Question

You are 30 years old today and decided to apply for a postgraduate in finance.

Your current annual salary is RM36,000 and is expected to grow by 4% annually. Graduates in finance earns RM50,000 upon graduation, with salaries growing by 3.5% yearly. Cost of the 2 years of study is RM25,000 per year which should be paid at the end of each study year.

So, If your retirement age is 67 and the discount rate is 7% annually, is it worthwhile to quit your current job and do your postgraduate? What is the IRR of your study?

Answer 1

lets find out the PV of the current salary.

we need to find the total FV of the current salary and discount it back to its PV.

Current Salary       = 36000

rate of growth r            = 4%   or   0.04

No. of years to retire n = 37 (67 -30)

FV of current salary   is given by annuity formula,

                               

                               

                                                               

                                                                =

but this is the FV of salary, we need to find the PV of this, PV will be done by discounting at 7%

                          PV    = FV /   ( 1+r)ⁿ   

                                  =2941280   /    (1+0.07)³⁷

                            =240,622.77

now lets find the PV of Graduate Salary

Starting Salary       = 50000

rate of growth r            = 3.5%   or   0.035

No. of years to retire n = 35 (67 -32)   2 years will be spent pursuing graduation

FV of current salary   is given by annuity formula,

                               

                               

                                                               

                                                               =

but this is the FV of salary, we need to find the PV of this, PV will be done by discounting at 7%

                          PV    = FV /   ( 1+r)ⁿ   

                                  =3333700 /    (1+0.07)³⁵

                            =$ 312,244.19

but there is an a cost of graduataion involved, we need to reduce the cost from this

PV   of cost      =   25000 / (1+0.07)¹    +    25000 / (1+0.07)²

                              =   23,364.59   + 21,835.97

                     =42,500.45

final Npv of gradution    = $ 267,043.75     ( 312,244.19 - 42,500.45)

since the PV of graduation is higher than the PV of not graduating,,, it is worthwhile to graduate.

IRR of graduation is 36.95%

for IRR of graduation, we will establish the Cash flows for each year and compute IRR in excel.

for the first 2 years there will be an outflow of 25000 - gradution fee

3rd year end will receive salary of 50000. this grows by 3.5% every year till age of 67

NOTE :   the current salary of 36000X(1.04) for 31st age, and   36000X(1.04)² for the 32nd age- may be considered as oppurtunity cost and included as a cash outflow in years 1 and 2.

so total cf for y 1   = 25000 + 36000X(1.04)   =   62,440

so total cf for y 2 = 25000 + 36000X(1.04)² =   63,937.60

  

excel formulas