You are an accountant who has been approached by two people, Bill and Steve, for some advice. Bill and Steve are planning to open a furniture store in Toronto. They plan to rent a showroom in downtown Toronto as well as a larger warehouse in Mississauga where they will store their inventory. The warehouse will store inventory which will be purchased from both local vendors and from manufacturers in Europe. They anticipate that it will cost about $200,000 to start the business. Each of the partners has $50,000 of capital to contribute to the business. They will share the duties of running the business and will share the profits equally. They plan to take about 80% of the profits out of the business each year and use the remaining 20% to expand their business. Bill took some business courses in college and has some basic knowledge of business and accounting. Steve is an interior designer who has never operated a business, and does not know anything about accounting. They have asked you to help them with some accounting issues. You are required to write a memo explaining the issues raised by Bill and Steve and how you suggest that they proceed.
a) Steve suggested that they set the company up as a partnership. Bill recalls that there are some advantages to setting up a corporation instead of a partnership. Explain the advantages (and disadvantages) of setting up a corporation versus a partnership and discuss which form of organization you suggest.
b) After the partners contribute their $100,000 of capital (combined) they will need to raise an additional $100,000 to start the business. They know some investors who are interested in investing equity in the business. Alternatively, their bank will lend them $100,000 at 6% interest, to be repaid in 60 monthly installments (i.e. 5 years). Discuss the relative benefits and risks of using debt versus equity. Assuming the Bill and Steve anticipate earning enough money to cover the principal and interest payments, which alternative would you suggest?
c) As part of the start-up, they will need two trucks to deliver furniture throughout Toronto. Steve wants to buy 2 brand new Ford trucks, but Bill suggested that they might wish to lease the trucks. The lease he is reviewing would be an eight-year lease. The trucks have a useful life of years. Discuss the benefits of leasing, and what type of lease would this be. Do you suggest leasing or buying the trucks? Why?
Please prepare a proper memo addressed to Bill and Steve that effectively answers these issues and provide recommendations as appropriate. Remember that Steve does not understand accounting, so make sure that your memo can be understood by a layperson.