FIN 533

Financial Management
Mini Case #1 –The MBA Decision

Spiros Kakos

February 18th 2016

1.) How does Ben’s age affect his decision to get an MBA?

Education is a lifelong process. We as human beings should be learning all the time. The knowledge that can be
gained through studying for an advanced business degree has become increasingly valuable for financial
professionals as their responsibilities expand. Many managers in my company that are already in their 30s and 40s
are evaluating how and when to squeeze an MBA into their lifelong educations. In my opinion, it is worth it for
Ben to go back to college. I understand that Ben is worried of spending extra money and not being employed for a
while but Ben is 28 years old. The issue is that the more time there is for an increased salary the more it will offset
the cost of going back to college. After 38 more years of working with at least a 3.5% increase in salary each year
seems like a nice situation to be in. I think you are never too old for an MBA.

2.) What other, perhaps non quantifiable factors, affect Ben’s decision to get an MBA?

There are several non-quantifiable factors that affect Ben’s decision to get an MBA. The first one is a change in
career; once Ben has an MBA I think many other doors will open up that he is not aware of. This may lead even
bigger salaries that he never imagined. Second is a family consideration. I am not sure of his currently family
situation, but taking two years to get an MBA is not just a business decision, it's also a life decision. Sometimes, the
interests of boyfriends, girlfriends, husbands, wives, or children are critical factors in making the decision of if,
when, and where to apply. The third is a desire to improve job skills. It seems like this is the main reason Ben is
really trying to increase his education. Fourth, the modern trend of career hopping is very popular these days. It is
very seldom that a person works in the same company or same field of work as they progress through their work.
Lastly, the decision to obtain a MBA degree might be for personal enrichment. It might be that Ben really just
wants to feel well rounded and satisfied that he has completed a difficult task. Ben’s situation is unique, and
regardless of his reason, going back to school requires a personal commitment. It takes time and money and can
be a lot to juggle.

3.) Assuming all salaries are paid at the end of each year, what is the best option for Ben – from a strictly
financial standpoint?

I think there are three options that can be calculated from this mini case:

a. Keeping his current work for 38 years.

Ben currently works at a money management firm where is annual salary is $53,000. If he stays in this position, he
expects his salary to increase at an annual rate of 3.0% until retirement. He plans to work for 38 more years. His
current benefit package includes a full paid health insurance plan. His average tax rate is 26%. He has funds to
cover the full cost of the MBA program he chooses.

After Tax Salary = $53,000 x (1- 0.26) = $39,220

g (discount rate) = 5.5%
r (growth rate) = 3%
t (period of years working) = 38

PV = c {1 – [(1+r) / (1+g)]t }/ (r – g]
PV = $39,220{(1 – [(1 + 0.03) / (1 + 0.055)] 38} / (0.055 - 0.03)
PV = $39,220 {(1 – [(1.03) / (1.055)] 38} / 0.025
PV = $39,220 (0.598 / 0.025)
PV = $938,149.63

b. Getting the MBA at Wilton University

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The MBA program at Wilton University is a two year program. It is considered one of the top 10 MBA programs in
the nation. The annual tuition is $58,000, payable at the beginning of each year. Books and supplies are estimated
to cost $2,000 per year, payable at the beginning of each year. Ben expects that if he earns an MBA at Wilton, he
will obtain a job that offers a beginning salary of $87,000 plus a signing bonus $10,000. The salary at this job will
increase 4% per year. His average income tax rate will be 31%. Wilton offers a health insurance plan that will cost
$3,000 per year, payable at the beginning of the year. Ben has calculated the appropriate discount rate to be
5.5%, which is $4,000 off room and board.

After Tax Salary = $53,000 x (1- 0.26) = $39,220

g (discount rate) = 5.5%
r (growth rate) = 4%
t (period of years working) = 36

Costs:
Direct Costs  $58,000 + $2,000 + $3,000 = $63,000
PV of Direct Costs  $63,000 + $63,000 / (1.055) = $122,715.64
PV of Lost Salary  $39,220 / (1.055) + $39,220(1 + 0.04) / (1 + 0.055)2 = $73,822.15

Salary:
PV of After Tax Bonus Paid in Two Years  $10,000(1 – 0.31) / 1.0552 = $6,199.32
After Tax Salary  $87,000(1 -0.31) = $60,030

His salary will increase 4% each year and will only work 36 more years now.

PV = c {1 – [(1+r) / (1+g)]t }/ (r – g]
PV = $60,030 {(1 – [(1 + 0.04) / (1 + 0.055)] 36} / (0.055 - 0.04)
PV = $60,030 {(1 – [(1.04) / (1.055)] 36} / 0.015
PV = $60,030 (0.4028 / 0.015)
PV = $ 1,612,050.35

Also, since the first salary will be received three years from the present time, his salary will need to be reduced for
two years to find todays value.

PV = $ 1,612,050.35 / 1.0552 = $1,448,350.53

Therefore, the total value of going to get a MBA at Wilton University is;

Value  -$73,822.15- $122,715.64 + $6,199.32 + $1,448,350.53 = $1,258,012.06

c. Getting the MBA at Mount Perry College

The MBA Program at Mount Perry College is a one year program. The tuition is $75,000 and is payable upon
enrollment. Books and supplies are expected to be $4,200. After graduating from Mount Perry, Ben expects to
receive a job offer that pays a beginning salary of $78,000 with a signing bonus of $8,000. The salary is expected to
grow at 3.5% every year. Ben’s average tax rate will be 29%. Mount Perry offers a health insurance plan that will
cost $3,000 per year, payable at the beginning of the year. Ben has calculated the appropriate discount rate to be
5.5%, which is $4,000 off room and board.

Cost:
Direct Costs (which are PV already because they are paid now)  $75,000 + $4,200 + $3,000 = $82,200
PV of Lost Salary  $39,220 / (1.055) = $37,175.36
Salary:

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PV of After Tax Bonus Paid in One Year  $8,000(1 – 0.29) / 1.055 = $5,383.89
After Tax Salary  78,000(1 -0.29) = $55,380

His salary will increase 3.5% each year and will only work 37 more years now.

PV = c {1 – [(1+r) / (1+g)]t }/ (r – g]
PV = $55,380 {(1 – [(1 + 0.035) / (1 + 0.055)] 37} / (0.055 - 0.035)
PV = $55,380 {(1 – [(1.035) / (1.055)] 37} / 0.02)
PV = $55,380 (0.50745 / 0.02)
PV = $1,405,123.99

Also, since the first salary will be received two years from the present time, his salary will need to be reduced for
one year to find todays value.

PV = $1,405,123.99 / 1.055 = $1,331,871.08

Therefore, the total value of going to get a MBA at Mount Perry College is;

Value  -$82,200 - $37,175.36 + $5,383.89 + $1,331,871.08= $1,217,879.61

So the best option for Ben Bates is getting the MBA at Wilton University. He will receive more money after
finishing his studies and get a salary and signing bonus with a total present value $1,258,012.06

4. Ben believes that the appropriate analysis is to calculate the future value of each option. How would you
evaluate this statement?

This is a somewhat correct statement. The future value measures the future sum of money that a given sum of
money is worth at a specified time in the future assuming a certain interest rate or rate of return. The future value
is calculated by multiplying the present value by the accumulation function. Therefore, present value and future
value vary jointly; when one increases, the other increases, assuming that the interest rate and number of periods
remain constant. Which in Ben’s case this is true. As the discount rate and number of periods increase, future
value increases or present value decreases.
Calculating the future value of each decision will result in the option with the highest present value having the
highest future value. Thus, a future analysis will result in the same decision. However, his statement that future
value analysis is the correct method is wrong since the present value analysis will give the correct answer as well.
The present value will give a better estimate than the future value in my opinion because it will show what his
money is worth currently.

5. What initial salary would Ben need to receive to make him indifferent between attending Wilton University
and staying in his current position?

To find the initial salary offer that Ben would need to make him indifferent to attending Wilton University and
staying at his current job, Ben would need to take the PV of his current job, add the cost of attending Wilton
University, and the PV of the bonus after taxes.

PV = $938,149.63 + $122,715.64 + $73,822.15 - $6,199.32 = $1,128,488.10

$1,128,488.10 is the PV that will make his current job exactly equal to going to Wilton University. Although, since
Ben’s salary will still be growing, the after tax salary needed is;

PV = c {1 – [(1+r) / (1+g)]t }/ (r – g]
$1,128,488.10 = c {1 – [(1+0.04) / (1+0.055)] 36}/ (0.055 – 0.04)

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$1,128,488.10 = c {1 – [(1.04) / (1.055)] 36}/ (0.015)
$1,128,488.10 = c (.4028 / 0.015)
c = $42,022.97

$42,022.97 is the after tax salary.

Pretax Salary  $42,022.97 / (1-0.31) = $60,902.85

$60,902.85 is the initial salary that Ben would need to be indifferent about going to Wilton University or staying in
his current position.

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