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 Wilton University. Ben currently works at the money management firm. His annual salary at the firm is $65,000 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 40 more years. 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 MBA degree at Wilton University requires two years of full-time enrollment at the university. The annual tuition and other supplies cost $78,000, payable at the beginning of each school year. Ben expects that after graduation from Wilton, he will receive a job offer for about $110,000 per year and work for 38 years. 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 appropriate discount rate is 6.5 percent. 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

Let's calculte the PV of both options
PV of annuity for growing annuity
P = (PMT/(r-g)) x (1-((1+g)/(1 + r)) ^n)
Where:
P = the present value of an annuity stream
PMT = the dollar amount of each annuity payment
r = the effective interest rate (also known as the discount rate)
i=nominal Interest rate
n = the number of periods in which payments will be made
g= Growth rate
Annual salary	65000
Average tax rate	26%
Net of tax	48100
Annual growth	3%
Time in years	40
Interest	6.500%
PV	= (PMT/(r-g)) x (1-((1+g)/(1 + r)) ^n)
PV	= (48100/(6.5%-3%)) * (1-((1+3%)/(1 + 6.5%)) ^40)
PV	1,013,223.78
After MBA means 2 years later
Annual salary	110000
Average tax rate	31%
Net of tax	75900
Annual growth	4%
Time in years	38
Interest	6.500%
PV at t2	= (PMT/(r-g)) x (1-((1+g)/(1 + r)) ^n)
PV at t2	= (75900/(6.5%-4%)) * (1-((1+4%)/(1 + 6.5%)) ^38)
PV at t2	1,804,927.68
PV at t0	1804927.68/(1+6.5%)^2
PV at t0	1,591,331.24
MBA cost PV		PV
T0	78,000.00	78,000.00
T1	78,000.00	73,239.44
		151,239.44
Net PV after MBA	1,440,091.81
Without MBA	1,013,223.78
As we can see he will reap fortunes after doing MBA from financial point view, he should opt for MBA programme.