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 $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 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 $70,000, payable at the beginning of each school year. Books and other supplies are estimated to cost $3,000 per year. Ben expects that after graduation from Wilton, he will receive a job offer for about $110,000 per year, with a $20,000 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 $85,000 to be paid upon matriculation. Books and other supplies for the program are expected to cost $4,500. Ben thinks that he will receive an offer of $92,000 per year upon graduation, with an $18,000 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 also estimates that room and board expenses will cost $2,000 more per year at both schools than his current expenses, payable at the beginning of each year. The appropriate discount rate is 6.3 percent.

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

4. Ben believes that the appropriate analysis is to calculate the future value of each option. How would you evaluate this statement?

5. What initial salary would Ben need to receive to make him indifferent between attending Wilton University and staying in his current position?

6. Suppose, instead of being able to pay cash for his MBA, Ben must borrow the money. The current borrowing rate is 5.4 percent. How would this affect his decision?

Answer 1

3	Present value of Cash Flow:
	(Cash Flow)/((1+i)^N)
	i=discount rate=6.3%=0.063
	N= year of Cash Flow
	Cash Flow for Ritter College , wilson University
	salary in first year	$110,000
	salary in second year	$114,400	(110000*1.04)
	Salary in Year (N+1)=1.04* (Salary in Year(N)					Tax Rate=31%
	N	A	B	C	D	E=D*(1-0.31)	F=A+B+C+E	G=F/(1.063^N)
	year	Tuition fees	Books etc	Signing bonus	Before tax salary	After Tax Salary	Net Cash Flow	Present Value of Net Cash Flow
	0	($70,000)	($3,000)				($73,000)	($73,000)
	1	($70,000)	($3,000)				($73,000)	-$68,674
	2			$20,000			$20,000	$17,700
	3				$110,000	$75,900	$75,900	$63,189
	4				$114,400	$78,936	$78,936	$61,822
	5				$118,976	$82,093	$82,093	$60,484
	6				$123,735	$85,377	$85,377	$59,176
	7				$128,684	$88,792	$88,792	$57,895
	8				$133,832	$92,344	$92,344	$56,642
	9				$139,185	$96,038	$96,038	$55,417
	10				$144,752	$99,879	$99,879	$54,218
	11				$150,543	$103,874	$103,874	$53,045
	12				$156,564	$108,029	$108,029	$51,897
	13				$162,827	$112,351	$112,351	$50,774
	14				$169,340	$116,845	$116,845	$49,676
	15				$176,114	$121,518	$121,518	$48,601
	16				$183,158	$126,379	$126,379	$47,549
	17				$190,484	$131,434	$131,434	$46,520
	18				$198,104	$136,692	$136,692	$45,514
	19				$206,028	$142,159	$142,159	$44,529
	20				$214,269	$147,846	$147,846	$43,566
	21				$222,840	$153,759	$153,759	$42,623
	22				$231,753	$159,910	$159,910	$41,701
	23				$241,024	$166,306	$166,306	$40,798
	24				$250,664	$172,958	$172,958	$39,916
	25				$260,691	$179,877	$179,877	$39,052
	26				$271,119	$187,072	$187,072	$38,207
	27				$281,963	$194,555	$194,555	$37,380
	28				$293,242	$202,337	$202,337	$36,572
	29				$304,972	$210,430	$210,430	$35,780
	30				$317,171	$218,848	$218,848	$35,006
	31				$329,857	$227,602	$227,602	$34,249
	32				$343,052	$236,706	$236,706	$33,508
	33				$356,774	$246,174	$246,174	$32,783
	34				$371,045	$256,021	$256,021	$32,073
	35				$385,886	$266,262	$266,262	$31,379
	36				$401,322	$276,912	$276,912	$30,700
	37				$417,375	$287,989	$287,989	$30,036
	38				$434,070	$299,508	$299,508	$29,386
	39				$451,433	$311,488	$311,488	$28,750
	40				$469,490	$323,948	$323,948	$28,128
							SUM	$1,524,568
	Net Present value of Option of Ritter College	$1,524,568