You are offered a 5 year contract for a position at a large factory. They offere

Question

You are offered a 5 year contract for a position at a large factory. They offered three different payment terms and asked you to decide your preferred option.

Option 1 (Fixed Salary): $75,000 per year with no annual raises

Option 2 (Increasing Salary): $65,000 for the first year with annual raises of 5% starting in year 2

Option 3 (Irregular Salary): Because of the irregular nature of the assignment, the company has offered to pay you a salary to reflect the intensity of the position. They will give you $2000 signing bonus today, $60,000 in the first year, $80,000 in the second year, $50,000 in the third year, and $70,000 in the last two years of the contract Assume, initially, that your salary is to be paid only at the end of each year and that the prevailing interest rate is 9% compounded annually.

(a) Draw a cash flow diagram that corresponds to each of the three salary options.

(b) Which of the three options should you choose?

(c) If each of these payment options are to be paid two times per month (bi-monthly) in equal installments, instead of the proposed one time per year, what would be the equivalent equal bi-monthly payments that you would receive under each salary option?

(d) You have estimated your living expenses (rent, food, gas, etc.) to be $3400 per bi-monthly pay period. What minimum annual salary would you need to receive (assume that you are paid in equal bi-monthly payments) to cover these expenses, assuming the interest rate stays the same?

Explanation / Answer

A & B) Cash Flow Diagram

Based on Total Cash flow and PV of Cash Flow Option 1 is Preferable

C) On Bi-monthly Installment

D) To Cover Living Expenses of $3400 per Bi-Monthly

24 (Bi-Monthly Period Per Year 2*12) * 3400 = 81600 Minimum

Yr/Option Option 1 Option 2 Option 3 0 2000 1 75000 65000 60000 2 75000 68250 80000 3 75000 71663 50000 4 75000 75246 70000 5 75000 79008 70000 Total 375000 359167 332000 PV @ 9% 291724 277071 258074

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