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 35% 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 2016, 0.8929; for 2017, 0.7972; and for 2018, 0.7118.
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Enter all amounts as positive numbers. When required, round your answers to the nearest dollar.
a. Considering only this 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).
2016 2017 2018
Taxable income $ $ $
Corporate tax liability $ $ $
Cash available for dividends before taxes $ $ $
Less: corporate tax liability $ $ $
Equals: cash available for dividends aftertaxes $ $ $
Less: tax on dividend at 15% rate $ $ $
After-tax cash flow $ $ $
Present value of cash flow $ $ $
b. Considering only this data, compute the present value of the future cash flows for the period, assuming that Ashley continues to operate the business as a sole proprietorship.