Pratt is ready to graduate and leave College Park. His future employer (Ferndale Corp.) offers the following four compensation packages 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 allow 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).
Required:
| Description | Option 1 | Option 2 | Option 3 | Option 4 |
| Salary | $60,000 | $50,000 | $45,000 | $45,000 |
| NQO's (100*10*(10-5)) | $ 5,000 | |||
| Restricted Stock | $10,000 | |||
| Taxable Total | $60,000 | $50,000 | $55,000 | $50,000 |
| Tax Rate | 35% | 35% | 35% | 35% |
| Tax Paid | $21,000 | $17,500 | $19,250 | $17,500 |
| Cash Paid at exercise | $ 5,000 | |||
| After-tax cash value | $39,000 | $32,500 | $35,750 | $27,500 |
| Health Care Expenses | $ 3,000 | |||
| NQO's | ||||
| After Tax Value | $36,000 | $32,500 | $35,750 | $27,500 |
Option 1 should be selected for maximizing after-tax value for year 1
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