Question

Ben Bates graduated from college six years ago with a finance undergraduate degree.

Although he is satisfied with his current job, his goal is to become an investment banker. He feels that an MBA degree would allow him to achieve his goal. After examining schools, he has narrowed his choice to either Wilton University or Mount Perry College. Although internships are encouraged by both schools, to get class credit for the internship, no salary can be paid. Other than internships, neither school will allow its student to work while enrolled in its MBA program.

Ben currently works at the money management firm of Dewey and Louis. His annual salary at the firm is $70,000 per year, and his salary is expected to increase at 3 percent per year until retirement. He is currently 28 years old and expects to work for 37 more years. His current job includes a fully paid health insurance plan, and his current average tax rate is 28 percent. Ben has a savings account with enough money to cover the entire cost of his MBA program.

The Ritter College of Business at Wilton University is one of the top MBA programs in the country. The MBA degree requires two years of full-time enrollment at the university. The annual tuition is $65,000, payable at the beginning of each school year. Books and other supplies are estimated to cost $2,000 per year. Ben expected that after graduation from Wilton, he will receive a job offer for about $100,000 per year, with a $10,000 signing bonus. The salary at this job will increase at 4% per year. Because of the higher salary, his average income tax rate will increase to 32 percent.

The Bradley School of Business at Mount Perry College began its MBA 16 years ago. The Bradley School is smaller and less well known than the Ritter College. Bradley offers an accelerated, one-year program, with a tuition cost of $75,000 to be paid upon matriculation. Books and other supplies for the program are expected to cost $3,000. Ben thinks that he will receive an offer of $85,000 per year upon graduation, with a $10,000 signing bonus. The salary at this job will increase at 3.5 percent. His average tax rate at this level of income will be 30 percent.

Both schools offer a health insurance plan that will cost $2,500 per year, payable at the beginning of the year. Ben also estimates that room and board expenses will cost $15,000 per year at either school. The appropriate discount rate is 6 percent.

Assuming all salaries are paid at the end of each year, what is the best option for Ben

– from a strictly financial standpoint?

Answer 1

We will calculate the PV of all three options and compare:

Option 1: Continue with his current job. Current Salary is 70000 and after tax will be = 50400. It will increase at 3% p.a. for 37 years to retirement. We can use the PV of growing annuity formula for this :

PV = Initial Cash Flow * [1 - {(1+g)/(1+r)}^t]/(r-g) ; where r is the discount rate, g is the growth rate and t is time period.

PV = 50400 * [ 1 - {(1+3%)/(1+6%)}³⁷ ] / (6%-3%) = 1,099,276.26

Option 2: Ritter MBA: Salary after MBA is $100000 . Post Tax it will be 68000 growing at 4% with 35 years to retirement.

PV of salary 2 years hence = 68000 * [ 1 - {(1+4%)/(1+6%)}³⁵ ] / (6%-4%) = 1,654,416.98

Now we discount this value, sign on bonus and cost of MBA to present time:

Annual MBA cost = 65000 + 2000 + 2500 + 15000 = 84500

PV = -84500 - 84500 / (1+6%) + (1654416.98 + 10000) / (1+6%)² = 1,317,108.21

Option 3 : Post MBA salary = 85000; post tax = 59500 growing at 3.5% for 36 years.

PV of salary 1 years hence = 59500 * [ 1 - {(1+3.5%)/(1+6%)}³⁶ ] / (6%-3.5%) = 1,372,097.78

Now we discount this value, sign on bonus and cost of MBA to present time:

Annual MBA cost = 75000 + 3000 + 2500 + 15000 = 95500

PV = -95500 + (1372097.78 + 10000) / (1+6%) = 1,208,365.83

Thus we see that option 2 Ritter College MBA is the best