1 Instructions You are the owner/operator of an aerospace business called Space Ace. Thanks to existing contracts with NASA, your business generates $10.5 million in yearly operating income. Recently, you decided to evaluate the implications of your organizational form, financing choice, and investment positions. Because of differences in personal liability and tax treatments, you want to understand the tradeoffs between organizing your business as a sole proprietorship versus a corporation. From the beginning, you have financed your business operations using 100% equity financing, but want to consider a mix of 60% equity and 40% debt financing. If your business uses debt, it will have a yearly interest expense of $1.05 million. In addition to the operating income, your business receives $144,000 in dividend income from an investment in FliHi Satellites and $59,000 in interest income from an investment in Ready Rockets, a primary supplier, bonds. You are the only owner of your business and the annual after-tax business income is your sole source of personal income. The corporate dividend income qualifies for the 50% dividend exclusion, the corporate income tax rate is 21%, individual personal income tax rates are in Table 1.2( 37% for this problem ) the personal capital gains tax rate is 20%, and net investment income tax rate is 3.8% on investment income exceeding $200,000.

1. Ignoring the investment income, calculate the total tax liability on Space Aces operating income, both as a sole proprietorship and a corporation, if its financed using 100% equity. What is the difference in your after-tax personal income?

2. Ignoring the investment income, calculate the total tax liability on Space Aces operating income, both as a sole proprietorship and a corporation, if its financed using 60% equity and 40% debt. What effect does using debt financing have the total tax liability for both the sole proprietorship and the corporation?

3. Calculate the total tax liability on all of Space Aces income, both as a sole proprietorship and a corporation, if its financed using 100% equity versus 60% equity and 40% debt. What are your observations?