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 $105,000 annual salary in years 0, 1, and 2. Mrs. X projects that her salary will be taxed at a 25 percent rate in year and a 40 percent rate in years 1 and 2. Firm B's tax rate for the three-year period is 30 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 $80,000. 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 $75,000 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 ($105,000 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 $75,000 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. Req A ReqB Reg ci Reg C2 Reg Di 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 Mrs. X $ Before-tax salary income Marginal tax rate Tax on income Year 105,000 $ 0.25 26.25015 Year 1 105,000 $ 0.40 42.000ls Year 2 105,000 0.40 42.000 $

Answer 1

here given that annual salary = $105,000

discount rate @ 8 %

tax rate for Mrs X = year 0 = 25 % tax rate for firm = 30 %

year 1& 2 = 40 %

solution a  

Mrs X

calculation of after tax cash flow

year	before tax cash flow	tax rate	after tax cash flow(before tax cash flowx(1-tax rate)
0	105,000	25	78,750
1	105,000	40	63,000
2	105,000	40	63,000

calculation of NPV of after tax cash flow

year	After Tax cash flow	pv @8	NPV
0	78,750	1	78,750.0
1	63,000	0.92	57,960
2	63,000	0.86	54,180
TOTAL	1,90,890

FIRM B

After tax cash flow = before tax cash flow x(1- t)

= 105,000(1-.30)

    =73,500

year	After Tax cash flow	pv @8	NPV
0	73,500	1	73,500
1	73,500	0.92	67620
2	73,500	0.86	63210
TOTAL	2,04,330

solution b

Mrs X

calculation of after tax cash flow

year	before tax cash flow	tax rate	after tax cash flow(before tax cash flowx(1-tax rate)
0	155,000	25	1,16,250
1	80,000	40	48,000
2	80,000	40	48,000

calculation of NPV of after tax cash flow

year	After Tax cash flow	pv @8	NPV
0	1,16,250	1	1,16,250
1	48,000	0.92	44,160
2	48,000	0.86	41,280
TOTAL	2,01,690

FIRM B

AFTER TAX CASH FLOW

year	before tax cash flow	tax rate	after tax cash flow(before tax cash flowx(1-tax rate)
0	155,000	30	108,500
1	80,000	30	56,000
2	80,000	30	56,000

year	After Tax cash flow	pv @8	NPV
0	108,500	1	108,500
1	56,000	0.92	51,520
2	56,000	0.86	48,160
TOTAL	2,08,180