Question 1- Personal Finance

Question

Question 1:

You are 22, it is January 1st 2018 and you have been working in your first full time job since the
summer when you graduated with your undergraduate degree in business. The current job you
are in with your company pays you total pre tax compensation of $40,000/year. The job is in a
mature industry with very little possibility of job loss and expected average annual increases in
salary of 2%/year. Currently you are debt free and have no financial capital. You are debating
the merit of completing an MBA starting in January of 2020. The cost of the MBA would be
$50,000/year for all expenses for two years. Either way you plan on retiring early in the
December in which you turn age 60. The risk free rate is 3%.

Part A ­ If you can expect to earn $60,000/year with 2% increases/year with the same employer
post graduation, is it worth doing the MBA? What is the net dollar benefit of completing the
MBA? (hint: you must compare human capital in the current state vs the human capital in the
alternate state post MBA)

Answer 1

Part A: Is completing the MBA worth it?

Yes! Based on the information provided, completing the MBA is financially worthwhile.

We need to compare the present value of future earnings with and without the MBA. This is called comparing human capital.

Step 1: Calculate earnings without the MBA.

The starting salary is $40,000 in 2018, and it increases by 2% each year.

Since the person is 22 in 2018 and retires at age 60, we assume they receive 39 annual salaries, from 2018 through 2056.

Using a 3% discount rate and 2% annual salary growth, the present value of these earnings is approximately:

$1,265,896.65

Step 2: Calculate earnings with the MBA.

The person continues working in 2018 and 2019, then attends the MBA program in 2020 and 2021.

During those two years, they pay $50,000 per year and give up their regular salary.

After graduating, they begin earning $60,000 in 2022, with annual raises of 2%.

We calculate the present value of their earnings in 2018 and 2019, add the present value of their higher earnings from 2022 through 2056, and subtract the present value of the two MBA payments.

The resulting net present value is approximately:

$1,529,200.41

Step 3: Compare the two options.

Net benefit = Value with MBA - Value without MBA

Net benefit = $1,529,200.41 - $1,265,896.65

Net benefit = $263,303.76

Final Answer:

Yes, completing the MBA is worth it! The MBA provides an additional $263,303.76 in present-value financial benefits.

Although the person sacrifices two years of salary and pays $100,000 in education expenses, the higher salary earned after graduation more than compensates for these costs.

This calculation assumes salaries and MBA expenses are paid at the end of each year, with no additional taxes or financing costs considered.