Question

Firm B wants to hire Mrs. X to manage its advertising department. The tirm offered Mrs. X a three-year employment contract under which it will pay her an $95,000 annual salary in years 0, 1, and 2. Mrs. X projects that her salary will be taxed at a 25 percent rate in year O 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 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 O be increased to $155,000 and the salary payments for years 1 and 2 be reduced to $65,000. 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 $155,000 in year O but only $60,000 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 ($95,000 annually for three years)? d-1. Firm B responds to Mrs. X's request with a counterproposal. It will pay her $155,000 in year O but only $60,000 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 D2 Req C1 Req C2 Req B Req A Req D1 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

Answer 1

a.						Year 0	Year 1	Year 2
	Mrs.X	Before-tax salary/income			a	95000	95000	95000
		Marginal tax rate			b	0.25	0.40	0.40
		Tax on income			c=a*b	23750	38000	38000
		Before-tax cashflow			d	95000	95000	95000
		Tax			e	-23750	-38000	-38000
		After-tax cashflow			f=d+e	71250	57000	57000
		Discount factor (8%)			g	1	0.926	0.857
		Present value			h=f*g	71250	52782	48849
		NPV of salary received by Mrs.X
		(Total of h)				172881
	Firm B	Before-tax deduction			a	95000	95000	95000
		Marginal tax rate			b	0.34	0.34	0.34
		Tax savings			c=a*b	32300	32300	32300
		Before-tax cash flow			d	-95000	-95000	-95000
		Tax savings			e	32300	32300	32300
		After-tax cash flow			f=d+e	-62700	-62700	-62700
		Discount factor (8%)			g	1	0.926	0.857
		Present value				-62700	-58060.2	-53733.9
		NPV of salary cost to Firm B			h=f*g
		(Total of h)				-174494
b.						Year 0	Year 1	Year 2
	Mrs.X	Before-tax salary/income			a	155000	65000	65000
		Marginal tax rate			b	0.25	0.40	0.40
		Tax on income			c=a*b	38750	26000	26000
		Before-tax cashflow			d	155000	65000	65000
		Tax			e	-38750	-26000	-26000
		After-tax cashflow			f=d+e	116250	39000	39000
		Discount factor (8%)			g	1	0.926	0.857
		Present value			h=f*g	116250	36114	33423
		NPV of salary received by Mrs.X
		(Total of h)				185787
	Firm B	Before-tax deduction			a	155000	65000	65000
		Marginal tax rate			b	0.34	0.34	0.34
		Tax savings			c=a*b	52700	22100	22100
		Before-tax cash flow			d	-155000	-65000	-65000
		Tax savings			e	52700	22100	22100
		After-tax cash flow			f=d+e	-102300	-42900	-42900
		Discount factor (8%)			g	1	0.926	0.857
		Present value				-102300	-39725.4	-36765
		NPV of salary cost to Firm B			h=f*g
		(Total of h)				-178791
c-1.						Year 0	Year 1	Year 2
	Firm B	Before-tax deduction			a	155000	60000	60000
		Marginal tax rate			b	0.34	0.34	0.34
		Tax savings			c=a*b	52700	20400	20400
		Before-tax cash flow			d	-155000	-60000	-60000
		Tax savings			e	52700	20400	20400
		After-tax cash flow			f=d+e	-102300	-39600	-39600
		Discount factor (8%)			g	1	0.926	0.857
		Present value				-102300	-36669.6	-33937
		NPV of salary cost to Firm B			h=f*g
		(Total of h)				-172907
c-2.	Yes.
	As per original offer NPV of salary cost is $ 174494
	As per the counter proposal NPV of salary cost is $ 172907
	So, Counter proposal is the best choice
d-1.						Year 0	Year 1	Year 2
	Mrs.X	Before-tax salary/income			a	155000	60000	60000
		Marginal tax rate			b	0.25	0.40	0.40
		Tax on income			c=a*b	38750	24000	24000
		Before-tax cashflow			d	155000	60000	60000
		Tax			e	-38750	-24000	-24000
		After-tax cashflow			f=d+e	116250	36000	36000
		Discount factor (8%)			g	1	0.926	0.857
		Present value			h=f*g	116250	33336	30852
		NPV of salary received by Mrs.X
		(Total of h)				180438
d-2.	Counter proposal
	NPV of the original offer is $ 172881
	NPV of the counter offer is $ 180438
	So, Counter proposal is the best choice