McGraw-Hill's Taxation of Individuals and Business Entities 3rd Edition by Brian Spilker, Benjamin Ayers, John Robinson, Edmund Outslay, Ronald Worsham, John Barrick, Connie Weaver

Exercise 50

{Planning} XYZ Corporation has a deferred compensation plan under which it allows certain employees to defer up to 40 percent of their salary for five years.(For purposes of this problem, ignore payroll taxes in your computations).a.Assume XYZ has a marginal tax rate of 35 percent for the foreseeable future and earns a after-tax return of 8 percent on its assets.Joel Johnson, XYZ's VP of finance, is attempting to determine what amount of deferred compensation XYZ should be willing to pay in five years that would make XYZ indifferent between paying current salary of $10,000 and paying the deferred compensation.What amount of deferred compensation would accomplish this objective?
b.Assume Julie, an XYZ employee, has the option of participating in XYZ's deferred compensation plan.Julie's marginal tax rate is 40 percent and she expects the rate to remain constant over the next five years.Julie is trying to decide how much deferred compensation she will need to receive from XYZ in five years to make her indifferent between receiving current salary of $10,000 and receiving the deferred compensation payment.If Julie takes the salary, she will invest it in a taxable corporate bond paying interest at 5 percent annually.What amount of deferred compensation would accomplish this objective?