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Raymond is a senior partner in a manufacturing firm and is approaching retirement age. In discussing 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-sharing agreement is as follows:
Component Raymond Other Partners
Salaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $125,000 $300,000
Bonus on income after the bonus . . . . . . .. . . 10% 0%
Percentage of remaining profits. . . . . . . . .. . . 40% 60%
The second alternative would consist of the following components:
1. A distribution of his share of current-year profits onMarch 31, 2016.
2. A distribution of his share of 2016–2017 profits on March 31 of each subsequent year. The profit-sharing agreement for 2016 and 2017 would be modified from the 2015 agreement as follows:
Component Raymond Other Partners
Salaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $80,000 $350,000
Bonus on income after the bonus . . . . . . . . . . 0% 10%
Percentage of remaining profits. . . . . . . . . . . . 20% 80%
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
Prepare a schedule that compares the two alternatives and expresses the respective cash flows in terms of their present value as of March 31, 2016, assuming an 8% discount rate.
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