1 Firm B wants to hire Mrs. X to manage its advertising department. The firm off
ID: 2365768 • 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 0,1 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 employment contract. b To reduce her tax cost, Mrs. X requests that the salary payment for year 0 be increase $140,000 and the salary payments for year 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 counter proposal. 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 (80,000 annually for three years") d Should Mrs. X accepts the original offer or the counter proposal ? support your conclusion with a comparison of the NPV of each other.Explanation / Answer
a)
Mrs. X
P.V. = (1-0.08)*80000*{(1+i)-0 + (1+i)-1 + (1+i)-2} , where i = 0.08 i.e. discount rate
= 0.92*80000*2.78
= $204848
Firm B
P.V. = (1-0.34)*80000*{(1+i)-0 + (1+i)-1 + (1+i)-2} , where i = 0.08 i.e. discount rate
= 0.66*80000*2.78
= $146956
b)
Mrs. X
P.V. = (1-0.08)[140000*(1+i)-0 + 50000*(1+i)-1 + 50000*(1+i)-2} , where i = 0.08 i.e. discount rate
= 0.92*229063.24
= $210830
Firm B
P.V. = (1-0.34)[140000*(1+i)-0 + 50000*(1+i)-1 + 50000*(1+i)-2} , where i = 0.08 i.e. discount rate
= 0.66*229063.24
= $151247.74
c)
Mrs. X
P.V. = (1-0.08)[140000*(1+i)-0 + 45000*(1+i)-1 + 50000*(1+i)-2} , where i = 0.08 i.e. discount rate
= 0.92*220246.91
= $202627
Firm B
P.V. = (1-0.34)[140000*(1+i)-0 + 45000*(1+i)-1 + 50000*(1+i)-2} , where i = 0.08 i.e. discount rate
= 0.66*220246.91
= $145362.96
d)
SHE SHOULD NOT ACCEPT THE OFFER AS THE N.P.V. IS THE WORST IN ALL THE 3 SCENARIOS.
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