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Essay, Pages 7 (1504 words)

Mini Case – The MBA Decision

1. How does Ben’s age affect his decision to get an MBA? Ben’s age is a very important factor which can affect his decision to get an MBA degree.

Firstly, Ben is now 28 years old and expects to work for 40 more years. So he has an expected work life of 68 years. So the earlier he gets an MBA, the better for him. For example: probably it won’t benefit him much if he decided to get an MBA at the age of 60.

No one would hire him as an investment banker even if he had an MBA that time.

Secondly, getting an MBA degree will cost Ben a lot of money. Currently at the age of 28, he already has a job experience of around 6 years. This job allowed Ben to have a savings account with enough money to cover the entire cost of his MBA program. If he wanted to start the MBA at the age of 23, probably he would not have that amount of savings.

Considering these factors, I believe that Ben’s age has an important role to play in his decision to get an MBA.

2. What other, perhaps non-quantifiable factors affect Ben’s decision to get an MBA? There might be several other non-quantifiable factors that can affect Ben’s decision to get an MBA. For example, neither school will allow its students to work while enrolled in its MBA program (other than internship). So, there won’t be any cash inflows for Ben while he will be doing his MBA as he has to leave the current job.

If Ben was too much dependent on his ‘current income’ flow (day-to-day needs, family needs, other obligations), then he will rethink this decision.

Ben has certain expectations about his salary level and expected growth of salary once he finishes his MBA. But there is inherent uncertainty/risk in these expectations. Due to economic downfall or recession, the salary level might be very low than he expected. Ben even might not get a new job after he completes the MBA program after one or two years.

3. Assuming all salaries are paid at the end of each year, what is the best option for Ben – from a strictly financial standpoint? We have to evaluate three options here: (i) Not getting an MBA and continuing the current job, (ii) Getting an MBA from Wilton University (The Ritter College of Business) and (iii) Getting an MBA from Mount Perry College (The Bradley School of Business) To evaluate from a strictly financial standpoint, we can calculate the Net Present Value (NPV) of each of the three options. This can be easily done because we have information of all the future expected cash flows (both inflows and outflows). The NPV values of the three options are as follows: i. Not getting an MBA:NPV = $935,283

ii. Getting MBA from Wilton University:NPV = $1,467,420 iii. Getting MBA from Mount Perry College:NPV = $1,301,013 Hence, according to NPV method, the best option for Ben would be to get an MBA from Wilton University as it has the highest NPV value. (Detail calculation for Question #3 is given later in the ‘calculation’ section)

4. Ben believes that the appropriate analysis is to calculate the future value of each option. How would you evaluate this statement? Ideally, present value analysis and future value analysis should always lead to the same decision. Hence if Ben calculates the future value of each option, he will get the same decision too. Having said so, the information Ben has is a series of future expected cash flows (fixed cash flow, annuity, growing annuity etc.). So it will be straight-forward for him to do the present value analysis. Otherwise he has to convert the present value into future value which is not necessary.

5. What initial salary would Ben need to receive to make him indifferent between attending Wilton University and staying in his current position? The initial salary (before tax deduction) that Ben would need to receive to make him indifferent between attending Wilton University and staying in his current position is $73,216. At this amount of initial salary, both the options will have same NPV. (Detail calculation for Question #5 is given later in the ‘calculation’ section)

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? In this case Ben has to consider the cash out flows he has to face to repay the loan (principle + interest). Assuming Ben takes a 5 year loan, with the borrowing rate of 5.4% and discount rate of 6.5%, the loan turns out to be a slightly better funding option for his MBA (with increased NPVs). Considering Ben borrows the money, the NPV values of the three options are as follows: i. Not getting an MBA:NPV = $935,283(no change from previous) ii. Getting MBA from Wilton University:NPV = $1,471,596 iii. Getting MBA from Mount Perry College:NPV = $1,303,654 Hence it can be seen that still the best option for Ben would be to get an MBA from Wilton University as it has the highest NPV value. However his decision on whether to borrow the money or not might get affected. (Detail calculation for Question #6 is given later in the ‘calculation’ section)

Calculation

Question # 3

i) Not getting an MBA

* Cash Inflow:

* Salary = $60,000 x (1 – 26%) = $44,400 [after 26% tax deduction] Expected to increase at 3% per year

Appropriate discount rate = 6.5%

Working years left = 40

Formula for Growing Annuity is as follows:

PV = C 1-1+g1+rTr-g

Here, C = $44,400, g = 3%, r = 6.5, T = 40

Hence, PV of Cash Inflow = $44,400 1-1+3%1+6.5%406.5%-3% = $935,283 * Cash Outflow:

There is no cash outflow relevant to this decision

Hence, NPV = $935,283

ii) Getting MBA from Wilton University

* Cash Inflow:

* Signing bonus of $20,000 at the end of year 2

* Salary = $110,000 x (1 – 31%) = $75,900 [after 31% tax deduction] Expected to increase at 4% per year

Appropriate discount rate = 6.5%

Working years left = 38

Hence, PV of Cash Inflow = ($20,000 + $75,9001-1+4%1+6.5%386.5%-4% ) / (1.065)2 = $1,608,964 * Cash Outflow:

* Annual Tuition = $65,000

Books and other supplies per year = $3,000

Health insurance plan per year = $3,000

Room and board expenses per year = $2000 (delta)

Total cost per year = $73,000

Hence PV of Cash outflow (annuity due) = $73,000 1-11+6.5%26.5% (1+6.5%) = $141,544

Hence NPV = $1,608,964 – $141,544 = $1,467,720

iii) Getting MBA from Mount Perry College

* Cash Inflow:

* Signing bonus of $18,000 at the end of year 1

* Salary = $92,000 x (1 – 29%) = $65,320 [after 29% tax deduction] Expected to increase at 3.5% per year

Appropriate discount rate = 6.5%

Working years left = 39

Hence, PV of Cash Inflow = ($18,000 + $65,3201-1+3.5%1+6.5%396.5%-3.5% ) / (1.065) = $1,390,513 * Cash Outflow:

* Annual Tuition = $80,000

Books and other supplies = $4,500

Health insurance plan = $3,000

Room and board expenses = $2000 (delta)

Total cost = $89,500

Hence PV of Cash outflow = $89,500

Hence NPV = $1,390,513 – $89,500 = $1,301,013

Question # 5

We need to solve for ‘Y’ where:

($20,000 + Y * (1-31%)1-1+4%1+6.5%386.5%-4% ) / (1.065)2 – $141,544 = $935,283 * Y * (1-31%) 1-1+4%1+6.5%386.5%-4% = ($935,283 + $141,544) * (1.065)2 – $20,000 * Y * 0.69 * 23.78 = $1,201,364

* Y = $73,216

Question # 6

ii) Getting MBA from Wilton University

Assuming Ben takes a 5 year loan to pay the yearly cost of $73,000 at 5.4% borrowing rate. Hence, $73,000 = Monthly Payment * 1-11+5.4%55.4%

Monthly Payment = $17,048

For payment of first year’s borrowed loan, this amount is payable through years 1 to 5. For payment of second year’s borrowed loan, this amount is payable through years 2 to 6.

| 0| 1| 2| 3| 4| 5| 6|

| || || || || || || ||

Loan Payment 1| x| ($17,048)| ($17,048)| ($17,048)| ($17,048)| ($17,048)| | Loan Payment 2| x| x| ($17,048)| ($17,048)| ($17,048)| ($17,048)| ($17,048)|

PV of loan payment = $17,048 * 1-11+6.5%56.5% + $17,048 * 1-11+6.5%56.5% /1.065 = $137,368 Hence NPV = $1,608,964 (from previous calculation) – $137,368 = $1,471,596

iii) Getting MBA from Mount Perry College

Assuming Ben takes a 5 year loan to pay the one year cost of $89,500 at 5.4% borrowing rate. Hence, $89,500 = Monthly Payment * 1-11+5.4%55.4%

Monthly Payment = $20,901

For payment of the borrowed loan, this amount is payable through years 1 to 5.

| 0| 1| 2| 3| 4| 5| 6|

| || || || || || || ||

Loan Payment| x| ($20,091)| ($20,091)| ($20,091)| ($20,091)|

($20,091)| |

PV of loan payment = $20,901 * 1-11+6.5%56.5% = $86,859

Hence NPV = $1,390,513 (from previous calculation) – $86,859 = $1,303,654