Question

11.26 It is late 2019, and you are a successful executive working in New York for a large company. Tomorrow morning you will have the opportunity to negotiate receiving a $100,000 bonus at the end of the year or an amount of deferred salary in three years. Both you and your employer can earn a before-tax rate of return of 10 percent. Your employer’s combined federal and state marginal tax rate is 25 percent and is expected to remain constant throughout the three-year period. Your combined state and federal marginal tax rate is 37%. However, you are being transferred to Florida (which does not have an individual income tax) at the beginning of next year. Accordingly, you expect your marginal tax rate to drop to 30 percent in 2020 and remain constant through 20200.

1. How much deferred salary would your employer be willing to pay you in three years?
2. How much deferred salary would you be willing to accept from your employer in three years?
3. What should you do?

Answer 1

Given data follows below :

Tomorrow morning you will have the opportunity to negotiate receiving a = $100,000

Both you and your employer can earn a before-tax rate of return of = 10 %

Employer’s combined federal and state marginal tax rate is = 25 %

Combined state and federal marginal tax rate is = 37%.

Expect your marginal tax rate to drop to = 30%

i)Calculating deferred salary would your employer be willing to pay you in three years

= $100,000 x 25% = $25000

= $100,000 - 25000 = $75,000

For 3 year rate of tax return = 6%

= $75,000(1.06)³

= $75,000 x 1.191916

=$89,393.92

Deferred salary

= $89,393.92 x ( 1/(1-0.25))

=$ $89,393.92 x 1.333333

=$119,191.89

$119,191.89 deferred salary would your employer be willing to pay you in three years.

b)Calculating deferred salary would you be willing to accept from your employer in three years

= $100,000 x 37% = $37000

= $100,000 - 37000 = $63,000

Interest rate

= $63,000(1.065)³

= $63,000 x 1.207949625

=$76,100.82

Marginal tax rate to drop to= 30 %

= $76,100.82 / (1-0.30)

= $76,100.82 / 0.70

=$108,715.45

$108,715.45 deferred salary would you be willing to accept from your employer in three years take 30%.

C)

$119,191.89 in three year  or $100,000 today. Like wise indifferent pertaining $108,715.45 or $100,000 today

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