Question

Gill Bates graduated from university six years ago with an undergraduate degree in finance. 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 this goal. After examining schools, he has narrowed his choice to either Canada University or America University. 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 students to work while enrolled in its MBA program. Gill currently works at the money management firm of Dewey and Louis. His annual salary at the firm is $65,000 per year, expected to increase at 3 percent per year until retirement. He is currently 28 years old and expects to work for 40 more years. His current job includes a fully paid health insurance plan, and his current average tax rate is 26 percent. Gill has a savings account with enough money to cover the entire cost of his MBA program. The Faculty of Management at Canada 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 $70,000, payable at the beginning of each school year. Books and other supplies are estimated to cost $3,000 per year. Gill expects that after graduation from Canada, he will receive a job offer for about $110,000 per year, with a $20,000 signing bonus. The salary at this job will increase at 4 percent per year. Because of the higher salary, his average income tax rate will increase to 31 percent. The School of Business at America University began its MBA program 16 years ago and is less well known than Canada University's Faculty of Management. America University offers an accelerated, one-year program, with a tuition cost of $85,000 to be paid upon graduation. Books and other supplies for the program are expected to cost $4,500. Gill thinks that he will receive an offer of $92,000 per year upon graduation, with an $18,000 signing bonus. The salary at this job will increase at 3.5 percent per year. His average tax rate at this level of income will be 29 percent. Both schools offer a health insurance plan that will cost $3,000 per year, payable at the beginning of the year. Gill also estimates that room and board expenses will cost $2,000 more per year at both schools than his current expenses, payable at the beginning of each year. The appropriate discount rate is 6.5 percent. 1. Assuming all salaries are paid at the end of each year, which is the best option for Gill—from a strictly financial standpoint.

Answer 1

	CURRENT JOB
	Present Salary (paid in year1)	$65,000
	Tax Rate	26%
	After tax salary in year1	$48,100	(65000*(1-0.26)
	After tax salary in year2	$49,543	(48100*1.03)
	After tax salary in year(N+1)=1.03*After tax Salary in Year(N)
	CANADA UNIVERSITY OPTION
	Total annual expenses	$75,000	(70000+3000+2000)
	Annaul Salary in 3	$110,000
	After tax salary in Year3	$75,900	(110000*(1-0.31)
	After tax salary in Year4	$78,936	(75900*1.04)
	After tax salary in year(N+1)=1.04*After tax Salary in Year(N)
	Signing Bonus in Year2	$20,000
	AMERICA UNIVERSITY OPTION
	Total annual expenses	$91,500	(85000+4500+2000)
	Annaul Salary in 2	$92,000
	After tax salary in Year2	$65,320	(110000*(1-0.29)
	After tax salary in Year3	$67,606	(75900*1.035)
	After tax salary in year(N+1)=1.035*After tax Salary in Year(N)
	Signing Bonus in Year1	$18,000
	Present Value of Cash Flow=(Cash Flow)/((1+i)^N)
	i=discount rate =6.5%=0.065
	N=Year of Cash Flow
	N	Continue Current Job		CANADA University		AMERICA University
		CF1	PV1=CF1/(1.065^N)	CF2	PV2=CF2/(1.065^N)	CF3	PV3=CF3/(1.065^N)
	Year	Cash Flow	Present Value	Cash Flow	Present Value	Cash Flow	Present Value
	0			($75,000)	($75,000)	($91,500)	($91,500)
	1	$48,100	$45,164	($75,000)	($70,423)	$18,000	$16,901
	2	$49,543	$43,680	$20,000	$17,633	$65,320	$57,590
	3	$51,029	$42,245	$75,900	$62,834	$67,606	$55,968
	4	$52,560	$40,856	$78,936	$61,359	$69,972	$54,391
	5	$54,137	$39,514	$82,093	$59,918	$72,421	$52,859
	6	$55,761	$38,215	$85,377	$58,512	$74,956	$51,370
	7	$57,434	$36,959	$88,792	$57,138	$77,580	$49,923
	8	$59,157	$35,744	$92,344	$55,797	$80,295	$48,517
	9	$60,932	$34,570	$96,038	$54,487	$83,105	$47,150
	10	$62,760	$33,434	$99,879	$53,208	$86,014	$45,822
	11	$64,642	$32,335	$103,874	$51,959	$89,024	$44,531
	12	$66,582	$31,272	$108,029	$50,740	$92,140	$43,277
	13	$68,579	$30,245	$112,351	$49,548	$95,365	$42,058
	14	$70,636	$29,251	$116,845	$48,385	$98,703	$40,873
	15	$72,756	$28,289	$121,518	$47,250	$102,158	$39,722
	16	$74,938	$27,360	$126,379	$46,140	$105,733	$38,603
	17	$77,186	$26,460	$131,434	$45,057	$109,434	$37,515
	18	$79,502	$25,591	$136,692	$44,000	$113,264	$36,459
	19	$81,887	$24,750	$142,159	$42,967	$117,228	$35,432
	20	$84,344	$23,936	$147,846	$41,958	$121,331	$34,433