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).

Answer 1

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