Question

Firm B wants to hire Mrs. X to manage its advertising department. The firm offered Mrs. X a 3-year employment contract under which it will pay her an $67,500 annual salary in years 0, 1, and 2. Mrs. X projects that her salary will be taxed at a 25 percent rate in year 0 and a 40 percent rate in years 1 and 2. Firm B’s tax rate for the 3-year period is 35 percent. Use Appendix A and Appendix B. a. Assuming an 8 percent discount rate for both Firm B and Mrs. X, compute the NPV of Mrs. X’s after-tax cash flow from the employment contract and Firm B’s after-tax cost of the employment contract. b. To reduce her tax cost, Mrs. X requests that the salary payment for year 0 be increased to $107,500 and the salary payments for years 1 and 2 be reduced to $47,500. How would this revision in the timing of the payments change your NPV computation for both parties? c-1. Firm B responds to Mrs. X’s request with a counterproposal. It will pay her $107,500 in year 0 but only $42,500 in years 1 and 2. Compute the NPV of Firm B’s after-tax cost under this proposal. c-2. From the firm’s perspective, is this proposal superior to its original offer ($67,500 annually for three years)? d-1. Firm B responds to Mrs. X’s request with a counterproposal. It will pay her $107,500 in year 0 but only $42,500 in years 1 and 2. Complete the below table to calculate the NPV of Mrs. X’s after-tax cash flow. d-2. Should Mrs. X accept the original offer or the counterproposal?

Answer 1

Part A.

Part B

Part c-1

Part C-2

This counter offer made by the Firm is better than the original offer because it results in after tax outflow of 110313, as compared to the 113070 in firm offer. Its thus superior for the firm than the original offer.

Part D-1 is same as part c-1 question.

Part D-2. Mrs. X should accept the counter proposal because it will generate her better inflow because of the tax savings.