Ben Bates graduated from college six years ago with a finance undergrad degree.
ID: 2709511 • Letter: B
Question
Ben Bates graduated from college six years ago with a finance undergrad 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 or Mount Perry. 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 Dewey and Lewis and makes $53,000 per year, and his salary is expected to increase at 3 percent per year until retirement. He is 28 years old, and expects to work for 38 more years. He has fully paid health insurance and his tax rate is 26 percent. Ben has savings with enough money to pay for his MBA. Wilton is one of the top MBA programs. The MBA requires two years of full-time enrollment, annual tuition is $58,000 per year. Books and supplies are $2,000 per year. Ben expects that after he graduates, he would make $87,000 per year with a $10,000 signing bonus., His salary would increase 4% per year - although his tax rate would then be 31%. Mount Perry offers an accelerated one-year programm for $75,000. Books and supplies are $4,200. Ben thinks he would make $78,000 per year with this degree with an $8,000 signing bonus. His salary after graduation would increase at 3.5% per year, and tax rate would be 29%. Both schools offer health insurance for $3000 per year. Room and board for Ben will decrease by $4000 per year for either school., The discount rate is 6.5%. 1) How does Ben's age affect his decision to get an MBA? 2) What other, perhaps noquantifiable 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 to 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 intial salary would Ben need to receive to make him indifferent between attending Wilson and staying at his current job? 6) Suppose, instead of being able to pay cash for his MBA, Ben must borrow money. The current borrowing rate is 5.4%. How would this affect his decision.
Explanation / Answer
Answer (1)
Ben is currently aged 28 years and can work for 38 years. If he takes MBA course in Wilton for 2 years and assuming he gets a job immediately after completion of MBA, his effective working life would be reduced by 2 years to 36 years. This affects the value of his savings at the end of working life substantially more particularly towards to the end of the working period. That is the capital appreciation which happens in years 37 and 38 for the savings will be substantial. Similar is the case with Mount Perry though reduces the working life by 1 year to 37 years will affect the final savings substantially.
Answer (2)
Non-quantitative factors which affects the decision could be
Answer (3)
After-tax salary at the end of working life
Existing Job - $ 120,593
Job taken after Wilton MBA - $ 246,359
Job taken after Mount Perry MBA = $ $ 197,763
Based on the financial point of view taking the MBA from Wilton would be a better choice.
Answer (4)
Calculation of future value provides a better estimate of the expected salaries over a long working life. Present value calculation reduces the values only by 2 years in case of Wilton MBA and by one year in case Mount Perry MBA. Also the Present value will not be taking the effect of expected salary increase in the different scenarios into account. Hence calculation of future values is a better option in this case.
Answer (5)
Salary required in current job to make Ben indifferent to taking MBA at Wilton and a job thereafter is $108,273.50
Answer (6)
In case Ben needs to borrow the amount, amount required for
Wilton MBA = $ 108,217.47
Mount Perry MBA = $ 77392.30
Based the amount required to be borrowed, Ben may choose studying MBA at Mount Perry.
Current Age = 28 Years
Expected period for working = 38 years
Annual Salary = $53,000
Tax rate = 26%
After Tax Salary = 53000 * (1-tax rate) = 53000 * (1-0.26) = 53000 * 0.74
= $ 39,220
Assuming that there will be no change in the tax rate during the life of Ben
After Tax Salary after 38 years = $ 39,220 * (1.03)^38 = $ 39,220 * 3.074783
= $ 120,593.008 or $ 120,593 per annum
Taking Wilton MBA
Period of Education = 2 years
Expected Salary - $ 87000 per annum
Signing Bonus = $ 10000
Working Period - 38 – 2 = 36 years
Growth rate of salary = 4%
Tax Rate =31%
After tax salary = 87000 * (1-0.31) = 87000 * 0.69 = $ 60,030
Assuming that he spends the signing bonus immediately, there will be no savings out of signing bonus.
Expected After Tax Salary at the end of working life = $60,030 * 1.04^36
= $ 60,030 * 4.103933
= $ 246,359
Mount Perry MBA
Period of Education - 1 year
Expected Salary - $ 78000 per annum
Signing Bonus = $ 8000
Working life = 38- 1 = 37 years
Tax rate = 29%
Exoected salary growth = 3.5%
Assuming that he spends the signing bonus immediately, there will be no savings out of signing bonus.
After Tax salary = $ 78000 * (1-0.29) = $ 78000 * 0.71 = $ 55,380
Expected after-tax salary at the end of working life = $55380 * 1.035^37 = $55380 * 3.571025
= $ 197,763.38 or $ 197,763
Salary at which Ben would be indifferent between current job and taking a job after Wilton MBA
Let x be the after tax salary in current job which should be growing at 3% for 38 years. This should be equivalent to the salary expected to be received at end of working life after Wilton MBA. That is
X * 1.03^38 = $ 246,359
X = $ 246359 /3.0747835 = $ 80,122.3896 or $ 80,122.39
Salary required in current job to make Ben indifferent = $ 80,122.39 /0.74 = $108,273.50
Wilton MBA
In case Ben Needs to Borrow the amount
Cash Flows involved
Year
1
2
Tuition Fee
58000
58000
Books & Supplies
2000
2000
Health Insurance
3000
3000
Reduction in Room & Board
-4000
-4000
Total Amount to be borrowed
59000
59000
Interest on loan @ 5.4%
3186
3186
Total Cash Required
62186
62186
Discount rate
6.5%
6.5%
Discounted Flow
58390.61
54826.86
Present Value of the cost = $ 108,217.47
Mount Perry MBA
Tuition Fee = 75000
Books & Supplies = 4200
Health Insurance = 3000
Reduction in Room & Board = 4000
Total Amount required = 78200
Interest @ 5.4% = 4222.80
Total Cash required = 82,422.80
Discounted Flow at 6.5% = $ 77392.30
Year
1
2
Tuition Fee
58000
58000
Books & Supplies
2000
2000
Health Insurance
3000
3000
Reduction in Room & Board
-4000
-4000
Total Amount to be borrowed
59000
59000
Interest on loan @ 5.4%
3186
3186
Total Cash Required
62186
62186
Discount rate
6.5%
6.5%
Discounted Flow
58390.61
54826.86
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.