1. Firm B wants to hire Mrs. X to manage its advertising department. The firm of
ID: 2342383 • Letter: 1
Question
1. 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 $80,000 annual salary in years 0, 1, and 2. Mrs. X projects that her salary will be taxed at a 25 percent rate in year 0 and a 40 percent rate in years 1 and 2. Firm B's tax rate for the three-year period is 34 percent. 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 0 be increased to $140,000 and the salary payments for years 1 and 2 be reduced to $50,000. How would this revision in the timing of the payments change your NPV computation for both parties? c. Firm B responds to Mrs. X's request with a counterproposal. It will pay her $140,000 in year 0 but only $45,000 in years 1 and 2. Compute the NPV of Firm B's after-tax cost under this proposal. From the firm's perspective, is this proposal superior to its original offer ($80,000 annually for three years)? d. Should Mrs. X accept the original offer or the counterproposal? Support your con- clusion with a comparison of the NPV of each offerExplanation / Answer
a Mrs X Firm B Year BTCF ATCF= BTCF(1-Tax) x Discount Factor at 8% =Present Value Year BTCF ATCF= BTCF(1-Tax) x Discount Factor at 8% =Present Value 0 80000 60000 1 60000 0 -80000 -52800 1 (52,800.00) 1 80000 48000 0.925925926 44444.44444 1 -80000 -52800 0.925926 (48,888.89) 2 80000 48000 0.85733882 41152.26337 2 -80000 -52800 0.857339 (45,267.49) NPV = sum total $ 145,596.71 NPV of cost = sum total $ (146,956.38) b Mrs X Firm B Year BTCF ATCF= BTCF(1-Tax) x Discount Factor at 8% =Present Value Year BTCF ATCF= BTCF(1-Tax) x Discount Factor at 8% =Present Value 0 140000 105000 1 105,000.00 0 -140000 -92400 1 (92,400.00) 1 50000 30000 0.925925926 27,777.78 1 -50000 -33000 0.925926 (30,555.56) 2 50000 30000 0.85733882 25,720.16 2 -50000 -33000 0.857339 (28,292.18) NPV = sum total $ 158,497.94 NPV of cost = sum total $ (151,247.74) c Mrs X Firm B Year BTCF ATCF= BTCF(1-Tax) x Discount Factor at 8% =Present Value Year BTCF ATCF= BTCF(1-Tax) x Discount Factor at 8% =Present Value 0 140000 105000 1 105,000.00 0 -140000 -92400 1 (92,400.00) 1 45000 27000 0.925925926 25,000.00 1 -45000 -29700 0.925926 (27,500.00) 2 45000 27000 0.85733882 23,148.15 2 -45000 -29700 0.857339 (25,462.96) NPV = sum total $ 153,148.15 NPV of cost = sum total $ (145,362.96) d Mrs X should accept counter proposal since NPV under counter proposal is higher than original offer. MRS X Firm B Original NPV $ 145,596.71 $ (146,956.38) Counter NPV $ 153,148.15 $ (145,362.96) Under Counter proposal both will be benefitted.
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