Question

Problem 13-3

Problem 13-3 (LO 3, 4) Evaluating whether or not to continue to share profits. Raymond is a senior partner in a manufacturing firm and is approaching retirement age. In dis- cussing succession planning with the company partners, two alternatives have been presented to Raymond. The first alternative would call for Raymond to receive a distribution of his share of current-year 2015 profits on March 31, 2016, along with a lump sum payment of $1,500,000 for his capital balance. The 2015 profit-shar ing agreement is as follows: Com Other Partners 125,000 $300,000 Salaries Bonus on income after the bonus........... 10% 40% 0% 60% The second alternative would consist of the following components: 1. A distribution of his share of current-year profits on March 31, 2016 2. A distribution of his share of 2016-2017 profits on March 31 of each subsequent year. The for 2016 and 2017 would be modified from the 2015 agreement as profit-sharing agreement nd Other Partners $80,000 $350,000 Bonus on income after the bonus .......__ . . . . _ 0% 20% 10% 3. On March 31, 2018, Raymond would receive a lump sum payment of $1,700,000 for his interest in capital. In order for Raymond to make an informed decision he has come to you seeking your advice on which alternative to accept. Raymond believes that they can invest all cash proceeds at a rate of 8% compounded annually. It is anticipated that the partnership will have income for years 2015-2017 of $550,000, $605,000, and $682,000, respectively. ternatives and expresses the respective Prepare a schedule that compares the two al in terms of their present value as of March 31 , 2016, assuming an 8% discount rate. Required cash flows

Required:

1- Analysis of all alternatives with cash flow schedules

2- All notes

Thanks

Answer 1

Analysis of First Alternative Cash flow components Distribution of prior years 155,000 income (see Note A) Distribution of capital investment 155,000 1,500,000 1,500,000 8% return on proceeds see (Note B) Total Present value index Net present value $1,655,000 $132,400 $142,992 $1,930,392 0.9259 0.8573 0.7938 $1,532.365 $113,50Z $113.50Z Note A: ear 20X5-Allocation of Other Raymond PartnersTotal Cumulative Profit and loss percentage Salary 40% $125,000 60% S300,000 S425,000 Bonus (see below) Balance 50,000 475,000 550,000 Total Bonus 10% (Net Income-Bonus) 110% Bonus-10% ($550,000) 110% Bonus $55,000 Bonus $50,000

Analysis of Second Alternative Cash flow components Distribution of prior years income (see Note A) $155,000 $104,000S 118,000 $ 377,000 Distribution of capital investment. 1,700,000 1,700,000 8% return on proceeds see (Note B) Total $155,000 $116,400 $1,839,712 $2,111,112 Present value index Net present value 0.9259 0.8573 0.7938 Note A ear 20X6-Allocation Other Cumulative Raymond Partners 80% Profit and loss percentage Salary 20% $ 80,000 S350,000 S430,000 Bonus (see below) Balance 55,000 485,000 605,000 Total

Bonus-10% (Net Income-Bonus) 110% Bonus-10% ($605,000) 110% Bonus $60,500 Bonus $55,000

ear 20X7-Allocation of $68 Other Raymond PartnersTotal Cumulative 80% Profit and loss percentage.. Salary 20% S 80,000 S350,000 S430,000 Bonus (see below) Balance 62,000 492,000 682,000 Total Bonus 10% (Net Income-Bonus) 110% Bonus-10% ($682,000) 110% Bonus = $68,200 Bonus $62,000 Note B Interest Rate Amount Invested Return Year 20X6 20X7 8.0% 8.0 8.0 $12.400 $12,400 9.312 $155,000 155,000 116,400 2