How would you select an organizational form for a business? Think about this question as you read the following scenario.
Joe Jones has created a business plan for a new product. He is not certain whether to organize his business as a regular corporation or a sole proprietorship. The following are his forecasted partial financial statements for the first four years of operation of the new venture named Uncle Joe's.
Forecasted partial Income Statement:
|
|
Year 1
|
Year 2
|
Year 3
|
Year 4
|
|
Sales
|
$15,000
|
$18,000
|
$23,400
|
$44,460
|
|
Cost of goods sold
|
8,000
|
10,000
|
15,000
|
21,000
|
|
Gross profit
|
7,000
|
8,000
|
8,400
|
23,460
|
|
Operating expenses
|
3,000
|
4,500
|
4,900
|
12,000
|
|
Interest
|
800
|
1,800
|
2,100
|
4,100
|
|
Earnings before taxes
|
2,200
|
2,700
|
2,800
|
7,900
|
|
Taxes
|
?
|
?
|
?
|
?
|
|
Net Income
|
?
|
?
|
?
|
?
|
Forecasted Balance Sheet:
|
|
Year 1
|
Year 2
|
Year 3
|
Year 4
|
|
Cash and inventories
|
$30,000
|
$45,000
|
$67,500
|
$101,250
|
|
Building and equipment
|
25,000
|
32,500
|
42,250
|
54,925
|
|
Total assets
|
55,000
|
77,500
|
109,750
|
156,175
|
Corporate Income Tax Schedule:
|
Taxable Income
|
Marginal Tax Rate
|
|
$1-30,000
|
10%
|
|
30,001-100,000
|
18
|
|
100,001-400,000
|
23
|
|
400,001-5,000,000
|
30
|
|
Over 5,000,000
|
40
|
Personal Income Tax Schedule:
|
Taxable Income
|
Marginal Tax Rate
|
|
$1-5,000
|
8%
|
|
5,001-20,000
|
12
|
|
20,001-60,000
|
19
|
|
60,001-180,000
|
25
|
|
Over 180,000
|
33
|
Using the information on Uncle Joes' finances, answer the following questions:
- Calculate the net income earned and the taxes that would have to be paid in each year if the new venture is formed as a corporation.
- Calculate the net income earned and the taxes that would have to be paid in each year if the new venture is formed as a sole proprietorship.
- Calculate the following ratios for each year and interpret them:
- Return on assets
- Net profit margin
- Asset intensity
- Joe's firm will need to acquire assets in order to support the projected revenue growth. How would you recommend Joe finance these assets?
Do you recommend that Joe form a corporation or a sole proprietorship? Justify your answer