Dana Harbert recently started a very successful small business. Indeed, the business had grown so…

Dana Harbert recently started a very successful small business. Indeed, the business had grown so rapidly that she was no longer able to finance its operations by investing her own resources in the business. She needed additional capital but had no more of her own money to put into the business. A friend, Gene Watson, was willing to invest $100,000 in the business. Harbert estimated that with Watson’s investment, the company would be able to increase revenue by $40,000. Furthermore, she believed that operating expenses would increase by only 10 percent. Harbert and Watson agree that Watson’s investment should entitle him to receive a cash dividend equal to 20 percent of net income. A set of forecasted statements with and without Watson’s investment is presented here. (Assume that all transactions involving revenue, expense, and dividends are cash transactions.) The balance for assets in Forecast 1 is computed as the beginning balance of $365,000 plus net income of $35,000. The balance for assets in Forecast 2 is computed as the beginning balance of $365,000, plus the $100,000 cash investment, plus net income of $58,100, less the $11,620 dividend. Alternatively, total assets can be computed by determining the amount of total claims (total assets 5 total claims). Harbert tells Watson that there would be a $3,486 tax advantage associated with debt financing. She says that if Watson is willing to become a creditor instead of an owner, she could pay him an additional $697.20