Question

memo format( word doc )

The MBA Decision

Raj Danielson graduated from university six years ago with a finance undergraduate degree. 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 Assiniboine University or the University of Passy. Both schools encourage internships, but to get class credit for the internship, no salary can be accepted. Other than internships, neither school allows its students to work while enrolled in its MBA program.
Raj currently works at the money management firm of Prash and Sid. His annual salary at the firm is $63,000 and his salary is expected to increase at 5 percent per year until retirement. He is currently 28 years old and expects to work for 38 more years. His current job includes a fully paid health insurance plan, and his current average tax rate is 24 percent. Raj has a savings account with enough money to cover the entire cost of his MBA program.

The Sentinel School of Business at Assiniboine 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 $65,000, payable at the beginning of each school year. Books and other supplies are estimated to cost $4,500 per year. Raj expects that after graduation from Assiniboine, he will receive a job offer for about $88,000 per year, with a $14,000 signing bonus. The salary at this job will increase at 5.5 percent per year. Because of the higher salary, his average income tax rate will increase to 31 percent.
The Pond School of Business at the University of Passy began its MBA program 16 years ago. The Pond School is smaller and less well known than the Sentinel School. It offers an accelerated one-year program, with a tuition cost of $90,000 to be paid upon matriculation. Books and other supplies for the program are expected to cost $3,000. Raj thinks that he will receive an offer of $85,000 per year upon graduation, with a
$9,000 signing bonus. The salary at this job will increase at 3.7 percent per year. His average tax rate at this level of income will be 31 percent.
Both schools offer a health insurance plan that will cost $2,500 per year, payable at the beginning of the year. Raj also estimates that room and board expenses will cost
$20,000 per year at both schools. The appropriate discount rate is 6.5 percent.
You are required to:

1.   (1%) How does Raj’s age affect his decision to get an MBA?
2.   (1%) What other, perhaps non-quantifiable, factors affect Raj’s decision to get an MBA?
3.   (4%) Assuming all salaries are paid at the end of each year, what is the best option for Raj from a strictly financial standpoint? Show your assumptions, calculations and explain why one of the option is better than the other alternatives.
There are three options to compare: remain at his current job, pursue a Wilton MBA, or pursue a Mt. Perry MBA. Compare the options using after-tax cash flows. Hint: room and board costs are irrelevant since presumably they will be the same whether he attends college or keeps his current job. Take in account the opportunity costs: lost salary during the MBA.
4.   (2%) What initial salary would Raj need to receive to make him indifferent between attending Assiniboine University and staying in his current position?
Since the first salary payment will not be received for three years, you need to compound this value two years into the future to arrive at the salary amount after graduation.
5.   (1%) Suppose, instead of being able to pay cash for his MBA, Raj must borrow the money. Explain how would this affect his decision?

Answer 1

1. Raj's age does affect the decision to get an MBA as it will directly impact the number of future years he will be working before his retirement. So, cash inflow will be dependant on the future years of service.

2. Other factors affecting Raj's decision:

- How serious is Raj to strive for the gaol i.e. become an investment banker considering the fact that he is satisfied with the current job.

- Will he be ready to pursue studies after a break of 6 years which turns out to be a huge problem for many people.

- After paying out for the MBA, will he have sufficient funds to bear his personal expenses during the course of his studies and may be some time after that.

- How much time will it take for him to get another job after completing MBA?

- Will there be an increase in salary he is expecting after completing course from 2 chosen Universities?

- Does he have any current loan payments going on say car loan, home loan?

- Any alternate source of income say rent revenue?

3.

Option 1 = Current job (No MBA),

Option 2 = MBA from Assiniboine University(2 years),

Option 3 = MBA from University of Passy(1 year)

Cash Outflow:

Option 1 : 0 (No MBA cost)

Option 2 : Beginning of Year 1 = 65000(Tuition fee) + 4500(Books) + 2500(Health Insurance) = 72,000

Beginning of Year 2 = 72,000

Outflow at time 0 = 72,000 + 72,000*(1+6.5%)^(-1) = $139,605.63

Option 3 : Beginning of Year 1 = 90000(Tuition fee) + 3000(Books) + 2500(Health Insurance) = 95,500

Outflow at time 0 = $95,500

(Room and board expenses are same for all options, so they can be ignored)

Cash Inflow:

Salary for year n = Current salary * (1+ salary increase %)^n

After Tax salary = Salary * (1 - tax rate %)

Discounted salary for year n = After tax salary for year n*(1+6.5%)^(-n)

	Option 1				Option 2				Option 3
Year	Salary	After tax Salary	Discounted Salary		Salary	After tax Salary	Discounted Salary		Salary	After tax Salary	Discounted Salary
0	63,000.00	47,880.00			0.00	0.00			0.00	0.00
1	66,150.00	50,274.00	47,205.63		0.00	0.00	0.00		0.00	0.00	0.00
2	69,457.50	52,787.70	46,540.77		0.00	0.00	0.00		85,000.00	58,650.00	51,709.32
3	72,930.38	55,427.09	45,885.26		88,000.00	60,720.00	50,267.00		88,145.00	60,820.05	50,349.82
4	76,576.89	58,198.44	45,238.99		92,840.00	64,059.60	49,795.01		91,406.37	63,070.39	49,026.07
5	80,405.74	61,108.36	44,601.82		97,946.20	67,582.88	49,327.45		94,788.40	65,404.00	47,737.12
6	84,426.03	64,163.78	43,973.63		103,333.24	71,299.94	48,864.28		98,295.57	67,823.94	46,482.06
7	88,647.33	67,371.97	43,354.28		109,016.57	75,221.43	48,405.46		101,932.51	70,333.43	45,260.00
8	93,079.69	70,740.57	42,743.66		115,012.48	79,358.61	47,950.95		105,704.01	72,935.77	44,070.07
9	97,733.68	74,277.59	42,141.63		121,338.17	83,723.34	47,500.70		109,615.06	75,634.39	42,911.42
10	102,620.36	77,991.47	41,548.09		128,011.77	88,328.12	47,054.69		113,670.82	78,432.86	41,783.23
11	107,751.38	81,891.05	40,962.90		135,052.41	93,186.17	46,612.86		117,876.64	81,334.88	40,684.70
12	113,138.95	85,985.60	40,385.96		142,480.30	98,311.40	46,175.18		122,238.07	84,344.27	39,615.06
13	118,795.90	90,284.88	39,817.15		150,316.71	103,718.53	45,741.61		126,760.88	87,465.01	38,573.53
14	124,735.69	94,799.12	39,256.34		158,584.13	109,423.05	45,312.11		131,451.03	90,701.21	37,559.39
15	130,972.48	99,539.08	38,703.44		167,306.26	115,441.32	44,886.65		136,314.72	94,057.16	36,571.92
16	137,521.10	104,516.04	38,158.32		176,508.10	121,790.59	44,465.18		141,358.37	97,537.27	35,610.40
17	144,397.15	109,741.84	37,620.88		186,216.05	128,489.07	44,047.66		146,588.63	101,146.15	34,674.17
18	151,617.01	115,228.93	37,091.00		196,457.93	135,555.97	43,634.07		152,012.40	104,888.56	33,762.55
19	159,197.86	120,990.38	36,568.60		207,263.12	143,011.55	43,224.36		157,636.86	108,769.44	32,874.89
20	167,157.76	127,039.89	36,053.54		218,662.59	150,877.19	42,818.50		163,469.43	112,793.90	32,010.58
21	175,515.64	133,391.89	35,545.75		230,689.03	159,175.43	42,416.45		169,517.80	116,967.28	31,168.98
22	184,291.43	140,061.48	35,045.10		243,376.93	167,930.08	42,018.17		175,789.95	121,295.07	30,349.52
23	193,506.00	147,064.56	34,551.51		256,762.66	177,166.23	41,623.63		182,294.18	125,782.99	29,551.59
24	203,181.30	154,417.79	34,064.87		270,884.61	186,910.38	41,232.80		189,039.07	130,436.96	28,774.65
25	213,340.36	162,138.67	33,585.08		285,783.26	197,190.45	40,845.64		196,033.51	135,263.12	28,018.13
26	224,007.38	170,245.61	33,112.05		301,501.34	208,035.92	40,462.11		203,286.75	140,267.86	27,281.51
27	235,207.75	178,757.89	32,645.69		318,083.91	219,477.90	40,082.18		210,808.36	145,457.77	26,564.25
28	246,968.14	187,695.78	32,185.89		335,578.53	231,549.18	39,705.83		218,608.27	150,839.71	25,865.84
29	259,316.54	197,080.57	31,732.57		354,035.35	244,284.39	39,333.00		226,696.78	156,420.78	25,185.80
30	272,282.37	206,934.60	31,285.63		373,507.29	257,720.03	38,963.68		235,084.56	162,208.35	24,523.64
31	285,896.49	217,281.33	30,844.99		394,050.19	271,894.63	38,597.82		243,782.69	168,210.05	23,878.89
32	300,191.31	228,145.40	30,410.55		415,722.95	286,848.84	38,235.40		252,802.65	174,433.83	23,251.09
33	315,200.88	239,552.67	29,982.23		438,587.71	302,625.52	37,876.38		262,156.35	180,887.88	22,639.79
34	330,960.92	251,530.30	29,559.95		462,710.04	319,269.93	37,520.74		271,856.13	187,580.73	22,044.57
35	347,508.97	264,106.82	29,143.61		488,159.09	336,829.77	37,168.43		281,914.81	194,521.22	21,464.99
36	364,884.42	277,312.16	28,733.14		515,007.84	355,355.41	36,819.43		292,345.65	201,718.50	20,900.65
37	383,128.64	291,177.76	28,328.44		543,333.27	374,899.96	36,473.71		303,162.44	209,182.09	20,351.15
38	402,285.07	305,736.65	27,929.45		573,216.60	395,519.45	36,131.23		314,379.45	216,921.82	19,816.10
Total			1,396,538.38				1,541,590.33				1,232,897.44

Net Present Value:

Option 1 = PV of Cash Inflow - PV of Cash Outflow = 1,396,538.38 - 0 = $1,396,538.38

Option 2 = 1,541,590.33 - 139,605.63 = $1,401,984.69

Option 3 = 1,232,897.44 - 95,500 = $1,137,397.44

So, the best option is Option 2 i.e. Pursue a Wilton MBA. Because it has the highest NPV out of the all 3 options.

4.

We can calculate this using the formulaes shown in question 3 and the Option 2 table created. Using trial and error of salary amount, we can see where the NPV of Option 2 = NPV of Option 1 = $1,396,538.38

Salary comes out to be $87,689 or $87,690 (round to 10s)

5. If Raj borrows the money, following factors will affect the decision:

- What will be the rate of interest for 1 year(Option 3) and 2 year (Option 2) loan period?

- When will the first installment be paid? Generally for education loans, first installment can be paid after getting the job and nothing is to be paid during the study period.

- How much loan will be taken i.e. partial or full?

- Tax benefit on interest payments.