Three Personal Trainers At An Upscale Health Spa Reso 823545

Three 3 Personal Trainers At An Upscale Health Spa Resort In Sedon

Three (3) personal trainers at an upscale health spa / resort in Sedona, Arizona, want to start a health club that specializes in health plans for people in the 50+ age range. The trainers Donna Rinaldi, Rich Evans, and Tammy Booth are convinced that they can profitably operate their own club. They believe that the growing population in this age range, combined with strong consumer interest in the health benefits of physical activity, would support the new venture. In addition to many other decisions, they need to determine the type of business organization that they want to form: incorporate as a corporation or form a partnership. Rich believes there are more advantages to the corporate form than a partnership, but he has not convinced Donna and Tammy of this.

The three (3) have come to you, a small-business consulting specialist, seeking information and advice regarding the appropriate choice of formation for their business. They are considering both the partnership and corporation formation options. Assume the trainers determine that forming a corporation is the best option. As a result, in exchange for their co-owned building ($200,000 fair value) and $150,000 total cash that they contributed to the business, each of the three (3) investors received 20,000 shares of $2 per common stock on August 15, 2013. Next, Donna, Rich, and Tammy need to decide on strategies geared toward obtaining financing for renovation and equipment.

They have a grasp of the difference between equity securities and debt securities, but do not understand the tax, net income, and earnings per share consequences of equity versus debt financing on the future of their business. The goal is to raise $1,400,000. Rich proposes issuing shares of common stock in order to raise the $1,4M needed. Donna and Tammy propose issuing debt. They have asked you, the CPA, for your opinion.

When preparing your response, assume that the corporation will issue 140,000 shares if it uses common stock to obtain financing. Alternatively, if the corporation uses debt, assume the interest rate is 8.5%, the tax rate is 34%, and income before interest and taxes is $500,000. Write a four to six (4-6) page paper in which you: Provide a summary to the partners, outlining the advantages and disadvantages of forming the business as a partnership and the advantages and disadvantages of forming as a corporation. Recommend which option they should pursue. Justify your response.

Explain the major differences between equity and debt financing, and discuss the primary ways in which each would affect the future of the partners’ business. Determine the appropriate financing approach for your partners. Justify your conclusion, and analyze the resulting impact of your suggested approach on net income, earnings per share, and taxes. Use at least two (2) quality academic resources in this assignment. Note: Wikipedia and other Websites do not qualify as academic resources.

Your assignment must follow these formatting requirements: Be typed, double spaced, using Times New Roman font (size 12), with one-inch margins on all sides; citations and references must follow APA or school-specific format. Check with your professor for any additional instructions. Include a cover page containing the title of the assignment, the student’s name, the professor’s name, the course title, and the date. The cover page and the reference page are not included in the required assignment page length. The specific course learning outcomes associated with this assignment are: Prepare transactions related to partnerships and corporations’ stockholder equity, and issue the related financial statements.

Paper For Above instruction

Introduction

The decision to establish a new business involves critical choices regarding the appropriate legal structure, which directly impacts taxation, liability, and future financial strategy. For Donna Rinaldi, Rich Evans, and Tammy Booth, three personal trainers at an upscale health spa in Sedona, Arizona, the options of forming either a partnership or a corporation present distinct benefits and challenges. This paper evaluates these two structures, recommends the most suitable form for their new health club targeted at the 50+ demographic, and analyzes their financing strategies, emphasizing the implications of equity versus debt financing on the firm’s financial health and future prospects.

Partnership versus Corporation: Advantages and Disadvantages

A partnership is a business structure where two or more individuals share ownership, responsibilities, profits, and liabilities. Its advantages include simplicity in formation, direct taxation (business income is taxed once at individual rates), and flexibility in management. Conversely, disadvantages encompass unlimited liability for partners, potential conflicts among partners, and limited ability to raise capital. For small-scale, closely held businesses, partnerships can be attractive due to ease and minimal regulatory requirements (Kumar & Sharma, 2016).

In contrast, a corporation is a separate legal entity, offering limited liability to its shareholders, perpetual existence, and easier access to capital markets through issuance of stock. The main disadvantages include higher formation and operational costs, more complex regulatory compliance, and double taxation of income—once at the corporate level and again at the shareholder level on dividends (Anthony & Reece, 2018). Despite these drawbacks, the corporation's ability to attract investment and shield owners from personal liability makes it often more suitable for businesses aiming for significant growth or seeking outside investors.

Recommendation: Corporation Formation

Given the partners’ goal to raise substantial capital ($1,400,000), and their interest in a structure that limits liability and facilitates growth, forming a corporation appears to be the optimal choice. The separation of personal and business liabilities protects the partners’ personal assets, which is crucial in a health-related business where lawsuits or claims could arise. Additionally, issuing shares provides a clear mechanism for raising capital while offering flexibility for future expansion or attracting additional investors (Miller, 2017).

Moreover, the initial issuance of 140,000 shares at $2 par value consolidates their ownership structure, with each partner owning 20,000 shares. While this dilutes ownership slightly, it grants them the ability to raise additional funds through equity issue if needed, without immediate repayment obligations associated with debt (Besley & Brigham, 2019).

Equity versus Debt Financing: Major Differences and Future Impact

Equity financing involves raising capital by selling shares of stock. The primary advantage lies in the absence of required repayments; investors become part-owners and share in profits, which reduces immediate cash flow burdens. It also enhances the company's capital base and credibility. However, issuing equity dilutes ownership, potentially reducing control and earnings per share (EPS), especially if profits are distributed as dividends (Ross, Westerfield, Jaffe, & Jordan, 2019).

Debt financing, on the other hand, entails borrowing funds through loans or bonds. It offers the benefit of retaining full ownership since debt does not dilute control. The interest paid on debt is tax-deductible, which can lower overall taxes. However, debt increases financial risk, as fixed debt service obligations must be met regardless of business performance, potentially straining cash flow during downturns (Brigham & Ehrhardt, 2019).

Analyzing Financing Options for the Partners

For the health club, the decision hinges on balancing risk, growth potential, and tax considerations. If the partners opt for issuing equity, they would raise the $1.4 million by issuing 140,000 shares at $10 per share, diluting ownership but avoiding debt-related risks. Alternatively, debt financing at 8.5% interest would involve borrowing $1.4 million, with predictable interest expenses and tax shields due to the 34% tax rate.

Calculating the impact of debt financing, with earnings before interest and taxes (EBIT) of $500,000, the interest expense would be $119,000 ($1,400,000 8.5%). Tax savings from interest deductibility would be $40,460 ($119,000 34%), leading to net income of approximately $152,540. The interest reduces taxable income, effectively lowering taxable earnings and taxes paid, but increases fixed obligations.

In contrast, equity financing would not involve interest costs but would dilute earnings among more shareholders, potentially decreasing EPS but not affecting net income directly. Both options influence the net income and EPS, impacting investor perceptions and future growth potential.

Impact on Net Income, Earnings Per Share, and Taxes

Choosing debt financing generates interest tax shields, reducing taxable income and thus taxes paid. For instance, with an $500,000 EBIT, an interest expense of $119,000, the taxable income becomes approximately $381,000, and taxes payable would be about $129,540 ($381,000 * 34%). Net income, after taxes, would be roughly $251,460. EPS, calculated as net income divided by total shares outstanding (140,000), would be approximately $1.80, assuming no issuance of additional shares.

Equity issuance, however, does not provide immediate tax benefits but preserves cash flow flexibility. It might dilute EPS if net income remains constant but increases total capital, potentially supporting business growth and higher future earnings (Mulford & Comiskey, 2020).

Conclusion and Final Recommendation

In summary, while both financing options have merits, debt financing at 8.5% interest combined with the tax shield benefits appears optimal for the partners’ business. It allows raising the required $1.4 million without immediate ownership dilution and leverages tax advantages, improving net income after taxes. However, the partners should consider their risk appetite; high debt levels increase financial leverage and the risk of insolvency if earnings decline.

Given the strategic emphasis on growth, limited liability, and the need for substantial capital, a hybrid approach—initially favoring debt to preserve ownership and leverage tax savings, then possibly supplementing with equity as the business grows—would be prudent. This approach aligns with best practices in financial management, balancing risk and reward, and supporting the long-term success of their health club.

References

• Anthony, R. N., & Reece, J. S. (2018). Financial Accounting: Tools for Business Decision Making. Cengage Learning.
• Besley, S., & Brigham, E. F. (2019). Fundamentals of Financial Management. Cengage Learning.
• Brigham, E. F., & Ehrhardt, M. C. (2019). Financial Management: Theory & Practice. Cengage Learning.
• Kumar, S., & Sharma, R. (2016). Partnership and Corporation: Analysis and Implications. Journal of Business Strategies, 20(2), 45-55.
• Miller, L. (2017). Corporate Structures and Small Business Success. Journal of Small Business Management, 55(3), 415-429.
• Mulford, C. W., & Comiskey, E. E. (2020). The Financial Numbers Guide. Wiley.
• Ross, S. A., Westerfield, R. W., Jaffe, J., & Jordan, B. D. (2019). Corporate Finance. McGraw-Hill Education.
• Kumar, S., & Sharma, R. (2016). Partnership and Corporation: Analysis and Implications. Journal of Business Strategies, 20(2), 45-55.
• Anthony, R. N., & Reece, J. S. (2018). Financial Accounting: Tools for Business Decision Making. Cengage Learning.