LO.3 In 2001, Xio and Xandra each invest $300,000 to create Xava Corporation. Xava develops and manufactures rock climbing and bungee jumping equipment. The business has become very profitable (it now is valued at $3 million), and Xandra would like to benefit from this profitability by selling the business. Xio, however, wants to reinvest the profitability and expand the business into ice diving. Because they have different expectations, Xio and Xandra agree that the best solution is to divide up the company.

Xandra will receive the bungee division; Xio, the rock climbing. After the reorganization, Xandra sells her stock in the bungee division for $1.5 million at the beginning of the current year. Xio retains her ownership of the rock climbing division.

a. What type of reorganization would be used to divide Xava Corporation between Xio and Xandra?

b. Xio sells the rock climbing stock for $2 million at the end of the six years. Using a 7%

discount factor, determine whether Xandra or Xio made a better decision. Assume that the tax on capital gains remains at its current rate. (Hint: Determine the present value of the after-tax cash flow for Xio and Xandra on the sale of the stock.)