Question

Carolyn Shaw is 27. - She works as an accountant for an oil company. - Her salary next year will be $80,000. - She expects to receive a 5 percent raise each year until she retires at age of 65. - Carolyn is considering a return to school to pursue an MBA degree. - She expects the cost of books, tuition, and fees to be $70,000 the first year and $72,000 the second. - These costs are paid at the beginning of the year (as you surely know). - She will not work while in school. - Graduates of the school Carolyn is considering receive starting salaries that average $130,000. - Raises average 7 percent per year. - Carolyn considers the opportunity costs to be 12 percent. a)Determine the present value of Carolyn’s lifetime earnings if she does not return to school. b)Determine the present value of Carolyn’s lifetime earnings with an MBA degree. Remember, she won’t start her job for two years. c) What is the NPV of an MBA degree given Carolyn Shaw's assumptions?

Answer 1

	The salary streams are growing annuities.
	The PV of growing annuities is given by the formula:
	= [(P/(r-g)]*[1-((1+g)/(1+r))^n]
	where
	P = First payment
	r = rate per period
	g = growth rate
	n = number of periods
a)	PV if Carolyn does not return to school = ((80000/(0.12-0.05))*((1-(1.05/1.12)^38)) =	$       10,44,479
b)	Discounted value at t2, if Carolyn returns to school =
	= ((130000/(0.12-0.07))*((1-(1.07/1.12)^36)) =	$       20,97,726
	PV = 2097726/1.12^2 =	$       16,72,294
c)	Difference in PVs of salaries	$         6,27,816
	PV of college fee for two years = 70000/1.12+72000/1.12^2 =	$         1,19,898
	NPV of Carolyn's MBA degree = 627816-119898 =	$         5,07,918