Question

THE MBA DECISION

Ben Bates graduated from college six years ago with a finance undergraduate degree. Since graduation, he has been employed in the finance department at East Coast Yachts. 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 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 schools will allow its students 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 $65,000 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 40 more years. His current job includes a fully paid health insurance plan, and his current average tax rate is 26 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 $70,000 , payable at the beginning of each school year. Books and other supplies are estimated to cost $3,000 per year. Ben expects that after graduation from Wilton, 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 Bradley School of Business at Mount Perry College began its MBA program 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 $85,000 , to be paid upon matriculation. Books and other sup- plies for the program are expected to cost $4,500. Ben thinks that after graduation from Mount Perry, he will receive an offer of $92,000 per year , with a $18,000 signing bonus The salary at this job will increase at 3.5 percent per year. His average income 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. Ben 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 6.3 percent.

1. How does Ben’s age affect his decision to get an MBA?

2. What other, perhaps non-quantifiable factors, affect Ben’s decision to get an MBA?

3. Assuming all salaries are paid at the end of each year, what is the best option for Ben—from a strictly financial standpoint?

4. Ben believes that the appropriate analysis is to calculate the future value of each option. How would you evaluate this statement?

5. What initial salary would Ben need to receive to make him indifferent between attending Wilton University and staying in his current position?

6. Suppose that instead of being able to pay cash for his MBA, Ben must borrow the money. The current borrowing rate is 5.4 percent. How would this affect his decision to get an MBA?

Answer 1

1	Ben's age affect the decision to get MBA. He is only 28 years old and work for another 40 year
	He will get benefit of increased income for (40-2)=38 years
	If his age was higher, the benefit of higher income would have been for less number of years
	Higher the years of income benefit, higher will be Net Present Value of the decision to get MBA
2	There are other non quantifiable factors like better job satisfaction, esteem, social recognition.
	Self actualization as per Maslow's hierarchy of needs
3	OPTION A-Ritter College(WILTON UNIVERSITY)
		Annual tution fees	$70,000
		books and other supplies per year	$3,000
		Total annual cost(Beginning of year)	$73,000
		Discount rate=6.3%
		Joining bonus	$20,000
		Annual income in first year after MBA(after tax)	75900	(110000)*(1-0.31)
		Annual income in second year after MBA(after tax)	78936	(110000*1.04)*(1-0.31)
		Annual income in third year after MBA(after tax)	82093.44	(78936*1.04)
		Present Value (PV) of cash flow=(Cash flow)/((1+i)^N)
		i=discount rate=6.3%=0.063
		Yearwise cash flow and PV of cash flows are given below:
		N	A	B=A/(1.063^N)
		Year	Cash flow	PV of cash flow
		0	($73,000)	-73000
		1	($73,000)	-68673.56538
		2	$20,000	17699.60061
		3	$75,900	63189.07273
		4	$78,936	61821.85855
		5	$82,093	60484.22661
		6	$85,377	59175.53686
		7	$88,792	57895.16306
		8	$92,344	56642.49255
		9	$96,038	55416.92592
		10	$99,879	54217.87672
		11	$103,874	53044.7712
		12	$108,029	51897.04803
		13	$112,351	50774.15799
		14	$116,845	49675.5638
		15	$121,518	48600.73974
		16	$126,379	47549.17153
		17	$131,434	46520.35596
		18	$136,692	45513.80075
		19	$142,159	44529.02426
		20	$147,846	43565.55525
		21	$153,759	42622.9327
		22	$159,910	41700.70555
		23	$166,306	40798.43253
		24	$172,958	39915.68187
		25	$179,877	39052.03118
		26	$187,072	38207.06719
		27	$194,555	37380.38559
		28	$202,337	36571.59079
		29	$210,430	35780.29579
		30	$218,848	35006.12194
		31	$227,602	34248.69879
		32	$236,706	33507.66392
		33	$246,174	32782.66272
		34	$256,021	32073.34829
		35	$266,262	31379.38121
		36	$276,912	30700.4294
		37	$287,989	30036.16799
		38	$299,508	29386.27913
		39	$311,488	28750.45183
		40	$323,948	28128.38185
			TOTAL	$        1,524,568
		NET PRESENT VALUE	NPV	$        1,524,568
	OPTION B-Ritter College	BRADLEY SCHOOL
		Yearwise cash flow and PV of cash flows are given below:
		Annual Salary=$92,000 after MBA
		N	A	B=A/(1.063^N)
		Year	Cash flow	PV of cash flow
		0	($89,500)	-89500
		1	$18,000	16933.2079
		2	$65,320	57806.89559
		3	$67,606	56284.23042
		4	$69,972	54801.67308
		5	$72,421	53358.16711
		6	$74,956	51952.68387
		7	$77,580	50584.22183
		8	$80,295	49251.80583
		9	$83,105	47954.48639
		10	$86,014	46691.33905
		11	$89,024	45461.46371
		12	$92,140	44263.98395
		13	$95,365	43098.04646
		14	$98,703	41962.8204
		15	$102,158	40857.49681
		16	$105,733	39781.28806
		17	$109,434	38733.42722
		18	$113,264	37713.16762
		19	$117,228	36719.7822
		20	$121,331	35752.56311
		21	$125,578	34810.82109
		22	$129,973	33893.88506
		23	$134,522	33001.10164
		24	$139,230	32131.83461
		25	$144,103	31285.46456
		26	$149,147	30461.38835
		27	$154,367	29659.01876
		28	$159,770	28877.78403
		29	$165,362	28117.12744
		30	$171,150	27376.50696
		31	$177,140	26655.39483
		32	$183,340	25953.27719
		33	$189,757	25269.6537
		34	$196,398	24604.03724
		35	$203,272	23955.95347
		36	$210,387	23324.94059
		37	$217,750	22710.54893
		38	$225,371	22112.34067
		39	$233,259	21529.88956
		40	$241,423	20962.78052
			TOTAL	$        1,347,156
		NET PRESENT VALUE	NPV	$        1,347,156
		BEST OPTION : WILTON UNIVERSITY, higher NPV
	4	Decision should be evaluate based on Net Present Value
		If you use Future value, you are assumimng that reinvestment
		of income is providing return at discount rate.
		This may not be a correct assumption
	5	Initial salary required to make it indifferent between the two school
		N	A	B=A/(1.063^N)
		Year	Cash flow	PV of cash flow
		0	($89,500)	-89500
		1	$18,000	16933.2079
		2	$73,483	65030.98758
		3	$76,055	63318.03588
		4	$78,717	61650.20427
		5	$81,472	60026.30425
		6	$84,323	58445.17864
		7	$87,275	56905.70075
		8	$90,329	55406.77354
		9	$93,491	53947.3289
		10	$96,763	52526.32682
		11	$100,150	51142.75471
		12	$103,655	49795.62665
		13	$107,283	48483.98267
		14	$111,038	47206.88811
		15	$114,924	45963.43292
		16	$118,947	44752.73102
		17	$123,110	43573.91967
		18	$127,418	42426.15885
		19	$131,878	41308.63067
		20	$136,494	40220.5388
		21	$141,271	39161.10787
		22	$146,216	38129.58292
		23	$151,333	37125.2289
		24	$156,630	36147.33011
		25	$162,112	35195.18972
		26	$167,786	34268.12921
		27	$173,658	33365.48799
		28	$179,736	32486.62283
		29	$186,027	31630.90746
		30	$192,538	30797.7321
		31	$199,277	29986.50304
		32	$206,252	29196.64218
		33	$213,470	28427.5867
		34	$220,942	27678.78855
		35	$228,675	26949.71416
		36	$236,678	26239.84399
		37	$244,962	25548.67218
		38	$253,536	24875.70621
		39	$262,410	24220.46654
		40	$271,594	23582.48623
			TOTAL	$        1,524,578
		NET PRESENT VALUE	NPV	$        1,524,578		1524568
		AFTER TAX INCOME	$73,483
		Annual Salary=73483/0.71=	$103,497