Question

Use intuition to decide which of the following you would prefer: (a) a salary of $35,000 per year with no raises for 10 years or (b) a salary of $32,000 per year with annual raises of 3% per year of each of the next 10 years. Explain the reason for your choice.

Answer 1

The excel calculates the cumulative salary in the two situations. The discounting for the salary cash flows has not been done because both will be discounted at the same rate hence, not creating a difference in the choice.

As it can be seen that the second alternative where there is a possibility of salary raise, gives a better sum than the one with no increse. The reasons for the same:

A. Although the first alternative starts with a higher salary but the second alternative has the compounding impact which increases the salary increased in the later years.

B. Also, the increased in the salary will also be helpful if we consider inflation. As inflation increases your purchasing power with the first alternative will only reduce. however, in second alternative the increase will help to nullify the impact of inflation to some extend.

C. The additional income can be invested in instruments which are giving higher returns hence, a means of additional income.