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 his 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 expected to increase at 3% 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%. Ben has 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 $3000 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% per year. Because of the higher salary, his average income tax rate will increase to 31%. 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 the graduation, with an $18,000 signing bonus. The salary at this job will increase at 3.5% per year. His average tax rate at this level of income will be 29%. 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 4.7%

Questions:

1.How does Ben's age affect his decision to get an MBA?

2.What other, perhaps nonquantifiable, factors affect Ben's decision to get an MBA?

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

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]

• 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 alternative with the highest NPV must be chosen.

Alternative 1 : Stay in current job

Inflow for year 1 is the current salary ($65000) increased by 3%, which is $66,950. Inflow for year 2 is $66,950 increased by 3%, and so on for each year.

Net inflow after tax for each year is Inflow multiplied by (1 - tax rate)

Discount factor for year x is = 1/(1+0.047)^x

In this way, we calculate the PV of cash inflows for each year upto 40 years. The sum of these PVs is the NPV of Alternative 1.

NPV of Alternative 1 is $1,400,192

Alternative 2 : Ritter College at Wilton University

Cash outflow for the first two years = (tuition fee + books + health insurance + increased living expenses), which is ($70,000 + $3,000 + $3,000 + $2,000), or $78,000. Cash inflow in year 3 is $130,000 (salary + signing bonus). Cash inflow in year 4 is $110,000 increased by 4%, which is $114,400. Cash inflow for each succeeding year is increased by 4%. Tax outflow is the cash inflow multiplied by tax rate, which is 31%. Net cash inflow = inflow - tax outflow - outflow. Discount factors remain the same as Alternative 1. The sum of PVs is calculated to find the NPV of Alternative 2.

NPV of Alternative 2 is $2,422,112

Alternative 3 : Mount Perry College

Cash outflow for the first year = (tuition fee + books + health insurance + increased living expenses), which is ($85,000 + $4,500 + $3,000 + $2,000), or $94,500. Cash inflow in year 2 is $110,000 (salary + signing bonus). Cash inflow in year 3 is $92,000 increased by 3.5%, which is $95,220. Cash inflow for each succeeding year is increased by 3.5%. Tax outflow is the cash inflow multiplied by tax rate, which is 29%. Net cash inflow = inflow - tax outflow - outflow. Discount factors remain the same before. The sum of PVs is calculated to find the NPV of Alternative 3.

NPV of Alternative 3 is $1,799,706

Alternative 2 has the highest NPV. Therefore, Ritter College of Business at Wilton University should be chosen

4]

This analysis can also be done by calculating the future value of each option 40 years from today. The important thing to note is that the future value of each alternative must be compared to the future value of the other alternatives. This will give the same final decision, as long as the discount rate and other variables are unchanged.