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.
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Benefit Description
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Option 1
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Option 2
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Option 3
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Option 4
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Salary
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$60,000
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$50,000
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$45,000
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$45,000
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Health insurance
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0
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5,000
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5,000
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5,000
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Restricted stock
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0
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0
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1,000 shares
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0
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NQOs
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0
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0
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0
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100 options
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Assume that the restricted stock is 1,000 shares that trade at $5 per share on the grant date (January 1, year 1) and are expected to be worth $10 per share on the vesting date at the end of year 1. Assume that the NQOs (100 options that each allow the employee to purchase 10 shares at $5 strike 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. Also assume that Pratt spends on average $3,000 on health-related costs that would be covered by insurance if he has coverage. Assume that Pratt's marginal tax rate is 35 percent.
a) What is the after-tax value of each compensation package for year 1?
b) If Pratt's sole consideration is maximizing after-tax value for year 1, which scheme should he select?
c) Assuming Pratt chooses Option 3 and sells the stock on the vesting date (on the last day of year 1), complete Pratt's Schedule D for the sale of the re- stricted stock.