After a recent staff evaluation, Susan Pearson’s employer offered her the following alternative remuneration proposals:
1. A salary increase of $2,500 per annum, from $40,000 to $42,500.
2. A contribution of $2,000 per year to the company’s deferred profit-sharing plan.
Pearson’s living expenses are modest, and if she accepts the salary increase she intends to invest the additional cash flow in secure 10% bonds. Coincidentally, the company’s deferred profit-sharing plan also achieves an average investment return of 10%.
Pearson plans to retire in 30 years, and her intention is to use the remuneration increase to help fund her retirement. Currently, she pays tax at a marginal rate of 40%.
Required:
Assuming that investment returns and tax rates remain stable at 10% and 40%, respectively, which alternative should Pearson prefer? You may also assume that if she accepts the deferred profit-sharing plan, it will be paid to her in a lump sum at the end of 30 years.