Ramon has finally arrived. He has interviewed for the CEO position with MMM Corporation. They have presented him with two alternative compensation offers. Alternative 1 is for a straight salary of $2,620,000. Option 2 is for a salary of $1,120,000 and performance-based compensation of up to $2,000,000. Assume that Ramon has a marginal tax rate of 40 percent and MMM has a marginal tax rate of 35 percent. Answer the questions under each of the following alternative scenarios.
a. If Ramon is 100 percent certain he can meet the qualifications for the full performance-based compensation, which offer should he choose?
b. If Ramon believes there is only a 20 percent chance that he can meet the performance-based requirements, which offer should he choose (assume he is risk neutral)?
c. What is MMM’s after-tax cost of providing Ramon with Option 1?
After-tax cost:
d. What is MMM’s expected after-tax cost of providing Ramon with Option 2 if it believes there is a 40 percent chance Ramon will qualify for the performance-based compensation?
Expected after- tax cost: