Consider an employer, Sears, designing a two-period, delayed-compensation contra
ID: 1197893 • Letter: C
Question
Consider an employer, Sears, designing a two-period, delayed-compensation contract for Jane, a prospective worker. If Jane declines Sears's offer, she may accept an alternative job at J.C. Penney paying a salary of $8,000 each period. Jane's MRP at Sears would be $6,000 in period 1 and $10,000 in period 2. For cash flow reasons, Sears can only afford to pay the worker $5,000 in period 1 under the delayed-compensation package. Assume Sears has a zero discount rate and Jane has a 10% discount rate, and that regardless of her employer, she would receive her paycheck at the beginning of any work period. What is the range of second period salaries that Sears would be willing to pay such that Sears earns positive profits and What is the range of second period salaries that Sears would be willing to pay such that Jane will accept the contract? Based on your answers to parts a and b, will Jane work for SearsExplanation / Answer
Let x be the second period's salary offered by Sears to Jane.
a. Sears's perspective:
Sears's discount rate is 0%. That is, Sears won't discount future cash flows.
Present value of MRP from Jane = $6,000 + $10,000 = $16,000
Present value of salary paid to Jane = $5,000 + x
Sears will pay the second year salary such that -
Present value of MRP from Jane > Present value of salary paid to Jane
$16,000 > $5,000 + x
x < $11,000
Therefore, the range of salary that Sears can pay Jane such that Sears earns a positive profit is $0 to $11,000.
b) Jane's point of view:
Jane's discount rate is 10% (or 0.10).
Present value of Salary offered by Sears = $5,000 + [x/(1+0.10)] = $5,000 + (x/1.10)
Present value of salary offered by J.C. = $8000 + [$8000/(1+0.10)] = $8,000 + ($8,000/1.10)
Jane will accept Sears's contract if
Present value of Salary offered by Sears > Present value of Salary offered by J.C.
$5,000 + (x/1.10) > $8,000 + ($8,000/1.10)
x/1.10 > $3,000 + ($8,000/1.10)
x > $3,300 + $8,000
x > $11,300
Jane will accept the contract from Sears only if the contract will pay more than $11,300.
(c) Sears wont pay more than $11,000. Jane won't accept it, as we saw in part b. This implies that Jane won't work for Sears.