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:
1. 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.
2. 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.
3. Calculate the following ratios for each year and interpret them:
o Return on assets
o Net profit margin
o Asset intensity
4. Joe's firm will need to acquire assets in order to support the projected revenue growth. How would you recommend Joe finance these assets?
5. Do you recommend that Joe form a corporation or a sole proprietorship? Justify your answer.