Question: The ABC Corporation is considering a joint venture with another company to start an Internet-based business. The new business will tap into the expertise ABC has developed in writing the complex software algorithms the firm uses to schedule and manage its complex manufacturing and distribution processes. Each entity is required to initially contribute $20 million for a 50% share in the joint venture. As with most Internet-based businesses, the joint-venture partners do not expect to earn positive profits for the foreseeable future.
a. Discuss the pros and cons of the alternative organizational firms that the joint venture might take. In your discussion, consider both the tax and nontax costs and benefits of the alternatives. Note that to file a consolidated tax return (that is, to include another company on ABC's tax return), a corporation must own at least 80% of the voting shares of the other corporation (compared to only 50% for financial accounting purposes). Which organizational form would you recommend the joint venture use?
b. In contributing the $20 million, ABC is considering two options:
i. the entire amount contributed as equity, or
ii. $10 million treated as equity with the remaining $10 million being treated as a note payable with annual interest rate of 10%.
Evaluate these two options.
When the joint venture eventually becomes profitable (in year 10), the business is expected to earn approximately 20% pretax per year. The joint venture is not expected to pay any dividends, and ABC expects to liquidate its position 20 years from today. It also expects to face the top corporate tax rate of 35% in each of the next 20 years. Finally, assume ABC's investment of $20 million in the joint venture was all equity
c. If the joint venture is organized as a C corporation, what is the expected annual after-tax return to ABC?
d. If the joint venture is organized as a limited liability company, what is the expected annual after-tax return to ABC?