Question

In: Finance

Assume today is March 16, 2016. Natasha Kingery is 30 years old and has a Bachelor...

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.

  1. Determine the interest rate she is currently earning on her inheritance by going to the U.S. Treasury Department Web site (treasury.gov) and selecting “Data” on the main menu. Then select “Daily Treasury Yiled Curve Rates” under the Interest Rate heading and enter the appropriate year, 2016, and then search down the list for March 16 to obtain the closing yield or interest rate that she is earning. Use this interest rate as the discount rate for the remainder of this problem. --> the identified rate for March 16th on a 30 year bond is 2.73
  2. Create a timeline in Excel for her current situation, as well as the certification program and MBA degree options, using the following assumptions:
    • Salaries for the year are paid only once, at the end of the year.
    • The salary increase becomes effective immediately upon graduating from the MBA program or being certified. That is, because the increases become effective immediately but salaries are paid at the end of the year, the first salary increase will be paid exactly one year after graduation or certification.
  3. Calculate the present value of the salary differential for completing the certification program. Subtract the cost of the program to get the NPV of undertaking the certification program.
  4. Calculate the present value of the salary differential for completing the MBA degree. Calculate the present value of the cost of the MBA program. Based on your calculations, determine the NPV of undertaking the MBA.
  5. Based on your answers to Questions 3 and 4, what advice would you give to Natasha? What if the two programs are mutually exclusive? That is, if Natasha undertakes one of the programs there is no further benefit to undertaking the other program. Would your advice be different?

* 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.

Solutions

Expert Solution

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.


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