Question

I need help with #10 A-C

Supplemental Exercises/Problems Note: These activities are for readers who have an understanding of financial statements] 10. (Income Taxes and Ratios Francine Delgado has developed a business plan for producing and selling a new hair care product that emits nutrients to the scalp when used. The product residues have been iudged to be environmentally safe. Following are her proiected partial financial statements for the first three years of operation of HairCare Products Company. Francine, however, is unsure whether to orga- nize her business as a proprietorship or a regular corporation. HAIRCARE PRODUCTS COMPANY PROJECTED PARTIAL INCOME STATEMENTS & BALANCE SHEETS YEAR 1 YEAR 3 YEAR 2 $400.000 200,000 200,000 100,000 Sales Cost of goods sold Gross profit Operating expenses Depreciation Earnings before interest and taxes Interest Earnings before taxes Taxes Net income $200,000 100,000 100,000 75.000 4,000 21,000 1,000 20,000 $1,800,000 800,000 1.000.000 200,000 20,000 780,000 4.000 775,000 3.000 92,000 2000 90.000

Answer 1

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Answer (a):

First, we complete the income statement to find Taxes and net Income

Year 2 Item Year 1 Year 3 Sales $400,000 -$200,000 $200,000 $1,800,000 -$800,000 $1,000,000 -$200,000 -$20,000 $780,000 -$4,000 $776,000 -$263,840 $200,000 -$100,000 $100,000 -$75,000 COGS Gross Profit Operating Expenses Depreciation EBIT -$100,000 -$8,000 $92,000 -$2,000 $90,000 -$18,850 $71,150 -$4,000 $21,000 -$1,000 $20,000 Interest EBT Taxes -$3,000 $17,000 Net Income $512,160

The taxes for each year are evaluated from the tax schedules given below:

Tax on Corporations 15% Taxable Income $1 - $50000 $50001 - $75000 $75001 - $100000 $100001 - $335000 $335001 - $776000 Total $7,500 $6,250 $8,500 $7,500 $6,250 $5,100 $3,000 24% 34% 39% $91,650 $149,940 $263,840 34% $3,000 $18,850

Answer (b):

Similary, for the second case when the company is organized as proprietorship

Item Year 1 Year 3 Year 2 Sales COGS $200,000 $400,000 $1,800,000| -$100,000 -$200,000| -$800,000 $200,000 $1,000,000 -$75,000 -$100,000| -$200,000 -$8,000 $92,000 -$2,000 $90,000 -$18,920 $71,080 $100,000 Gross Profit Operating Expenses Depreciation EBIT -$4,000 $21,000| -$1,000 $20,000| -$2,583 $17,418 -$20,000 $780,000 -$4,000 $776,000 -$249,284 $526,717 Interest EBT Taxes Net Income

The tax schedules for this case as given below:

Tax on Corporations Taxable Income Tax on first $8,350 Additional taxes: ($20,000 - $8,350)(0.15) $835 $1,748 Tax on first $82,250 Additional taxes: ($90,000 - $82,250)(0.28) $16,750 $2,170 Tax on first $372,950 Additional taxes: ($776,000 - $372,950)(0.35) Total $108,216 $141,068 $249,284 $18,920 $2,583

Answer (c):

Ratios for two cases for company as corporation and Propreitorship (ROA and Profit Margin)

Corporation:

Return on Assets = Net Profit/Total Assets Year 1= $17,000/$100,000 = 17.00% Year 2 = $71,150/$200,000 = 35.58% Year 3 = $512,160/$800,000 = 64.02% Net Profit Margin = Net Profit/Revenues Year 1 = $17,000/$200,000 = 8.50% Year 2 = $71,150/$400,000 = 17.79% Year 3 = $71,150/$400,000 = 17.79% Asset Intensity = Revenues/Total Assets Year 1 = $200,000/$100,000 = 2.00 Year 2 = $400,000/$200,000 = 2.00 Year 3 = $1,800,000/$800,000 = 2.25

Propreitorship:

Return on Assets = Net Profit/Total Assets Year 1 = $17,417.50/$100,000 = 17.42% Year 2 = $71,080/$200,000 = 35.54% Year 3 = $526,716.50/$800,000 = 65.84% Net Profit Margin = Net Profit/Revenues Year 1 = $17,417.50/$200,000 = 8.71% Year 2 = $71,080/$400,000 = 17.77% Year 3 = $526,716.50/$1,800,000 = 29.26% Asset Intensity = Revenues/Total Assets Year 1 = $200,000/$100,000 = 2.00 Year 2 = $400,000/$200,000 = 2.00 Year 3 = $1,800,000/$800,000 = 2.25

Answer (d):

One of the major sources of finance for Francine Deldago is by borrowing funds from close relatives, friends and family since it's her own firm. Other sources include funds from Angel investors, raising private equity from venture capitalists etc. The projected financials from abover are stable and healthy which increases the chance of getting funds from external sources.

Answer (e):

Initially the company should be formed as a corporation, becasue the advantage that the organization gets from tax liability and ROA in corporation terms is on a higher side (From above statements).

In the future, as the firm grows it can be later changed to a proprietorship structure as we can see profit margins are doubling year on year.