In: Finance
Assume today is March 16, 2016. Natasha Kingery is 30 years old and has a Bachelor of Science degree in computer science. She is currently employed as a Tier 2 field service representative for a telephony corporation located in Seattle, Washington, and earns $38,000 a year that she anticipates will grow at 3% per year. Natasha hopes to retire at age 65 and has just begun to think about the future.
Natasha has $75,000 that she recently inherited from her aunt. She invested this money in 30-year Treasury Bonds. She is considering whether she should further her education and would use her inheritance to pay for it.*
She has investigated a couple of options and is asking for your help as a financial planning intern to determine the financial consequences associated with each option. Natasha has already been accepted to both of these programs, and could start either one soon.
One alternative that Natasha is considering is attaining a certification in network design. This certification would automatically promote her to a Tier 3 field service representative in her company. The base salary for a Tier 3 representative is $10,000 more than what she currently earns and she anticipates that this salary differential will grow at a rate of 3% a year as long as she keeps working. The certification program requires the completion of 20 Web-based courses and a score of 80% or better on an exam at the end of the course work. She has learned that the average amount of time necessary to finish the program is one year. The total cost of the program is $5000, due when she enrolls in the program. Because she will do all the work for the certification on her own time, Natasha does not expect to lose any income during the certification.
Another option is going back to school for an MBA degree. With an MBA degree, Natasha expects to be promoted to a managerial position in her current firm. The managerial position pays $20,000 a year more than her current position. She expects that this salary differential will also grow at a rate of 3% per year for as long as she keeps working. The evening program, which will take three years to complete, costs $25,000 per year, due at the beginning of each of her three years in school. Because she will attend classes in the evening, Natasha doesn’t expect to lose any income while she is earning her MBA if she chooses to undertake the MBA.
* If Natasha lacked the cash to pay for her tuition upfront, she could borrow the money. More intriguingly, she could sell a fraction of her future earnings, an idea that has received attention from researchers and entrepreneurs; see M. Palacios, Investing in Human Capital: A Capital Markets Approach to Student Funding, Cambridge University Press, 2004.
Time Line of Natasha for all three options with NPV of all
options, I have used NPV function of excel to calculate the Net
Present Value of all cash flows. The formula is select rate of
interest and all cash flow. (type =NPV in a excel cell and click
in
formula bar)
Age |
Year |
Date |
Current situation |
Certification |
MBA |
30 |
0 |
16 March 2016 |
0 |
-5000 |
-25000 |
31 |
1 |
16 March 2017 |
38,000 |
48,000 |
13,000 |
32 |
2 |
16 March 2018 |
39,140 |
49,440 |
14,140 |
33 |
3 |
16 March 2019 |
40,314 |
50,923 |
60,314 |
34 |
4 |
16 March 2020 |
41,524 |
52,451 |
62,124 |
35 |
5 |
16 March 2021 |
42,769 |
54,024 |
63,987 |
36 |
6 |
16 March 2022 |
44,052 |
55,645 |
65,907 |
37 |
7 |
16 March 2023 |
45,374 |
57,315 |
67,884 |
38 |
8 |
16 March 2024 |
46,735 |
59,034 |
69,921 |
39 |
9 |
16 March 2025 |
48,137 |
60,805 |
72,018 |
40 |
10 |
16 March 2026 |
49,581 |
62,629 |
74,179 |
41 |
11 |
16 March 2027 |
51,069 |
64,508 |
76,404 |
42 |
12 |
16 March 2028 |
52,601 |
66,443 |
78,696 |
43 |
13 |
16 March 2029 |
54,179 |
68,437 |
81,057 |
44 |
14 |
16 March 2030 |
55,804 |
70,490 |
83,489 |
45 |
15 |
16 March 2031 |
57,478 |
72,604 |
85,994 |
46 |
16 |
16 March 2032 |
59,203 |
74,782 |
88,573 |
47 |
17 |
16 March 2033 |
60,979 |
77,026 |
91,231 |
48 |
18 |
16 March 2034 |
62,808 |
79,337 |
93,968 |
49 |
19 |
16 March 2035 |
64,692 |
81,717 |
96,787 |
50 |
20 |
16 March 2036 |
66,633 |
84,168 |
99,690 |
51 |
21 |
16 March 2037 |
68,632 |
86,693 |
1,02,681 |
52 |
22 |
16 March 2038 |
70,691 |
89,294 |
1,05,761 |
53 |
23 |
16 March 2039 |
72,812 |
91,973 |
1,08,934 |
54 |
24 |
16 March 2040 |
74,996 |
94,732 |
1,12,202 |
55 |
25 |
16 March 2041 |
77,246 |
97,574 |
1,15,568 |
56 |
26 |
16 March 2042 |
79,564 |
1,00,501 |
1,19,035 |
57 |
27 |
16 March 2043 |
81,950 |
1,03,516 |
1,22,606 |
58 |
28 |
16 March 2044 |
84,409 |
1,06,622 |
1,26,285 |
59 |
29 |
16 March 2045 |
86,941 |
1,09,821 |
1,30,073 |
60 |
30 |
16 March 2046 |
89,549 |
1,13,115 |
1,33,975 |
61 |
31 |
16 March 2047 |
92,236 |
1,16,509 |
1,37,995 |
62 |
32 |
16 March 2048 |
95,003 |
1,20,004 |
1,42,134 |
63 |
33 |
16 March 2049 |
97,853 |
1,23,604 |
1,46,398 |
64 |
34 |
16 March 2050 |
1,00,789 |
1,27,312 |
1,50,790 |
65 |
35 |
16 March 2051 |
1,03,812 |
1,31,131 |
1,55,314 |
NPV |
13,54,210 |
16,60,255 |
18,65,339 |
In normal situation she will keep earning her salary as described and she also has $ 75000 which she inherited from her aunt. So the present value will be NPV of all earning and PV of $ 75000 which $ 1,429,210 (1354210+75000)
In case of certification as she will be doing a course the course fees of 5000 is taken as outflow and so is negative. Now she has Present value of her earning and $ 70000 as 5000 has been used to pay Course fees. So NPV = $ 1,730,255 (1660255+70000)
In case of MBA as she will pay the fees in 3 years so the difference between her annual income and fees payment is taken for first 3 years. In first year she has pay the fees from the money she received from her aunt. And 2nd and 3rd year fees is paid from her salary so NPV will be $ 1,915,339 (1865339+50000)
To calculate the present value of the salary differential for completing the certification program we have got the Incremental NPV as shown in table below;
Incremental for Course |
Incremental for MBA |
-5,000 |
-25000 |
10,000 |
-25000 |
10,300 |
-25000 |
10,609 |
20000 |
10,927 |
20,600 |
11,255 |
21,218 |
11,593 |
21,855 |
11,941 |
22,510 |
12,299 |
23,185 |
12,668 |
23,881 |
13,048 |
24,597 |
13,439 |
25,335 |
13,842 |
26,095 |
14,258 |
26,878 |
14,685 |
27,685 |
15,126 |
28,515 |
15,580 |
29,371 |
16,047 |
30,252 |
16,528 |
31,159 |
17,024 |
32,094 |
17,535 |
33,057 |
18,061 |
34,049 |
18,603 |
35,070 |
19,161 |
36,122 |
19,736 |
37,206 |
20,328 |
38,322 |
20,938 |
39,472 |
21,566 |
40,656 |
22,213 |
41,876 |
22,879 |
43,132 |
23,566 |
44,426 |
24,273 |
45,759 |
25,001 |
47,131 |
25,751 |
48,545 |
26,523 |
50,002 |
27,319 |
51,502 |
3,56,371 |
6,70,226 |
NPV of incremental salary after doing the Certification Course is the $ 356,371 from this if we deduct the course fees the incremental benefit is $ 351,371 (356371-5000)
NPV of incremental salary after doing the MBA is the $ 670,226 from this if we deduct the course fees the incremental benefit is $ 597,201 (670226-73024). In this case we will have to deduct the present value of MBA fees as it is done over a period of 3 years to do this have used the PV function in Excel to get the present value of fees beginning of the year. Refer to the formula below in excel.
=PV(2.73%,3,25000,,1)
Now if we have to compare which is better i would say the MBA is better as the differential NPV of MBA is approx 70% more than Certification Course. So i would suggest Natasha to go for MBA.
If the two programs are mutually exclusive then to will suggest going for MBA as it will always have merits as compared to a certification course.