity and extent of technical and environmental risk is frequently greater than in most other forms of business enterprise. Therefore, as others have done before, let me emphasize that recourse to formal project evaluation cannot eliminate uncertainty and risk. What it can and should do is permit orderly consideration of the factors that are pertinent to an investment opportunity and produce a brief economic point of reference for management decisions. Evaluation Criteria Right at the outset, I would like to discard from general application in an exploration and producing setting all those profitability measures that fall under the heading of accounting methods. In this category I include all criteria that involve investment and/or income averaging to produce a percentage return on investment figure. Though these older evaluation methods may have utility under conditions of more or less equal project life and level income stream between competing projects, neither of these conditions is met in the usual range of exploration and producing investment opportunities. Instead, I would like to focus on four profit indicators that I believe do have utility in our end of the business. These are:1. Payout timea measure of the length of time required foraccumulated net earnings from a project toequal the amount of project investment;2. Undiscounted profit ratio a simple expression ofultimate net profit returned by a venture as amultiple of the total investment in that venture;3. Discounted cash-flow rate of returnthe constantrate of interest that can be earned on outstandingproject investment while permitting exact amortizationof the full amount invested over the project's usefullife; and4. Present value ratio or present value profit ratioaratio of project revenue to investment or project profitto investment, with both investment and income reducedto present value terms at a predetermined rate of interest. I propose to enlarge upon these concepts by drawing upon an actual development drilling case history. This case history involves 40 separate development drilling proposals, each one evaluated on an after-tax basis, and each without bearing any part of prior exploration expenditure. JPT P. 727ˆ