Question

Ben Bates graduated from college six years ago with a finance undergraduate degree. Although he is satisfied with his current job, his goal is to become an investment banker. He feels that an MBA degree would allow him to achieve this goal. After examining schools, he has narrowed his choice to either Wilton University or Mount Perry College. Although internships are encouraged by both schools, to get class credit for the internship, no salary can be paid. Other than internships, neither school will allow its students to work while enrolled in its MBA program. Ben currently works at the money management firm of Dewey and Louis. His annual salary at the firm is $53,000 per year, and his salary is expected to increase at 3 percent per year until retirement. He is currently 28 years old and expects to work for 38 more years. His current job includes a fully paid health insurance plan, and his current average tax rate is 26 percent. Ben has a savings account with enough money to cover the entire cost of his MBA program. The Ritter College of Business at Wilton University is one of the top MBA programs in the country. The MBA degree requires two years of full-time enrollment at the university. The annual tuition is $58,000, payable at the beginning of each school year. Books and other supplies are estimated to cost $2,000 per year. Ben expects that after graduation from Wilton, he will receive a job offer for about $87,000 per year, with a $10,000 signing bonus. The salary at this job will increase at 4 percent per year. Because of the higher salary, his average income tax rate will increase to 31 percent. The Bradley School of Business at Mount Perry College began its MBA program 16 years ago. The Bradley School is smaller and less well known than the Ritter College. Bradley offers an accelerated one-year program, with a tuition cost of $75,000 to be paid upon matriculation. Books and other supplies for the program are expected to cost $4,200. Ben thinks that he will receive an offer of $78,000 per year upon graduation, with an $8,000 signing bonus. The salary at this job will increase at 3.5 percent per year. His average tax rate at this level of income will be 29 percent. Both schools offer a health insurance plan that will cost $3,000 per year, payable at the beginning of the year. Ben has also found that both schools offer graduate housing. His room and board expenses will decrease by $4,000 per year at either school he attends. The appropriate discount rate is 5.5 percent.

1.

A)How does Ben’s age affect his decision to get an MBA?

B) What other, perhaps nonquantifiable, factors affect Ben’s decision to get an MBA?

C) Assuming all salaries are paid at the end of each year, what is the best option for Ben from a strictly financial standpoint?

Answer 1

1]

As Ben is quite young and in the early phase of his career, he can afford stop working for 1 or 2 years and invest that time in an MBA. The MBA would better his career prospects and increase the probability of higher salary in the future. It can be seen as investment in his future and his career

2]

What other, perhaps nonquantifiable factors affect Ben’s decision to get an MBA

• The satisfaction and status achieved by having a master's degree
• networking and soft skills provided by an MBA program
• opportunity for career growth

3]

From a strictly financial standpoint, the option with the highest NPV must be chosen.

Alternative 1 - Stay in current job

PV of growing annuity = P * [1 - ((1 + g) / (1 + r))ⁿ] / (r - g),

where P = first payment. This is next year after-tax salary = $53,000 * (1 + 3%) * (1 - 26%) = $40,396.60

r = discount rate. This is 5.5%.

g = growth rate. This is 3%.

n = number of years. This is 38.

PV of after-tax salary = $40,396.60 * [1 - ((1 + 3%) / (1 + 5.5%))³⁸] / (5.5% - 3%)

PV of after-tax salary = $966,294.12

NPV of Alternative 1 =  $966,294.12

Alternative 2 - Ritter College of Business at Wilton University

NPV = PV of after-tax salary - PV of expenses

Year 0 and Year 1 expense = tuition + books + insurance - decreased room and board expenses = $58,000 + $2,000 + $3,000 - $4,000 = $59,000

PV of lumpsum = future value / (1 + discount rate)^{number of years}

PV of expenses = ($59,000 / (1 + 5.5%)⁰) + ($59,000 / (1 + 5.5%)¹) = $114,924.17

PV of after-tax signing bonus = $10,000 * (1 - 31%) / (1 + 5.5%)² = $6,199.32

PV of growing annuity = P * [1 - ((1 + g) / (1 + r))ⁿ] / (r - g)

As it is a 2-year program, it is assumed that he will work for 36 years.

PV of after-tax salary (2 years from today) = $87,000 * (1 - 31%) * [1 - ((1 + 4%) / (1 + 5.5%))³⁶] / (5.5% - 4%)

PV of after-tax salary (2 years from today) = $1,612,050.35

PV of after-tax salary today =  $1,612,050.35 / (1 + 5.5%)² = $1,448,350.53

NPV of Alternative 2 = PV of after-tax salary today + PV of after-tax signing bonus - PV of expenses

NPV of Alternative 2 = $1,448,350.53 + $6,199.32 - $114,924.17

NPV of Alternative 2 = $1,339,625.68

Alternative 3 - Bradley School of Business at Mount Perry College

NPV = PV of after-tax salary - PV of expenses

Year 1 expense = tuition + books + insurance - decreased room and board expenses = $75,000 + $4,200 + $3,000 - $4,000 = $78,200

PV of lumpsum = future value / (1 + discount rate)^{number of years}

PV of expenses = $78,200 / (1 + 5.5%)¹ = $74,123.22

PV of after-tax signing bonus = $8,000 * (1 - 29%) / (1 + 5.5%)¹ = $5,383.89

PV of growing annuity = P * [1 - ((1 + g) / (1 + r))ⁿ] / (r - g)

As it is a 1-year program, it is assumed that he will work for 37 years.

PV of after-tax salary (1 year from today) = $78,000 * (1 - 29%) * [1 - ((1 + 3.5%) / (1 + 5.5%))³⁷] / (5.5% - 3.5%)

PV of after-tax salary (1 year from today) = $1,405,123.99

PV of after-tax salary today =  $1,405,123.99 / (1 + 5.5%)¹ = $1,331,871.08

NPV of Alternative 3 = PV of after-tax salary today + PV of after-tax signing bonus - PV of expenses

NPV of Alternative 3 = $1,331,871.08 + $5,383.89 - $74,123.22

NPV of Alternative 3 = $1,263,131.74

As Alternative 2 has the highest NPV, Ritter College must be chosen