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Firm B wants to hire Ms. Ali to manage its advertising department. The firm offered Ms. Ali a three-year employment contract under which it will
Firm B wants to hire Ms. Ali to manage its advertising department. The firm offered Ms. Ali a three-year employment contract under which it will pay her an $82,000 annual salary in years 0, 1, and 2. Ms. Ali's projected tax rate is 25 percent in year 0 and 43 percent rate in years 1 and 2. Firm B's tax rate for the three-year period is 34 percent. Use Appendix A and Appendix B.
Required:
- a. Assuming an 8 percent discount rate for both Firm B and Ms. Ali, compute the NPV of Ms. Ali'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, Ms. Ali requests that the salary payment for year 0 be increased to $145,000 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?
- c1. Firm B responds to Ms. Ali's request with a counterproposal. Firm B will pay Ms. Ali $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.
- c2. From the firm's perspective, is this proposal superior to its original offer ($80,000 annually for three years)?
- d1. Firm B responds to Ms. Ali'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 Ms. Ali's after-tax cash flow.
- d2. Should Ms. Ali accept the original offer or the counterproposal?
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