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Problem
Profit allocation involving interest on capital balances. Rivera, Sampson, and Elliott are partners in a commercial plumbing business. Rivera and Sampson have also started another contracting company and have cash flow needs, which require periodic distributions from the partnership. In order to deal fairly with the level of part¬nership withdrawals, the partnership agreement calls for profit sharing as follows:
Component
Rivera
Sampson
Elliott
Salaries
$80,000
$100,000
Bonus on income after the bonus
0%
10%
Interest on "average net capital"
Percentage of remaining profits
30%
40%
Drawing Account
Beginning balance January 1
$
March 31 draws
30,000
40,000
June 30 draws
10,000
25,000
September 30 draws
20,000
50,000
Capital Account
Beginning balanceJanuary 1
70,000
March 31 anticipated profit allocation
March 31 capital investment
-
September 30 anticipated profit allocation
September 30 loan conversion
15,000
Sampson had loaned the partnership money in the past, and the transaction was properly classified as a loan payable on the statements of the partnership. On September 30, the loan and accrued interest totaling $15,000 were converted from a loan payable to a capital investment in the partnership.
Determine how the current-year profit of $330,000 is to be allocated among the partners.
Find the current value of the debt and the equity, and their required returns. Using those, find the firm's WACC, ignoring taxes.
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