10. LO.5, 6 Ashley runs a small business 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 25% over the three years before any profits from the business are considered.
Assume that the corporation will face a flat 21% Federal corporate income tax and no state income tax. Ashley’s after-tax cost of capital is 12%.

a. Considering only these data, construct a spreadsheet to 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 Ashley’s dividends that qualify for the 15% rate).

b. Considering only these 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.

c. Should Ashley incorporate the business in year 1? Why or why not?