Financial Alternatives Financial Alternatives Facts Cecile one of the big shareholder, invests $100,000 for a sole ownership of stock in an S corporation. New food product development is ongoing in the corporation and Cecile expects that the business plan requires approximately $200,000 in capital, this will only be possible if all other prospected trades payable. The first $100,000 of this total is to come from Ceciles contributed capital while the remaining $100,000 of funds will come from other sources including: a. Corporation borrowing from local banks b. Borrowing from her late husband’s real estates c.
Borrowing from personal corporation funds From all the borrowed money, the corporation should pay interest at a rate accepted within each type of borrowing. Therefore, each of the borrowing mechanism deployed above, will attract different interest rates to the capital and the business itself including the accrued profit (Damodaran, 2012). For instance, personal income usually attract different tax rates and taxing systems compared to corporate financial incomes. Taxing Cecil’s Capital Contribution The cost of organizational capital is usually defined the cost that is payable in raising the funds and they include loaning from issuing bonds and bank loans.
Such terms of loans are usually attract annual percentage. The weighted average cost of capital (WACC) which is expressed as the arithmetic average of each source of capital by proportion of funding obtained from each source. Therefore; the borrowing from personal corporation funds will be taxed as ratio of the amount of each contributor. Nonetheless, such taxes are deducted on annual basis (Stickney, 2010). Moreover, it is worth noting that all these including Borrowing from her late husband’s real estate contributes to cost of debt and all these are subject to annual taxation.
The following rates and taxes will be incurred respective of each type and form of capital sources as was accrued by Cecile for her business. The yields of bonds before and after tax on the $100,000 pretax Organizational capital and personal corporation funds Federal interest before tax After tax Taxable loan $100,000 $69,200 Tax exemption $75,800 $75,000 Subsidy tax rate from Federal $40,800 Interest saving from S & L 24,200 Windfall to Cecil $16,600 Percentage of windfall 41 % Capital from bank Before tax interest After tax interest Taxable amount $100,000 $65,000 Tax exempts $75,800 $75,800 Subsidy from the federal taxation unit $35,000 Savings from the S $ L $24,200 Windfall to Cecil $10,800 Percentage windfall 31% From the above calculations, it is apparent that different sources of income attract different taxation rates.
In essence, funds obtained from bank and other financial institutions usually attract low tax rates compared to funds obtained from personal incomes. Therefore, it would be highly profiting for Cecil to obtain her capital from banks and other financial institutions that she does not have direct effect or contribution (Damodaran, 2012). However, the government usually give large subsidies to personal funds before taxing than on loan, but the same does not set off the interest rates attracted or subjected on these funds.
Hence, I strongly recommend for Cecil to consider borrowing her capital from institutions that will lead her to minimal taxation as opposed to personal funds that will never be profitable for he business (Stickney, 2010). References Damodaran, A. (2012). Investment valuation: Tools and techniques for determining the value of any asset. Hoboken, N.J: Wiley. Stickney, C. P. (2010). Financial accounting: An introduction to concepts, methods, and uses. Mason, OH: South-Western/Cengage Learning.