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XYZ Corporation has a deferred compensation plan under which it allows certain employees to defer up...

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Accounting

XYZ Corporation has a deferred compensation plan under which itallows certain employees to defer up to 20 percent of their salaryfor five years. For purposes of this problem, ignore payroll taxesin your computations. (Use Table 1.) (Round yourintermediate calculations and final answers to the nearest wholedollar amount.)

Problem 13-61 Part a

a. Assume XYZ has a marginal tax rate of 21percent for the foreseeable future and earns an after-tax rate ofreturn of 13 percent on its assets. Joel Johnson, XYZ’s VP offinance, is attempting to determine what amount of deferredcompensation XYZ should be willing to pay in five years that wouldmake XYZ indifferent between paying the current salary of $10,400and paying the deferred compensation. What amount of deferredcompensation would accomplish this objective?

Answer & Explanation Solved by verified expert
4.0 Ratings (731 Votes)

If XYZ is to pay $10,400,

its after tax cost would be [$10,400 × (1 ? 0.21)] = 8¸216.00

If it defers the compensation it would save $8,216 after-taxes

After Tax return is 13%

Hence, after- taxes Amount in 5 years =$8,216 × 1.135

                                                                           =$15¸137.45

So, XYZ should be indifferent between paying Joel $8,216 after-taxes now or $15,137.45 after taxes in 5 years.

Assuming XYZ’s marginal tax rate remains at 21%, $15,137.45 after-taxes is $19,161.33 before-taxes [$15,137.45 / (1 ? 0.21)].

Hence, amount of deferred compensation = 19,161.33
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