Required information Pratt is ready to graduate and leave College Park. His futu

Question

Required information

Pratt is ready to graduate and leave College Park. His future employer (Ferndale Corp.) offers the following four compensation packages from which Pratt may choose. Pratt will start working for Ferndale on January 1, year 1.

  

Assume that the restricted stock is 1,000 shares that trade at $5 per share on the grant date (January 1, year 1) and are expected to be worth $10 per share on the vesting date at the end of year 1. Each NQO allows the employee to purchase 10 shares at a $5 strike price). The stock trades at $5 per share on the grant date (January 1, year 1) and is expected to be worth $10 per share on the vesting date at the end of year 1. Also assume that Pratt spends on average $3,000 on health-related costs that would be covered by insurance if he had coverage. Assume that Pratt’s marginal tax rate is 35 percent. Assume that Pratt spends $3,000 in after-tax dollars for health expenses when he doesn’t have health insurance coverage (treat this as an outflow), and that there is no effect when he has health insurance coverage. (Ignore FICA taxes and time value of money considerations). (Leave no answers blank. Enter zero if applicable.)

a. What is the after-tax value of each compensation package for year 1? (tax rates are 35%)

option 1    option 2     option 3    option 4

NQO's

taxable totals

tax rates

tax paid

cash paid at exercise

after-tax value

NQO's

after tax values

b. If Pratt’s sole consideration is maximizing after-tax value for year 1, which scheme should he select?

Option 1

Option 2

Option 3

Option 4

Benefit Description Option 1 Option 2 Option 3 Option 4 Salary $60,000 $ 50,000 $ 45,000 $ 45,000 Health insurance No coverage 5,000 5,000 5,000 Restricted stock 0 0 1,000 shares 0 NQOs 0 0 0 100 options

Explanation / Answer

Part A

Part B

If Pratt’s sole consideration is maximizing after-tax value for year 1, he should select option 1 because he maximizes his after tax value.

Description option 1 option 2 option 3 Salary 60000 50000 45000 Restricted stock 0 0 10000 Taxable income 60000 50000 55000 Tax rate 35% 35% 35% Tax paid 21000 17500 19250 After tax cash value 39000 32500 35750 NQO's 0 0 0 Health care expense 3000 0 0 After tax value 36000 32500 35750

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