Patton is considering joining Microtech Enterprises as a partner. The company provides data imaging for a variety of end users. Patton will have to contribute $100,000 of capital upon admission as a partner and will need to decide on a profit-sharing arrangement. Three alternatives are being proposed as follows:
Alternative A —Patton will be allocated a salary of $120,000, 10% of average capital after considering withdrawals, and 10% of net income. At the end of each calendar quarter, $30,000 will be distributed to Patton. No additional profits will be allocated to Patton.
Alternative B —Patton will be allocated a salary of $96,000, 10% of average capital after considering withdrawals in excess of $60,000, and a bonus of 10% of net income. At the end of the second, third, and fourth calendar quarters, Patton will receive a distribution of $24,000. At the end of the first quarter of the following year, Patton will receive a distribution of $60,000. No additional profits will be allocated to Patton.
Alternative C —Patton will be allocated a salary of $80,000 and 20% of net income. Patton will receive a distribution of $20,000 at the end of calendar quarters 1 through 3 and $80,000 at the end of quarter 4.
Patton has retained you to assist in evaluating the above alternatives and has asked you to assume that cash distributions could be reinvested at 6%. Furthermore, Patton believes that the probability of various levels of partnership income is as follows:
A 30% probability of $500,000 of income, a 50% probability of $560,000 of income, and a 20% probability of $600,000 of income.
Required
1. Prepare a schedule that evaluates the alternatives in terms of profitability and the present value of cash flows for the first year of the partnership.
2. Discuss which alternative you consider to be the most attractive.