Three (3) personal trainers at an upscale health spa / resort in Sedona, Arizona, want to start a health club that specializes in health plans for people in the 50+ age range. The trainers Donna Rinaldi, Rich Evans, and Tammy Booth are convinced that they can profitably operate their own club. They believe that the growing population in this age range, combined with strong consumer interest in the health benefits of physical activity, would support the new venture. In addition to many other decisions, they need to determine the type of business organization that they want to form: incorporate as a corporation or form a partnership. Rich believes there are more advantages to the corporate form than a partnership, but he has not convinced Donna and Tammy of this. The three (3) have come to you, a small-business consulting specialist, seeking information and advice regarding the appropriate choice of formation for their business. They are considering both the partnership and corporation formation options.
Assume the trainers determine that forming a corporation is the best option. As a result, in exchange for their co-owned building ($200,000 fair value) and $150,000 total cash that they contributed to the business, each of the three (3) investors received 20,000 shares of $2 per common stock on August 15, 2013. Next, Donna, Rich, and Tammy need to decide on strategies geared toward obtaining financing for renovation and equipment. They have a grasp of the difference between equity securities and debt securities, but do not understand the tax, net income, and earnings per share consequences of equity versus debt financing on the future of their business. The goal is to raise $1,400,000. Rich proposes issuing shares of common stock in order to raise the $1,4M needed. Donna and Tammy propose issuing debt.
They have asked you, the CPA, for your opinion. When preparing your response, assume that the corporation will issue 140,000 shares if it uses common stock to obtain financing. Alternatively, if the corporation uses debt, assume the interest rate is 8.5%, the tax rate is 34%, and income before interest and taxes is $500,000.
Write a four to six (4-6) page paper in which you:
- Provide a summary to the partners, outlining the advantages and disadvantages of forming the business as a partnership and the advantages and disadvantages of forming as a corporation. Recommend which option they should pursue. Justify your response.
- Explain the major differences between equity and debt financing, and discuss the primary ways in which each would affect the future of the partners' business.
- Determine the appropriate financing approach for your partners. Justify your conclusion, and analyze the resulting impact of your suggested approach on net income, earnings per share, and taxes.
- Use at least two (2) quality academic resources in this assignment.