A prospective MBA student earns $50,000 per year in her current job and expects

Question

A prospective MBA student earns $50,000 per year in her current job and expects that amount to increase by 12% per year. She is considering leaving her job to attend business school for two years at a cost of $45,000 per year. She has been told that her starting salary after business school is likely to be $85,000 and that amount will increase by 15% per year. Consider a time horizon of 10 years, use a discount rate of 11%, and ignore all considerations not explicitly mentioned here. Assume cash flows (i.e., immediate, one year from now, two years from now, etc.) that allow you to ignore beginning-of-year and end-of-year cash flow issues. Also assume that the choice can be implemented immediately so that for the MBA alternative the current year is the first year of business school. What is the net present value of the more attractive alternative?

Explanation / Answer

Calculate PV of cash flows by using the formula PV = cashflow for the period (FV) /(1+i)^n

where i is the discount rate = 11% and n is the time period (year)

Doing MBA is more attractive option as NPV is more in that case That is $ 487,587

Years Earning without MBA ($) PV of cashflows Earning With MBA ($) PV of cashflows 1 50000 45045 -45000 -40541 2 56000 45451 -45000 -36523 3 62720 45860 85000 62151 4 70246 46273 97750 64391 5 78676 46690 112413 66711 6 88117 47111 129274 69115 7 98691 47535 148666 71606 8 110534 47964 170965 74186 9 123798 48396 196610 76860 10 138654 48832 226102 79630 Total NPV 469158 487587 Discount rate 11%

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