Marla recently inherited $50,000 and is considering two alternatives for investing these funds. Investment A is stock of a C corporation, expected to pay annual dividends of 8 percent. Investment B is stock of an S corporation. Based on income projections, Marla's share of the S corporation's ordinary income would be approximately $10,000 per year. However, the S corporation does not expect to make cash distributions for the foreseeable future. Marla would hold either investment for three years, at which time she believes the C corporation stock could be sold for $60,000 and the S corporation stock could be sold for $90,000.
Marla recently inherited $50,000 and is considering two alternatives for investing these funds. Investment A is stock of a C corporation, expected to pay annual dividends of 8 percent. Investment B is stock of an S corporation. Based on income projections, Marla's share of the S corporation's ordinary income would be approximately $10,000 per year. However, the S corporation does not expect to make cash distributions for the foreseeable future. Marla would hold either investment for three years, at which time she believes the C corporation stock could be sold for $60,000 and the S corporation stock could be sold for $90,000.
Chapter1: Financial Statements And Business Decisions
Section: Chapter Questions
Problem 1Q
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Transcribed Image Text:Marla recently inherited $50,000 and is considering two alternatives for investing these funds. Investment A is stock
of a C corporation, expected to pay annual dividends of 8 percent. Investment B is stock of an S corporation. Based
on income projections, Marla's share of the S corporation's ordinary income would be approximately $10,000 per year.
However, the S corporation does not expect to make cash distributions for the foreseeable future. Marla would hold
either investment for three years, at which time she believes the C corporation stock could be sold for $60,000 and
the S corporation stock could be sold for $90,000.
Assume that the initial investment would be made in year 0, dividends on the C corporation stock would be received
in years 1, 2, and 3; S corporation earnings would be allocated in years 1, 2, and 3; and either investment would be
sold in year 3. Assume that Marla's S corporation income would not qualify for the QBI deduction. Also assume that
Marla's marginal tax rate on ordinary income is 35 percent. Use Appendix A.
a. Using a 4 percent discount rate, calculate the net present value of after-tax cash flows attributable to either
investment. Assume a 15% rate on capital gains and dividends.
b. Which investment she should choose?

Transcribed Image Text:Complete this question by entering your answers in the tabs below.
Required A Required B
Using a 4 percent discount rate, calculate the net present value of after-tax cash flows attributable to either investment.
Assume a 15% rate on capital gains and dividends. Use appropriate factors from the Appendix A. (Cash outflows should be
indicated by a minus sign. Round intermediate calculations to the nearest whole dollar amount.)
Investment A
Before-tax cash flows
Tax (cost) or savings
After-tax cash flows
NPV
Investment B
Before-tax cash flows
Tax (cost) or savings
After-tax cash flows
NPV
Year 0
$ (50,000)
$
Year 0
0
Year 1
Year 1
Year 2
Year 2
Year 3
Year 3
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