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galina1969
4 days ago
11

Pratt is ready to graduate and leave College Park. His future employer (Ferndale Corp.) offers the following four compensation p

ackages from which Pratt may choose. Pratt will start working for Ferndale on January 1, year 1. 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 NQO's 0 0 0 100 options Assume that the restricted stock is 1,000 shares that trade at $5 per share on the grant date (January 1, year 1); shares are expected to be worth $10 per share on the vesting date at the end of year 1; and no 83(b) election is made. Assume that the NQOs (100 options) each allows the employee to purchase 10 shares at $5 exercise 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, and the options are exercised and sold at the end of the year. Also assume that Pratt spends on average $3,000 on health-related costs that will be covered by insurance if he had coverage or is an after-tax expense if he isn't covered by insurance (treat this as a cash outflow). Assume that Pratt’s marginal tax rate is 35 percent. (Ignore FICA taxes and time value of money considerations). What is the after-tax value of each compensation package for year 1? If Pratt’s sole consideration is maximizing after-tax value for year 1, which scheme should he select?
Business
1 answer:
Nady [3.2K]4 days ago
5 0
A. Option 1 After-tax value of the Compensation Package is $36,000. Option 2 After-tax value of the Compensation Package is $32,500. Option 3 After-tax value of the Compensation Package is $35,750. Option 4 After-tax value of the Compensation Package is $35,750. B. Option 1 Now, let's calculate the after-tax value for each compensation package for the initial year: OPTION 1 COMPENSATION PACKAGE: Salary: $60,000 Restricted Stock: $0 Taxable Total: $60,000 Tax Rate: 35% Tax Paid: ($21,000) After-tax cash value: $39,000 Health care expenses: ($3,000) Final After-tax value: $36,000. Thus, Option 1 provides an After-tax value of $36,000. OPTION 2 COMPENSATION PACKAGE: Salary: $50,000 Restricted Stock: $0 Taxable Total: $50,000 Tax Rate: 35% Tax Paid: ($17,500) After-tax cash value: $32,500 Health care expenses: ($0) Final After-tax value: $32,500. Thus, Option 2 results in an After-tax value of $32,500. OPTION 3 COMPENSATION PACKAGE: Salary: $45,000 Restricted Stock: $10,000 Taxable Total: $55,000 Tax Rate: 35% Tax Paid: ($19,250) After-tax cash value: $35,750 Health care expenses: ($0) Final After-tax value: $35,750. Thus, Option 3 leads to an After-tax value of $35,750. OPTION 4 COMPENSATION PACKAGE: Salary: $45,000 NQO's: $10,000 Taxable Total: $55,000 Tax Rate: 35% Tax Paid: ($19,250) After-tax cash value: $35,750 Health care expenses: ($0) Final After-tax value: $35,750. Thus, Option 4 also results in an After-tax value of $35,750. Therefore, when focusing solely on maximizing after-tax value for year 1, Option 1 is the best choice at $36,000.
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