Question

Firm B wants to hire Mrs. X to manage its advertising department. The firm offered Mrs. X a three-year employment contract under which it will pay her an $104,000 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 three-year period is 34 percent. Use Appendix A and Appendix a. Assuming an 8 percent discount rate for both Firm Band 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 O be increased to $164,000 and the salary payments for years 1 and 2 be reduced to $74,000. 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 $164,000 in year O but only $69,000 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 ($104,000 annually for three years)? d-1. Firm B responds to Mrs. X's request with a counterproposal. It will pay her $164,000 in year O but only $69,000 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? Complete this question by entering your answers in the tabs below. Reg A Req B Req C1 Req C2 Reg D1 Req D2 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. (Deductions and Cash Outflows should be entered with a minus sign. Round discount factor(s) to 3 decimal places, all other intermediate calculations and final answers to the nearest whole dollar amount. Enter tax rate in two decimals and not in percentage.) Show less A Year 0 Year 1 Year 2 Mrs. X Before-tax salary/income Marginal tax rate Tax on income

Answer 1

Req A
Mrs. X's NPV
Year	0	1	2
Salary	$1,04,000	$1,04,000	$1,04,000
Tax Rate	0.25	0.40	0.40
After Tax Salary	$78,000	$62,400	$62,400
PV Factor @ 8% (1/1.08^n)	1	0.926	0.857
NPV	$78,000	$57,778	$53,498	$1,89,276
Firm B's NPV
Year	0	1	2
Salary	-$1,04,000	-$1,04,000	-$1,04,000
Tax Rate	0.34	0.34	0.34
After Tax Salary	-$68,640	-$68,640	-$68,640
PV Factor @ 8% (1/1.08^n)	1	0.926	0.857
NPV	-$68,640	-$63,556	-$58,848	-$1,91,043
Req B
Mrs. X's NPV
Year	0	1	2
Salary	$1,64,000	$74,000	$74,000
Tax Rate	0.25	0.40	0.40
After Tax Salary	$1,23,000	$44,400	$44,400
PV Factor @ 8% (1/1.08^n)	1	0.926	0.857
NPV	$1,23,000	$41,111	$38,066	$2,02,177
Firm B's NPV
Year	0	1	2
Salary	-$1,64,000	-$74,000	-$74,000
Tax Rate	0.34	0.34	0.34
After Tax Salary	-$1,08,240	-$48,840	-$48,840
PV Factor @ 8% (1/1.08^n)	1	0.926	0.857
NPV	-$1,08,240	-$45,222	-$41,872	-$1,95,335
Req C1
Firm B's NPV
Year	0	1	2
Salary	-$1,64,000	-$69,000	-$69,000
Tax Rate	0.34	0.34	0.34
After Tax Salary	-$1,08,240	-$45,540	-$45,540
PV Factor @ 8% (1/1.08^n)	1	0.926	0.857
NPV	-$1,08,240	-$42,167	-$39,043	-$1,89,450
Req C2
Yes, the proposal is superior for Firm from it's original offer as the proposal has NPV of cashflow as $189450, which is less than the NPV of cashflow as $191043 for original offer.
Req D1
Mrs. X's NPV
Year	0	1	2
Salary	$1,64,000	$69,000	$69,000
Tax Rate	0.25	0.40	0.40
After Tax Salary	$1,23,000	$41,400	$41,400
PV Factor @ 8% (1/1.08^n)	1	0.926	0.857
NPV	$1,23,000	$38,333	$35,494	$1,96,827
Req D2
Mrs. X should accept the counter proposal as it has higher NPV of $196827 as compared to NPV of $ 189276 in the original offer.