Reference no: EM131087200

Question 1

Deferred compensation plans offer favorable tax treatment, yet many employees and self-employed individuals do not take advantage of them.

Choose a deferred compensation plan, discuss it features, its tax benefits, and limitations if any.

Discuss whether or not you would participate in the particular deferred compensation if given the opportunity.

Respond to this...Deferred compensation plans are accounts that are funded by a person's income however paid out at a later date.

Essentially These plans can be in the form of retirement plans, pensions, and employee stock option plans.

After researching different types of deferred compensation plans I found out that they are often utilized by people who are making a high annual salary. For example 401k contributions max out at $18,000 regarding tax deferred savings. However an individual making 500k a year may want to contribute more into a deferred tax account after they have maxed their 401k; this is where the deferred compensation plans come in.

I found a deferred compensation plan on Fidelity. As a matter of fact the company I work for also has an ESOP and utilizes fidelity as their plan holder. Deferred compensation plans like the one I found allow for high earners the ability to take income from their salaries tax deferred and place them in accounts. These accounts are then set up in increments of 5 - 10 yearsor until that individual retires.

One of the cons to these plans is that they are often not backed by FDIC regulations and can lose principle. Additionally and unlike 401k's you cannot borrow from these accounts. Often time's people can borrow from their 401k's for a first time home purchase or for qualified expenses. You also can never roll one into an IRA. Also the plan I researched and like the one my company uses is also backed by the company and is part of the assets on the company's balance sheet. This means that if the company goes bankrupt all of the ESOP shares also go insolvent.

Personally I like the idea of setting aside as much tax deferred money as I can however I am far from the "high" earners that really are able to utilize deferred compensation plans. I am still content with traditional IRA's and Roth IRA's that I use as a 401k. I also do not like the fact that your principal can be lost if the company goes bankrupt. Currently my Roth IRA is FDIC insured and I still get the tax savings.

Reference

https://www.fidelity.com/viewpoints/retirement/nqdceferences

Question 2

The company you work for has had the policy to extend credit terms to a majority of your customers, and this has had a two-fold effect. The company has gained many new customers, but the company has also experienced difficulties collecting the monies owed due to the volume of accounts receivables.

How would you address the accounting effects of this approach with upper management? Also, in your view, what would be the next steps for improvement that the company would need to undertake in order to correct the problem? Explain your reasoning.

Respond to this...I would tell upper management that it would be in the best interest to the company that it revises the way it extends credit. Although the positive aspect is the company has received new customers, it does put the company in a bad way with the debt they are trying to collect. I would propose that the company impose a limit on how much credit it extends to it's customers. If the customer has a good track record of paying his bills on time, then he should be allowed to have his credit extended. If the customer does not have a good record of paying bills, then his credit extension should be rejected, or granted when his record improves.

Question 3

Explain how the Two-Stage Free Cash Flow to the Firm valuation method can be used to calculate firm value. Provide an example.

Respond to this...The two stage growth model computes the intrinsic value of a stock as the present value of future free cash flows to equity assuming growth rates. In the first stage, free cash flow to the equity is assumed to grow at an abnormal rate (either high or low) for some number of years. In the second stage, the free cash flow to equity is assumed to grow at a normal rate from year 1 in perpetuity.

The concept of free cash flow is cash that can be paid as a dividend without it affecting the value of existing operations. For example, if Bill borrowed $500,000 to start up his business, his equity within the first 5 years is very low (stage 1). Starting at the 6th year of his business operations and thereafter, his equity flow is growing at a normal or consistent rate (stage 2) after all his liabilities (start-up loan & operating expenses) are paid. Generally speaking, if a firm has a consistent equity flow in the second stage, they are in better shape financially then one that is not.

Reference: https://www.ftsnet.com/public/ftsmodhtm/ftsFCF/page1.htm