Problem 1-10 (LO. 4, 5)

Ashley runs a small business in Boulder, Colorado, that makes snow skis. She expects the business to grow substantially over the next three years. Because she is concerned about product liability and is planning to take the company public in year 2, she currently is considering incorporating the business. Pertinent financial data are as follows:

	Year 1	Year 2	Year 3
Sales revenue	$150,000	$320,000	$600,000
Tax-free interest income	5,000	8,000	15,000
Deductible cash expenses	30,000	58,000	95,000
Tax depreciation	25,000	20,000	40,000

Ashley expects her combined Federal and state marginal income tax rate to be 35% over the three years before any profits from the business are considered. Her after-tax cost of capital is 10%, and the related present value factors are: for 2016, 0.8929; for 2017, 0.7972; and for 2018, 0.7118.

Click here to access the tax table to use for this problem.

Enter all amounts as positive numbers. When required, round your answers to the nearest dollar.

a. Considering only this data, compute the present value of the future cash flows for the three-year period, assuming that Ashley incorporates the business and pays all after-tax income as dividends (for Ashleys dividends that qualify for the 15% rate).

	2016			2017			2018
Taxable income	$			$			$
Corporate tax liability	$			$			$
Cash available for dividends before taxes	$			$			$
Less: corporate tax liability	$			$			$
Equals: cash available for dividends after taxes	$			$			$
Less: tax on dividend at 15% rate	$			$			$
After-tax cash flow	$			$			$
Present value of cash flow	$			$			$

b. Considering only this data, compute the present value of the future cash flows for the period, assuming that Ashley continues to operate the business as a sole proprietorship.

	2016			2017			2018
Taxable income	$			$			$
Individual tax liability	$			$			$
Cash available for withdrawals before taxes	$			$			$
Less: individual tax liability	$			$			$
Equals: cash available for withdrawals after taxes	$			$			$
Present value of cash flow	$			$			$

c. Should Ashley incorporate the business in year 1?

Please show calculations.

Income Tax RatesCorporations Taxable income The Tax Is: But not Over- Of the Amount Over- Over- 0 50,000 75,000 100,000 335,000 10,000,000 15,000,000 18,333,333 $ 50,000 75,000 100,000 335,000 10,000,000 15,000,000 18,333,333 15% 7,500 + 25% 13,750 + 34% 22,250 + 39% 113,900 + 34% 3,400,000 + 35% 5,150,000 + 38% 35% 50,000 75,000 100,000 335,000 10,000,000 15,000,000