Chapter 3: Organizing and Financing A New Venture
47
6. [Income Taxes] In the second year of operation, the Capital-Ideas Company forecasts
revenues to grow to $5 million dollars, and expenses before income tax to be 70 percent
of revenues. Rework Parts A, B, and C of Problem 5 to reflect this new level of revenues
and expenses.
A. Earnings before taxes = $5,000,000 x (1 – 0.70) = $1,500,000. Taxed as a
proprietorship filing as a single tax payer.
Dollar
Marginal
Amount
Over But not over
Amount
Tax Rate
of Taxes
–
9,525
9,525
10.0%
952.50
9,525
38,700
29,175
12.0%
3,501.00
82,500
43,800
22.0%
9,636.00
75,000
24.0%
42,500
32.0%
300,000
35.0%
37.0%
$520,689.50
B. Taxed as a corporation.
Amount
Over But not over
Amount
Tax Rate
of Taxes
–
9,525
9,525
10.0%
952.50
9,525
38,700
12.0%
82,500
22.0%
24.0%
32.0%
35.0%
8
Chapter 3: Organizing and Financing A New Venture
48
C. Corporate Level: $1,500,000 (taxable income) – $315,000 (income taxes) =
$1,185,000 after-tax net income)
Personal Level: $1,185,000 in dividend income
7. [Income Taxes] Rolf Lee is now exploring whether it might be better to organize the
Capital-Ideas Company as a subchapter S corporation based on information contained in
Problem 5.
A. Calculate the amount of federal income tax that Capital-Ideas Company would pay
next year.
A Subchapter S corporation has the same tax liability as a proprietorship. Therefore,
B. What would be the marginal tax rate on the last dollar of taxable income and what
would be the average tax rate?
A Subchapter S corporation has the same tax liability as a proprietorship. Therefore,
8. [Income Taxes] Rolf Lee is also considering organizing the Capital-Ideas Company as a
limited liability company.
A. Use information contained in Problem 6 to estimate the federal income tax liability in
the second year of operation if Capital-Ideas is an LLC.
Chapter 3: Organizing and Financing A New Venture
49
A limited liability company (LLC) has the same tax liability as a proprietorship.
Therefore, the federal income tax liability will be $520,689.50 (see Part A of Problem
6 for calculations).
B. What would be the marginal tax rate on the last dollar of taxable income and what
would be the average tax rate?
A limited liability corporation (LLC) has the same tax liability as a proprietorship.
9. [Intellectual Property] Francine Delgado, founder of the HairCare Products Company,
has developed HairCarePlus which is a shampoo product containing healthy nutrients
that are absorbed through the scalp when the product is used. She also believes that
preliminary tests of HairCarePlus show that product residues are environmentally safe.
A. Francine was wondering whether she might be able to patent the HairCarePlus
product. What are the characteristics of patents and what type of patent, if any,
might Francine seek?
Francine can certainly apply to receive patent protection. However, in order to obtain
B. What other ways, other than through patents, might Francine explore to try to protect
the HairCarePlus product?
To further protect her product, she may also attempt to obtain a copyright for the
SUPPLEMENTAL EXERCISES/PROBLEMS
Chapter 3: Organizing and Financing A New Venture
50
[Note: These activities are for readers with an existing 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
A. Use the tax rate schedules presented in the chapter to estimate the dollar amount of
taxes that would have to be paid in each year by the HairCare Products Company if
the venture was initially formed as a corporation. Also calculate the after-tax net
income for each year.
YEAR 1
Flat Corp.
Taxable Income
Tax Rate
Tax Payable
Net Income
Chapter 3: Organizing and Financing A New Venture
51
90,000
21.0%
18,900.00
21.0%
162,960.00
Total Tax
Total Tax
B. Use the tax rate schedules presented in the chapter to estimate the dollar amount of
taxes that would have to be paid in each year if the HairCare Products Company was
organized as a proprietorship, represented Francine’s only source of income, and she
was single. Also calculate the after-tax net income for each year.
Year 1: Earnings before taxes = $20,000
From Table A: Tax on first $9,525 x .10 = $952.50
C. Use ratios from Chapter 2 to calculate the return on assets (ROA) model and its net
profit margin and asset intensity ratios.
Assuming Taxed as a Corporation:
Return on Assets = Net Profit/Total Assets
YEAR 1 = $15,800/$100,000 = 15.80%
Chapter 3: Organizing and Financing A New Venture
52
YEAR 2 = $71,100/$400,000 = 17.78%
YEAR 3 = $613,040/$1,800,000 = 34.06%
Assuming Taxed as a Proprietorship:
Return on Assets = Net Profit/Total Assets
YEAR 1 = $17,790.50/$100,000 = 17.79%
YEAR 2 = $74,110.50/$200,000 = 37.06%
D. In order to grow sales, HairCare Products will need to invest in assets to support
sales growth. How might the venture’s assets be financed?
Since this is a development stage firm that is about to enter its startup stage, Francine
E. Would you recommend that the HairCare Products Company be initially formed as a
proprietorship or as a corporation? Why? Should Francine consider changing the
form of business organization for the HairCare Products Company as the firm grows
over time?
By forming the business as a proprietorship, Francine may incur a lower tax liability
when the firm is in its startup stage. Based on the 2018 income tax laws, personal
Chapter 3: Organizing and Financing A New Venture
53
11. [Income Taxes and Ratios] Now let’s assume that Francine Delgado (see Problem 10)
organizes the HairCare Products Company as a proprietorship, is married, and files a
joint tax return with her husband, Franco.
A. Calculate the tax liability (using tax tables presented in the chapter) and net income
in each of the three years for the HairCare Products Company assuming no other
personal income or deductions.
Year 1: Earnings before taxes = $20,000
From Table A: Tax on first $19,050 = $1,905.00
B. For this proprietorship scenario, calculate and make ratio comparisons with the
calculations in Part C of Problem 10.
Return on Assets = Net Profit/Total Assets
YEAR 1 = $17,981.00/$100,000 = 17.98%
Chapter 3: Organizing and Financing A New Venture
54
C. Would you recommend that the venture be organized as a proprietorship or as a
regular corporation? Why?
By forming the business as a proprietorship, Francine may incur a lower tax liability
when the firm is in its startup stage. However, if she has substantial personal assets,
D. What other forms of business organization might Francine consider when forming the
HairCare Products Company? What are their pros and cons?
Francine might consider forming her business as an S corporation or limited liability
MINI CASE 1: INTERACT SYSTEMS, INC. (REVISITED)
Interact Systems, Inc. has developed software tools that help hotel chains solve application
integration problems. Interact’s Application Integration Server (AIS) provides a two-way
interface between central reservations systems (CRS) and property management systems (PMS).
All reservation traffic is routed from the CRS to individual hotel properties. This allows
Interact Systems to create a database that can be used to track customers and to facilitate
marketing programs, such as frequent stay or VIP programs, as a way of increasing customer
satisfaction. Interact forecasts application integration expenditures in the hospitality industry to
exceed $1 billion by 2021.
A. What are the advantages of having formed the company as a corporation?
Chapter 3: Organizing and Financing A New Venture
55
An important advantage relates to investor liability whereby liability is limited to
B. What other organizational structures would have been appropriate?
Interact Systems might also have been organized as a Subchapter S (or just S) corporation or
C. Could Interact Systems qualify for S corporation status with the IRS? Why or why not?
Probably yes. An S corporation must have 100 or fewer owners (the previous limit was less
than 75 owners). This is not likely a constraint for Interact Systems as long as very large
D. What is the intellectual property involved in Interact Systems’ business model?
Interact Systems has developed software tools and programs that help hotel chains solve
application integration problems through its Application Integration Server (AIS). The AIS
E. What methods of protection are available for Interact Systems’ intellectual property?
Intellectual property can be protected through (a) patents, (b) trade secrets, (c) trademarks,
and (d) copyrights. Interact Systems might be able to seek “utility” patents on its computer
F. What considerations are important in deciding whether to use an employment contract for
the newly hired CEO?
Chapter 3: Organizing and Financing A New Venture
56
Eric Westskow joined Interact as CEO and president in early 2018. Greg Thomas had
founded Interact Systems in 2015 and was responsible for developing the venture’s software
MINI CASE 2: COOPERATIVE CONSTRUCTS
PART A
Several years ago, Dick and Barbara Harris were asked to attend an organizational meeting for a
newly-forming neighborhood baby-sitting cooperative. The idea was simple. Concerned and
caring parents would join together in the cooperative and exchange baby sitting services.
Although they were not particularly interested in committing to trading baby sitting favors as
their children were quickly approaching the age where babysitting services would be
unnecessary, Dick and Barbara felt socially obliged to attend the meeting with their two children.
Eight other families came to the meeting.
Reflecting on some bad previous experiences with not-for-profit organizations, the
couple debated on the drive home what could be done to satisfy their concerns. Dick was
wondering how the organization could formally barter services among themselves without
A. What type of an organization is necessary for the babysitting cooperative?
Chapter 3: Organizing and Financing A New Venture
57
Although it is possible that the informally organized cooperative might be deemed an
B. Is there potential for liability for members other than those directly involved?
There is almost always potential liability for members unless they have organized in such a
way to limit such liability. Of particular concern here is that members are performing a
C. What are the non-tax differences between exchanging poker chips and charging $4 per hour?
The currency (poker chip) is really just a type of accounting for a joint liability of the many
to the individual chip owner. It acts as a medium of exchange only for babysitting services.
D. What is the difference between exchanging poker chips and charging $4 per hour from the
perspective of the Internal Revenue Service (IRS)?
E. Assuming you had appropriately aged children, would you be willing to join the cooperative?
Answers will vary according to students’ understanding of the problem and the issues.
F. What, if any, are the intellectual property issues in an isolated cooperative?
Chapter 3: Organizing and Financing A New Venture
58
PART B
The organizers for Dick and Barbara’s cooperative had great success and many inquiries from
other neighborhoods on how to organize and operate. After helping several other groups
organize, the time commitment grew to the point where the organizers decided to form a
A. Discuss different organizational structures for Cooperative Constructs and their
(dis)advantages.
In this phase of CC’s execution, it is even more critical that it be formally organized. It is
B. Identify the Cooperative Construct’s intellectual property.
Clearly, the cooperative’s techniques, videos, materials and even approach are all aspects of
C. What intellectual property protection is appropriate for their materials, organization name,
and approach?
Presumably, the videos and written materials would be easy to copyright. The entity and