Question

B. Suppose a 48-year-old salesperson earning $50,000 a year (after taxes) is considering a career move. Specifically, this person – who plans to retire when (s)he turns 62 regardless of job – is thinking about quitting sales work for 2 years to earn an MBA degree. With MBA degree in hand, suppose this person can become an executive and earn $75,000 per year (after taxes). Suppose MBA tuition is $30,000 per year. Suppose the relevant discount rate is 3.5% per year. Based on this information, demonstrate and explain how one could reckon whether or not this change promises to be a good move. You are expected to show how one would set up and perform the calculation(s).

Answer 1

If this person joins MBA, she shall pass out when she is 50 years and will work for another 12 years (= 62 - 50).

Annual incremental benefit per year ($) = 75,000 - 50,000 = 25,000, for 12 years starting after 2 years.

After 2 years, Present worth (PW) of MBA fees ($) = 30,000 x P/A(3.5%, 2) = 30,000 x 1.8997** = 56,991

After 2 years, Present worth (PW) of salary foregone ($) = 50,000 x P/A(3.5%, 2) = 50,000 x 1.8997** = 94,985

After 2 years, Present worth (PW) of Annual incremental benefit ($) = 25,000 x P/A(3.5%, 12) = 25,000 x 9.6633**

= 241,583

Therefore,

Net PW of MBA degree ($) = PW of Annual incremental benefit - PW of MBA fees - PW of salary foregone

= 241,583 - 56,991 - 94,985 = 89,607

Since Net PW of an MBA degree is positive, this change will be a good move.

**P/A(r%, N) = [1 - (1 + r)^-N] / r

P/A(3.5%, 2) = [1 - (1.035)^-2] / 0.035 = (1 - 0.9335) / 0.035 = 0.0665 / 0.035 = 1.8997

P/A(3.5%, 12) = [1 - (1.035)^-12] / 0.035 = (1 - 0.6618) / 0.035 = 0.3382 / 0.035 = 9.6633