Question

Adina, age 32, is a married architect with one child. Her salary has reached a plateau at $85,000 a year. She believes that if she pursues an MBA degree full-time, she would move into a managerial position and her salary would rise by $60,000 a year. Adina wants to maintain her current lifestyle, which already generates substantial yearly cash savings and accumulate the capital to leave to her son. Her MBA course would take two years to complete and cost $52,000 a year. Because she plans to pay for the MBA out of existing savings and would be spending the money to qualify for a new position, she would not be eligible for any tax benefits. Assume that Adina pays one-third of her salary in taxes and her tax bracket will remain unchanged after the raise, that she can earn 6 percent after taxes on investments with a similar risk to her job, and that she plans to retire at age 65. Furthermore, assume that all salary and schooling payments are made in a lump sum at the beginning of each year. What is her rate of return on this investment? Should she pursue an MBA? If so, what will be the value of her human capital, assuming a calculation that incorporates salary forgone and her extra salary from obtaining her MBA upon graduation?

Answer 1

Discount Rate = 6%, the rate at which Adina can invest

Post Tax Salary Pre MBA = 85000*2/3 = 56667

MBA Scenario	32	33	34	35	36	37	38	39	40	41	42	43	44	45	46	47	48	49	50	51	52	53	54	55	56	57	58	59	60	61	62	63	64	65
MBA Cost	(52,000)	(52,000)
Post MBA Salary			145,000	145,000	145,000	145,000	145,000	145,000	145,000	145,000	145,000	145,000	145,000	145,000	145,000	145,000	145,000	145,000	145,000	145,000	145,000	145,000	145,000	145,000	145,000	145,000	145,000	145,000	145,000	145,000	145,000	145,000	145,000	-
Taxes			48,333	48,333	48,333	48,333	48,333	48,333	48,333	48,333	48,333	48,333	48,333	48,333	48,333	48,333	48,333	48,333	48,333	48,333	48,333	48,333	48,333	48,333	48,333	48,333	48,333	48,333	48,333	48,333	48,333	48,333	48,333
Post Tax Salary, after MBA	(52,000)	(52,000)	96,667	96,667	96,667	96,667	96,667	96,667	96,667	96,667	96,667	96,667	96,667	96,667	96,667	96,667	96,667	96,667	96,667	96,667	96,667	96,667	96,667	96,667	96,667	96,667	96,667	96,667	96,667	96,667	96,667	96,667	96,667
Less: Post Tax Salary, pre MBA foregone	(56,667)	(56,667)	(56,667)	(56,667)	(56,667)	(56,667)	(56,667)	(56,667)	(56,667)	(56,667)	(56,667)	(56,667)	(56,667)	(56,667)	(56,667)	(56,667)	(56,667)	(56,667)	(56,667)	(56,667)	(56,667)	(56,667)	(56,667)	(56,667)	(56,667)	(56,667)	(56,667)	(56,667)	(56,667)	(56,667)	(56,667)	(56,667)	(56,667)
Net Differential cash flow, due to pursuing MBA	(108,667)	(108,667)	40,000	40,000	40,000	40,000	40,000	40,000	40,000	40,000	40,000	40,000	40,000	40,000	40,000	40,000	40,000	40,000	40,000	40,000	40,000	40,000	40,000	40,000	40,000	40,000	40,000	40,000	40,000	40,000	40,000	40,000	40,000
Discount Factor	1.00	0.94	0.89	0.84	0.79	0.75	0.70	0.67	0.63	0.59	0.56	0.53	0.50	0.47	0.44	0.42	0.39	0.37	0.35	0.33	0.31	0.29	0.28	0.26	0.25	0.23	0.22	0.21	0.20	0.18	0.17	0.16	0.15
Notional PV of Incremental Cash Flow, Post MBA	(108,667)	(102,516)	35,600	33,585	31,684	29,890	28,198	26,602	25,096	23,676	22,336	21,072	19,879	18,754	17,692	16,691	15,746	14,855	14,014	13,221	12,472	11,766	11,100	10,472	9,879	9,320	8,792	8,295	7,825	7,382	6,964	6,570	6,198

PV	314,443
IRR	10%

Where PV (present Value

To answer the questions based on above data

What is her rate of return on this investment?

Its the IRR of MBA = 10%

Should she pursue an MBA?

Pursuing MBA has a positive IRR of 10%, greater than alternate choice of return from investing at 6%. SO pursuing MBA is a value creating choice

If so, what will be the value of her human capital, assuming a calculation that incorporates salary forgone and her extra salary from obtaining her MBA upon graduation?

Additional Value created from doing MBA is the present value of cash flow, over and above the no MBA decision i.e.Notional PV of Incremental Cash Flow, Post MBA = $314,443