Question

You have just turned twenty-six years of age and feel it is necessary to upgrade your qualifications. After some consideration, you feel that undertaking full-time study for an MPA degree at the Fletcher School is one alternative. For the two years of full-time study, tuition and living expenses will be $55,000 per year. In addition, you will have to give up your current job with a salary of $75,000 per year. Assume all cash flows occur at the end of the year. Assume a real interest rate of 3% per year, ignoring taxes. Also assume that the salary increase is a fixed real amount that starts after you complete your degree (at the end of the year following graduation) and lasts until retirement at age sixty-five. In order to justify the investment, by how much does your salary have to increase as a result of getting the MPA degree?

Answer 1

To justify the investment, the present value of cash outflows must equal the present value of increased salary

Present value of cash outflows = present value of expenses + present value of lost salary for 2 years

Present value = cash flow / (1 + interest rate)^{number of years}

Present value of cash outflows = ($55,000 / 1.03¹) + ($55,000 / 1.03²) + ($75,000 / 1.03¹) + ($75,000 / 1.03²)

Present value of cash outflows = $248,751.06

Let us say the increase in salary is X. This increased salary lasts for 37 years, from age 29 to 65.

Present value of increased salary = X * PVAF(3%,37) , where PVAF is the present value annuity factor. The value of PVAF(3%, 37) is found from the PVAF tables to be 22.167235435059

Present value of increased salary = X * 22.167235435059

To justify the investment, the present value of cash outflows must equal the present value of increased salary.

$248,751.06 =  X * 22.167235435059

X = $11,121.45

The increase in salary required to justify the investment is $11,121.45