Question

7. Ramon has finally arrived. He has interviewed for the CEO position with MMM Corporation. They have presented him with two alternative compensation offers. Alternative 1 is for a straight salary of $2,515,000. Option 2 is for a salary of $1,015,000 and performance-based compensation of up to $2,000,000. Assume that Ramon has a marginal tax rate of 40 percent and MMM has a marginal tax rate of 35 percent. Answer the questions under each of the following alternative scenarios.

c. What is MMM’s after-tax cost of providing Ramon with Option 1?

After-tax cost

?

d. What is MMM’s expected after-tax cost of providing Ramon with Option 2 if it believes there is a 40 percent chance Ramon will qualify for the performance-based compensation?

Expected after-tax cost

?

9. Nicole’s employer, Poe Corporation, provides her with an automobile allowance of $40,500 every other year. Her marginal tax rate is 30 percent. Poe Corporation has a marginal tax rate of 35 percent. Answer the following questions relating to this fringe benefit.

a. What is Nicole’s after-tax benefit if she receives the allowance this year?

After-tax benefit

?

b. What is Poe’s after-tax cost of providing the auto allowance?

After-tax cost

?

Answer 1

7.c. After tax cost with Option 1:
($1,015,000 x (1-35%)) + ($1,500,000 x (1-0%))
= 659,750+ 1,500,000 = $2,159,750

d. Expected after-tax cost with Option 2:
($1,015,000 x (1-35%)) + ($2,000,000 x (1-35%) x 40%)
= 659,750+ 520,000 = $1,179,750

9.a. After-tax benefit (if she receives the allowance this year) = automobile allowance - Marginal tax rate 30%
= 40,500 - 30% = $28,350

b. Poe’s after-tax cost of providing the auto allowance = automobile allowance - Corporation marginal tax rate 35%
= 40,500 - 35% = $26,325