In: Finance
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Q. Your brother, age 30, working for ABC Corp. wants to quit his job and go back to school for MBA degree. At his current job, he is making $60000 per year and was planning to work until age 65 years. If he goes back to school, he will forego two years of income, but his real income after graduation would be $90000 per year until retirement at age 65. He has been accepted to an MBA program that costs a real $40000 per year. If his real opportunity cost is 10 percent, would leaving his job to get an MBA be a smart financial decision? Show all your calculations along with the recommendation.
Here two methods can be used for the comparison of two options. Equivalent annual worth method or NPV method. It is easy to use EUAW method.
Option 1: Continue his job with ABC corp.
He is getting $60,000 per year and for next 35 years he will get the same salary
EUAW for 35 years =$60,000(as he is getting same salary, EUAB is $60,000 itself)
Option 2: Quit job and go to MBA for two years
MBA program costs$40,000 for two years. After two years he will get a salary of $90,000 for next 33 years( till age 65)
EUAB for salary=$90,000-90,000/(1+r)*Annual value factor-90,000/(1+r)2 *annual value factor,as salary starts after two years
Annual value factor is 0.10/1-(1.10)-35 =0.10/1-0.035584 =0.10/0.96 4416=0.10369(this is also reciprocal of PV annuity=1/9.644159)
EUAB of salary=$90,000-$90,000/1.1*0.10369-$90,000/(1.1)2 *0.10369
=$90,000-$8,483.703-$7.712.457=$73,803.84
EUAC for MBA program fee for two years=40,000/1.1*annual value factor +($40,000/(1.10)2*Annual value factor)
40,000/1.1*0.10/1-(1.10)-35 +($40,000/(1.10)2*0.10/1-(1.10)-35 )
=$40,000/1.1*0.10/1-0.035584 +$40,000/(1.10)2*0.10/1-0.035584
=$40,000/1.1*0.10/0.96 4416+$40,000/(1.10)2*0.10/0.964416
=$40,000*0.10369/1.1+40,000*0.10369/(1.1)2
=+$3770.534+$3,427.759=$7198.2935
EUAW=EUAB-EUAC=$73,803.84-$7198.2935=$66,605.55
=$66,605.55 which is > $60,000,EUAW of option one
EUAW of option two is better than EUAW of option 1,So he should quit the job for two years .It would be a better decision.
Alternatively we can do this comparison using NPV method:
Dscounting factor |
cash flow option 2 |
PV of cash flows |
|
1 |
0.909090909 |
-40,000 |
-36363.6 |
2 |
0.826446281 |
-40,000 |
-33057.9 |
3 |
0.751314801 |
90000 |
67618.33 |
4 |
0.683013455 |
90000 |
61471.21 |
5 |
0.620921323 |
90000 |
55882.92 |
6 |
0.56447393 |
90000 |
50802.65 |
7 |
0.513158118 |
90000 |
46184.23 |
8 |
0.46650738 |
90000 |
41985.66 |
9 |
0.424097618 |
90000 |
38168.79 |
10 |
0.385543289 |
90000 |
34698.9 |
11 |
0.350493899 |
90000 |
31544.45 |
12 |
0.318630818 |
90000 |
28676.77 |
13 |
0.28966438 |
90000 |
26069.79 |
14 |
0.263331254 |
90000 |
23699.81 |
15 |
0.239392049 |
90000 |
21545.28 |
16 |
0.217629136 |
90000 |
19586.62 |
17 |
0.197844669 |
90000 |
17806.02 |
18 |
0.17985879 |
90000 |
16187.29 |
19 |
0.163507991 |
90000 |
14715.72 |
20 |
0.148643628 |
90000 |
13377.93 |
21 |
0.135130571 |
90000 |
12161.75 |
22 |
0.122845974 |
90000 |
11056.14 |
23 |
0.111678158 |
90000 |
10051.03 |
24 |
0.101525598 |
90000 |
9137.304 |
25 |
0.092295998 |
90000 |
8306.64 |
26 |
0.083905453 |
90000 |
7551.491 |
27 |
0.076277684 |
90000 |
6864.992 |
28 |
0.069343349 |
90000 |
6240.901 |
29 |
0.063039409 |
90000 |
5673.547 |
30 |
0.057308553 |
90000 |
5157.77 |
31 |
0.052098685 |
90000 |
4688.882 |
32 |
0.047362441 |
90000 |
4262.62 |
33 |
0.043056764 |
90000 |
3875.109 |
34 |
0.039142513 |
90000 |
3522.826 |
35 |
0.035584103 |
90000 |
3202.569 |
9.644158973 |
642354.5 |
For option 1 ,NPV=PV of equity*$60,000=9.644159*$60,000=$578,649.54<PV of option 2($642,354.5).So he should attend MBA program