Question

You’ve just accepted a lucrative consulting contract with a medium sized local manufacturing firm to help improve the efficiency of their manufacturing processes. The company has offered three different payment options for your consideration.

Option 1 (Fixed Salary): $79,400 per year with no annual raises

Option 2 (Increasing Salary): $72,250 for the first year with annual raises of 5% starting in year 2

Option 3 (Irregular Salary): Because of the irregular nature of the assignment, the company has offered to pay you a salary to reflect the intensity of the assigned tasks. They will give you $7500 signing bonus today, $70,000 in the first year, $92,000 in the second year, $65,000 in the third year, and $81,000 in the last two years of the contract.

Assume, initially, that your salary is to be paid only at the end of each year and that the prevailing interest rate is 9% compounded annually.

(a) Draw a cash flow diagram that corresponds to each of the three salary options.

(b) Which of the three options should you choose? Explain your choice and support it with numerical analysis.

(c) If each of these payment options are to be paid two times per month (bi-monthly) in equal installments, instead of the proposed one time per year, what would be the equivalent equal bi-monthly payments that you would receive under each salary option? [2 points] (d) You have estimated your living expenses (rent, food, gas, etc.) to be $3500 per bi-monthly pay period. What minimum annual salary would you need to receive (assume that you are paid in equal bi-monthly payments) to cover these expenses, assuming the interest rate stays the same?