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 years 0, 1, and 2. Mrs. X projects that her salary will be taxed at a 25 percent rate in year 0 and a 40 percent rate in years 1 and 2. Firm B’s tax rate for the three-year period is 34 percent. 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 the employment contract. To reduce her tax cost, Mrs. X requests that the salary payment for year 0 be increased to $140,000 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? Firm B responds to Mrs. X’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 Firm B’s after-tax cost under this proposal. From the firm’s perspective, is this proposal superior to its original offer ($80,000 annually for three years)? Should Mrs. X accept the original offer or the counterproposal? Support your conclusion with a comparison of the NPV of each offer. 2. Firm D is considering investing $400,000 cash in a three-year project with the following cash flows. Year 0 Year 1 Year 2 Investment/return of investment $(400,000) –0– $400,000 Revenues 80,000 $ 65,000 35,000 Expenses (25,000) (25,000) (10,000) Before-tax net cash flow $(345,000) $ 40,000 $425,000 Under each of the following assumptions, determine if Firm D should make the investment. In each case, use a 10 percent discount rate to compute NPV. The revenue is taxable, the expenses are deductible, and the marginal tax rate is 15 percent. The revenue is taxable, the expenses are deductible, and the marginal tax rate is 40 percent. The revenue is taxable, only one-half the expenses are deductible, and the marginal tax rate is 15 percent. Firm D can deduct the expenses in the year paid (against other sources of income) but can defer recognizing the $180,000 total income until year 2. (It will collect the revenues as indicated in years 0, 1, and 2 so that before-tax cash flows do not change.) The marginal tax rate is 40 percent.