A prospective MBA student earns $60,000 per year in her current job and expects

Question

A prospective MBA student earns $60,000 per year in her current job and expects that amount to increase by 14% 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 $95,000 and that amount will increase by 12% per year. Consider a time horizon of 10 years, use a discount rate of 15%, and ignore all considerations not explicitly mentioned here. Assume all cash flows occur at the start of each year (i.e, immediate, one year from now, two years from now.. nine years from now). 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 choice?

Explanation / Answer

OPTION A:DO NOT JOIN BUSINESS SCHOOL Present Value(PV) of Cash Flow= Cash flow/((1+i)^N) i= discount rate=15%=0.15 N=Year of cash flow Year wise cash flow and PV of cash flows given below: Immediate Cash flow (Year0) $60,000 Cash flow in year1 $68,400 (1.14*60000) Cash flow in year(N+1)=1.14*(Cash flow in year (N)) N A PV=A/(1.15^N) YEAR Cash flow PV of cash flow 0 $60,000 $                60,000 1 $68,400 $                59,478 2 $77,976 $                58,961 3 $88,893 $                58,448 4 $101,338 $                57,940 5 $115,525 $                57,436 6 $131,698 $                56,937 7 $150,136 $                56,442 8 $171,155 $                55,951 9 $195,117 $                55,464 SUM $              577,058 Net Present value=Sum of PV of Cash Flows $    577,058 OPTION B:JOIN BUSINESS SCHOOL Year wise cash flow and PV of cash flows given below: Immediate Cash flow (Year0) ($45,000) Cash flow in year1 ($45,000) (1.14*60000) Cash flow in year2 $95,000 Cash flow in year3 $106,400 (95000*1.12) Cash flow in year(N+1)=1.12*(Cash flow in year (N)) N>2 N A PV=A/(1.15^N) YEAR Cash flow PV of cash flow 0 ($45,000) $              (45,000) 1 ($45,000) $              (39,130) 2 $95,000 $                71,834 3 $106,400 $                69,960 4 $119,168 $                68,135 5 $133,468 $                66,357 6 $149,484 $                64,626 7 $167,422 $                62,940 8 $187,513 $                61,298 9 $210,015 $                59,699 SUM $              440,719 Net Present value=Sum of PV of Cash Flows $    440,719 More attractive choice: DO NOT JOIN BUSINESS SCHOOL Net Present value of more attractive choice $    577,058

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