Question

A prospective MBA student earns $55,000 per year in her current job and expects that amount to increase by 7% per year. She is considering leaving her job to attend business school for two years at a cost of $40,000 per year. She has been told that her starting salary after business school is likely to be $100,000 and that amount will increase by 10% per year. Consider a time horizon of 10 years, use a discount rate of 13%, and ignore all considerations not explicitly mentioned here. Assume all cash flows occur at the start of each year (i.e., immediate, one year from now, two years from now,..., nine years from now). Also assume that the choice can be implemented immediately so that for the MBA alternative the current year is the first year of business school. What is the net present value of the more attractive choice? Please round your answer to the nearest dollar.

Answer 1

If prospective MBA student leaves her job for more attractive choice (i.e. joining business school and earn $100,000 per year after that), then there will be an opportunity cost of salary that she would have earned from the current job.There is also a cost of study in Business School for first two years and there will be a cash inflow of salary after business school (i.e. for 8 years after business school). The calculation net present value is shown as follows:-

Years	Opportunity cost (A) (increase by 7% per year)	Business school cost (B)	Salary after business school (C) (increase by 10% per year)	Net cash Inflow(outflow) (C-A-B)	PVF@13% (D) (start of each year)	PV of net cash inflow(outflow) (E = D*C)
1	55,000	40,000	-	(95,000)	1	(95,000)
2	58,850	40,000	-	(98,850)	0.885	(87,482.25)
3	62,969.50	-	100,000	37,030.50	0.783	28,994.88
4	67,377.36	-	110,000	42,622.64	0.693	29,537.49
5	72,093.78	-	121,000	48,906.22	0.613	29,979.51
6	77,140.35	-	133,100	55,959.65	0.543	30,386.09
7	82,540.17	-	146,410	63,869.83	0.480	30,657.52
8	88,317.98	-	161,051	72,733.02	0.425	30,911.53
9	94,500.24	-	177,156.10	82,655.86	0.376	31,078.60
10	101,115.26	-	194,871.71	93,756.45	0.333	31,220.90
	Net Present Value					60,284.27

Therefore the net present value of more attractive choice is $60,284.