Question

Jane is unhappy with her current salary and is considering doing a two-year MBA. For simplicity assume the MBA starts today (i.e., in t=0). Tuition is $25,000 per year payable at the beginning of a year. Jane must additionally buy books and supplies worth $5,000 per year which are again payable at the beginning of a year. If Jane pursues the MBA she expects to get a job right after graduation. The job entails a signup bonus of $10,000 immediately when she starts the job and a starting salary of $86,000. Jane expects this salary to grow at a rate of 6% annually. Salaries are paid at the end of a year. Regardless of whether she pursues the MBA or stays in her current job Jane expects to retire in 38 years from today. Does it pay for Jane to do an MBA? Perform NPV calculation.

Answer 1

Taking all the inputs from the question, we'll use the following steps for calculating the NPV of the MBA as a project. We'll use 10% as the discount rate, as it is not given.

Decision rule: To find the Cost recovery time for the MBA-Job scenario and go ahead with MBA if it is under 3 years. This means if our costs of MBA are being recovered in first 3 years of starting the job, the MBA as a project can be undertaken.

STEPS TO COMPUTE THE NET PRESENT VALUE

1. Write the Net cash flows for years 0-12 (say). This is done by subtracting the cash outflow of a year from the cash inflow of the same year.

2. Compute discount factor for each year. This done by the formula 1/(1+r)ⁿ where r is the rate of interest and n is the year.

3. Calculate the Present Value of each year's cash flow by finding the product of each cash flow and its corresponding discount factor.

4. Find the Cumulative Present value of each year's cash flow in order to track in which year the cost is getting recovered.

Note: The table below shows all the workings. The cash flows taken are at the end of the year.

Decision: Since the NPV is coming out to be positive in Year 2 of Job, as per the decision rule, the project can be accepted. Jane should go ahead and pursue MBA.