XYZ LLC is planning to purchase land and a commercial building for $200,000,000. An appraisal of the property has identified that 15% of the purchase price relates to land with the remaining relating to the building. A Cost Segregation Study (“Cost Seg”) was performed which showed that 90% of the building cost related to real property and that 8% and 2% related to 7 and 5 year personal property respectively. XYZ LLC plans to hold the property for 7 years and then sell it for $210,000,000. Calculate the after tax IRR assuming no cash flow other then tax savings from depreciation under two alternatives: 1) assuming no Cost Seg data is used to calculated depreciation and 2) Cost Seg data is used. Also, assume that when the personal property is sold that it will have no value.
Economic Gain – 10 million
Depreciation rates are as follows:
· Real Property – 39 year straight line
· 7 and 5 Year Personal Property – double declining with switch to straight line or:
7 Year Property 5 Year Property
1. 14.29% 1. 20%
2. 24.49% 2. 32%
3. 17.49 % 3. 19.2%
4. 12.49 % 4. 11.52%
5. 8.93 % 5. 11.5%
6. 8.92 % 6. 5.76%
Agatha is planning to start a new business venture and must decide whether to operate as a sole proprietorship or incorporate. She projects that the business will generate annual cash flow and taxable income of $100,000. Agatha’s personal marginal tax rate, given her other sources of income, is 35 percent.
Problem 2 (continued)
a. If Agatha operates the business as a sole proprietorship, calculate the annual after-tax cash flow available for reinvestment in the business venture.
b. If Agatha operates the business as a regular (C) corporation that makes no dividend distributions, calculate the annual after-tax cash flow available for reinvestment in the business.
c. Now suppose that Agatha wishes to withdraw $20,000 per year from the business, and will reinvest any remaining after-tax earnings. What are the tax consequences to Agatha and the business of such a withdrawal if the business is operated as a sole proprietorship? How much after-tax cash flow will remain for reinvestment in the business? How much after-tax cash flow will Agatha have from the withdrawal?
d. What are the tax consequences to Agatha and the business of a $20,000 withdrawal in the form of a dividend if the business is operated as a C corporation? How much after-tax cash flow will remain for reinvestment in the business? How much after-tax cash flow will Agatha retain from the dividend?
e. If Agatha wishes to operate the business as a corporation but also wishes to receive cash flow from the business each year, what would you recommend to get a better tax result?