Ashley runs a small business, in Boulder Colorado. 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 is considering incorporating the business.The financial data is as follows: Year 1 - Sales revenue = 150,000 tax-free interest= 5,000 deductible cash expenses= 30,000 tax depreciation= 25,000 Year 2 sales revenue= 320,000 tax-free interest= 8,000 deductible cash expenses= 58,000 tax depreciation= 20,000 Year 3 sales revenue= 600,000 tax free interest= 15,000 deductible cash expenses= 95,000 tax depreciation= 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 12%.
a) Considering only this data, compute the present value of the future cash flows for the three-year period, assuming 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 this data, compute the present value of the future cash flows for the period, assuming Ashley continues to operate the business as a sole proprietorship.
c) Should Ashley incorporate the business in year 1? Why or why not?