Suppose you will retire in 9 years. Throughout your life you will face a tax rate of 31% and earn an after-tax rate of return of 8% on your investments. Your company’s pension plan earns a 12% return,...

Suppose you will retire in 9 years. Throughout your life you will face a tax rate of 31% and earn an after-tax rate of return of 8% on your investments. Your company’s pension plan earns a 12% return, and the company itself earns a 10% after-tax return on its own projects. The company faces a current tax rate of 34% and will face a 40% rate in year 9.

a. How much in deferred compensation (D*) would the company have to pay you in year 9 to make you indifferent between future compensation and a $100 bonus now?

 b. How much of a contribution to your pension plan (P*) would the company have to make to make you indifferent between pension benefits in 9 years and a $100 bonus now?

c. What is the present value of the after-tax cost of each form of compensation (current bonus of $100, deferred compensation of D*, and pension plan contribution of P*) to the company, using a discount rate of 10%?

                                                                             (Exercise written by Richard Sansing, Dartmouth College.)