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In: Finance

Show your work in Excel and submit your excel sheet. Q. Your brother, age 30, working...

Show your work in Excel and submit your excel sheet.

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.

Solutions

Expert Solution

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


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