Fred Ethridge is a valued employee of a large Canadian company. He is in the process of negotiating a new compensation package for the coming year. As he is looking to purchase a new residence, one of the alternatives that is being considered is an interest free loan that would be used to purchase this property.
Fred needs $350,000 to comfortably finance this purchase. As he has an excellent credit rating, the Royal Bank is prepared to extend the $350,000 on a 5 year, closed mortgage at a rate of 4.75 percent. The company has indicated that they will extend a $350,000, 5 year, interest free loan in lieu of a raise.
The Company's accounting department will calculate the after tax cost of providing the loan and his employer will offer Fred the alternative of additional salary that has the same after tax cost to the Company.
The Company is subject to tax at a combined federal/provincial rate of 29 percent. When funds are available, the Company has alternative investment opportunities that earn a pre-tax rate of 10 percent. Because of Fred's current high salary, any additional compensation will be taxed at a combined federal/provincial rate of 49 percent.
Assume that the prescribed rate for the current year is 2 percent.
Required:
A. Determine the tax consequences to Fred and the cost to the Company, in terms of lost after-tax earnings, of providing Fred with a $350,000 interest free loan for the first year of the loan.
B. Determine the amount of additional salary that could be provided to Fred for the same after tax cost to the Company that you calculated in Part A.
C. Which alternative would you recommend that Fred accept? Explain your conclusion.

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The Answer of Fred Ethridge is a valued employee of a large Canadian company. He is in the process of negotiating a new compensation package for the coming year. As he is looking to purchase a new residence, one of the alternatives that is being considered is an interest free loan that would be used to purchase this property.
Fred needs $350,000 to comfortably finance this purchase. As he has an excellent credit rating, the Royal Bank is prepared to extend the $350,000 on a 5 year, closed mortgage at a rate of 4.75 percent. The company has indicated that they will extend a $350,000, 5 year, interest free loan in lieu of a raise.
The Company's accounting department will calculate the after tax cost of providing the loan and his employer will offer Fred the alternative of additional salary that has the same after tax cost to the Company.
The Company is subject to tax at a combined federal/provincial rate of 29 percent. When funds are available, the Company has alternative investment opportunities that earn a pre-tax rate of 10 percent. Because of Fred's current high salary, any additional compensation will be taxed at a combined federal/provincial rate of 49 percent.
Assume that the prescribed rate for the current year is 2 percent.
Required:
A. Determine the tax consequences to Fred and the cost to the Company, in terms of lost after-tax earnings, of providing Fred with a $350,000 interest free loan for the first year of the loan.
B. Determine the amount of additional salary that could be provided to Fred for the same after tax cost to the Company that you calculated in Part A.
C. Which alternative would you recommend that Fred accept? Explain your conclusion.

Fred Ethridge Is a Valued Employee of a Large Canadian