Ashley runs a small business in Boulder, Colorado, that makes snow skis. She exp

Question

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 25% 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 2017, 0.8929; for 2018, 0.7972; and for 2019, 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 these 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 Ashley’s dividends that qualify for the 15% rate).

Explanation / Answer

Computation of PV of future cash flow for the three year period assuming ashley incorporates the business and pays all after tax income as dividends Corporate tax Liability Yr1 Yr2 Yr3 Sales $150,000 $320,000 $600,000 tax Free Interest 0 0 0 Cash Expense ($30,000) ($58,000) ($95,000) Depreciation ($25,000) ($20,000) ($40,000) Taxable Income $95,000 $242,000 $465,000 Tax Liability Minimum $13,750 $22,250 $113,900 Difference Amt TI-$75000*34% $6,800 TI-$100000*39% $55,380 TI-$335000*34% $44,200 $20,550 $77,630 $158,100 After Tax Cash Flows Yr1 Yr2 Yr3 Sales $150,000 $320,000 $600,000 tax Free Interest $5,000 $8,000 $15,000 Cash Expense ($30,000) ($58,000) ($95,000) Depreciation $0 $0 $0 Tax Liability ($20,550) ($77,630) ($158,100) After tax cash flow available as dividend $104,450 $192,370 $361,900 Tax on dividend@ 15% $15,668 $28,856 $54,285 After tax cash flow $88,783 $163,515 $307,615 PV factor $0.8929 $0.7972 $0.7118 PV 79274 130354 218960

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