Question

XYZ Corporation has a deferred compensation plan under which it allows certain employees to defer up to 20 percent of their salary for five years. For purposes of this problem, ignore payroll taxes in your computations. (Round your intermediate calculations and final answers to the nearest whole dollar amount.)

a. Assume XYZ has a marginal tax rate of 21 percent for the foreseeable future and earns an after-tax rate of return of 9 percent on its assets. Joel Johnson, XYZ’s VP of finance, is attempting to determine what amount of deferred compensation XYZ should be willing to pay in five years that would make XYZ indifferent between paying the current salary of $13,100 and paying the deferred compensation. What amount of deferred compensation would accomplish this objective?

b. Assume Julie, an XYZ employee, has the option of participating in XYZ’s deferred compensation plan. Julie’s marginal tax rate is 37 percent and she expects the rate to remain constant over the next five years. Julie is trying to decide how much deferred compensation she will need to receive from XYZ in five years to make her indifferent between receiving the current salary of $13,100 and receiving the deferred compensation payment. If Julie takes the salary, she will invest it in a taxable corporate bond paying interest at 5 percent annually (after taxes). What amount of deferred compensation would accomplish this objective?

Answer 1