Question:

At this year's Christmas party your friend Tom tells you he will be taking a new position in the new-year.He's already accepted the position but was wondering if you can help him decide which compensation package makes the most sense.He reminds you that he intends to retire in 12 years from today.He then explains the offers below:

Offer A:

Tom will receive an annual salary of $200,000[1]and receive a one-time $20,000 bonus on the day he starts the job (Assume today).He will also receive a 4% raise each year on his anniversary to cover inflation.With this offer Tom will continue working from the company's "field" office where he and his family currently live.

Offer B:

Tom will receive an additional 15% above the annual salary in Offer A if he relocates his family 500 miles away to the company's headquarters. However, he will not receive the $20,000 bonus. He will still receive a 4% raise each year on his anniversary to cover inflation. Tom will need to sell his current home, which was purchased during a bustling economy in 2004.In 2004, he paid $500,000 for the house, today it's worth $375,000 and he owes $425,000 to the bank for the house.He also estimates that the move will cost him $5,000 in moving expenses.

Answer the following questions to help Tom decide which offer is best:

Identify the opportunity and sunk costs mentioned in each offer.Are there any additional opportunities or sunk costs that you would want to consider if this was your own personal situation?

What will Tom's salary be at the end of 7 years in Offer A and Offer B?

What will Tom's net income be at his anticipated retirement for Offer A and Offer B?

What is the Net Present Value (NPV) of Offer A and Offer B for Tom with a discount rate of 8%?

What offer should Tom accept? Why?

[1]You may assume his salary is paid in a single lump sum at the end of each year.

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