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In this slide deck, the authors discuss their attempt at building a Net Present Value based Excel model that can be used to help potential MBA candidates assess the financial prudence of their decision to go for an MBA (as opposed to continuing on their present career paths). The model takes into consideration various real-world parameters involved in the decision process (including constant and variable salary growth trends, loan rates and types, and which B-school the candidate is targeting) and supports plugging in data from various external sources in the given templates.
Please go through the slide deck first before attempting to use the Excel model for academic or practical purposes. The latter is also uploaded as part of this collection (in addition to the data sheets used by the authors for their study).
This study was conducted in Summer 2011 by Ashwin Shah, Mehnaz Alam and Nabil Quadri as part of their mandatory mid-term work for UCLA Extension course # W5491(Math for Finance X410.21).

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You are on page 1of 72

That is the question Investigating the Value of an MBA Education using NPV Decision Model

W5491: Math for Finance X410.21 (Summer 2011-UCLA Extension ) Prof. Nicholas Nucho

Ashwin Shah

Mehnaz Alam

Nabil Quadri

Agenda

Background Our Approach Schools

Loans

Introducing the Candidates Our NPV Model in Action WaitHow did that all work? Pushing the Boundaries

Conclusion

2

Background

Core curriculum: Accounting, Communications, Economics, Finance

Pros:

Potential to accelerate careers across various industries MBA graduates usually command higher salaries Opportunity to change careers Exposure to different networks

Cons

4

Expensive Risk of not increasing salary post MBA Time Commitment Strain on loved ones Loss of 2 years of income

A decision of this magnitude can be an overwhelming

The goal of this project is to provide a useful and

Our Approach

Overview

We recognize there are many components that factor into

For the purposes of this project, we decided to focus on the

Our approach was to build a model that will calculate the

7

Approach to Evaluation

Ultimately, this decision will vary based on an individuals

investment since each program leads to a different post-MBA income and income growth rate.

Our Process

Gathered detailed data about MBA programs, potential earnings,

variables including tuition and other expenses, loan rates and terms and pre- and post- MBA incomes

Ensured our model meets financial modeling best practices Carefully crafted candidate profiles to reflect varied career

situations

Schools

10

Ivy League

Big Ten

Private Online

11

Bloomberg Business Week 2010 rankings used to order the schools

paper Estimating the Internal Rate of Return on an MBA, John B.White., Morgan P. Miles, and Roger M.White

12

Originally, we considered including non-US schools and programs

Foreign currency exchange trends International discount rates International income growth rates

Not directly comparable with US-only scenarios So, for the purposes of this project, we did not include non-US

MBA programs

13

Loans

14

Loan Programs

We took 3 loan programs: one for each

Loan Type: Federal Subsidized Graduate Loan Federal Unsubsidized Graduate Loan Citibank Graduate Student Loan (Private)

graduation

15

16

Currently: 26 year old male

Pre-MBA Income:

17

Currently: 28 year old

Pre-MBA Income:

18

Currently: 25 year old male

Pre-MBA Income:

19

20

21

$1,400,000.00

$1,200,000.00 $1,000,000.00 $800,000.00 $600,000.00 $400,000.00 $200,000.00 Federal subsidized graduate Federal unsubsidized graduate Citibank

$0.00

Calculated using : Horizon of 30 years Discount rate of 5% Non MBA Income growth rate of 2%

22

$1.60 $1.40 $1.20 $1.00 $0.80 $0.60 $0.40 $0.63 $1.36 $1.10 $1.01 $0.87

$0.92

$0.63

$0.39

$0.70

$0.30

Federal subsidized graduate

$0.20

$0.00

In millions

Calculated using : Horizon of 30 years Discount rate of 5% Non MBA Income growth rate of 2% Loan Interest Rate of 6.8% with maturity of 20 years

23

$1.60

$1.40 $1.20 $1.00 $1.34 $1.08 $0.99 $0.85 $0.61 $0.60 $0.40 $0.20 $0.38 $0.28 Federal unsubsidized graduate $0.90 $0.68

$0.80

$0.61

$0.00

In millions

Calculated using : Horizon of 30 years Discount rate of 5% Non MBA Income growth rate of 2% Loan Interest Rate of 6.8% with maturity of 20 years

24

$1.40 $1.31

$1.20 $1.06 $1.00 $0.97 $0.83 $0.80 $0.66 $0.60 $0.59 $0.59 Citibank $0.35 $0.88

$0.40

$0.26

$0.20

$0.00

In millions

Columbia

Yale

GeorgeTown Babson Olin Rocheter Arizona State McDonough Simon School Carey of Business

Univ of Phoenix

Calculated using : Horizon of 30 years Discount rate of 5% Non MBA Income growth rate of 2% Loan Interest Rate of 8.0% with maturity of 30 years

25

26

$400,000.00 $200,000.00 $$(200,000.00) $(400,000.00) Federal subsidized graduate $(600,000.00) $(800,000.00) Federal unsubsidized graduate Citibank

Calculated using : Horizon of 30 years Discount rate of 5% Non MBA Income growth rate of 2%

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$0.60 $0.39 $0.40 $0.20 $0.00 ($0.20) ($0.40) ($0.57) ($0.60) ($0.80) ($0.58) $0.13 $0.04 ($0.10) ($0.05) ($0.27)

($0.34)

($0.34)

In millions

Calculated using : Horizon of 30 years Discount rate of 5% Non MBA Income growth rate of 2% Loan Interest Rate of 6.8% with maturity of 20 years

28

$0.60 $0.40 $0.20 $0.00 ($0.20) ($0.36) ($0.40) ($0.60) ($0.60) ($0.80) ($0.60) $0.37

($0.36)

In millions

29

$0.40 $0.33

$0.20 $0.07 $0.00 ($0.01) ($0.10) ($0.15) ($0.20) ($0.32) ($0.39) ($0.40) ($0.39) Citibank

($0.60)

($0.63)

($0.63)

($0.80) Harvard Business School Kellogg School of Management Columbia Kelley School of Business Yale GeorgeTown Babson Olin Rocheter Arizona State McDonough Simon School Carey of Business Univ of Phoenix

In millions

Calculated using : Horizon of 30 years Discount rate of 5% Non MBA Income growth rate of 2% Loan Interest Rate of 8.0% with maturity of 30 years

30

31

$800,000.00 $600,000.00 $400,000.00 $200,000.00 $Federal subsidized graduate Federal unsubsidized graduate Citibank

$(200,000.00)

$(400,000.00)

Calculated using : Horizon of 30 years Discount rate of 5% Non MBA Income growth rate of 2%

32

$1.00

$0.80

$0.80 $0.60

$0.40 $0.20 $0.00 $0.54 $0.45 $0.31 $0.37 $0.14

$0.07

$0.08

($0.16)

($0.20) ($0.40)

In millions

33

$1.00 $0.80 $0.60 $0.40 $0.20 $0.00 ($0.18) ($0.20) ($0.40) ($0.22) $0.78

$0.05

$0.05

$0.12

In millions

34

$0.80

$0.75

$0.60 $0.49 $0.40 $0.40 $0.26 $0.20 $0.09 $0.02 $0.00 ($0.21) $0.02 Citibank $0.31

($0.20)

($0.25)

($0.40) Harvard Business School Kellogg School of Management Columbia Kelley School of Business Yale GeorgeTown Babson Olin Rocheter Arizona State McDonough Simon School Carey of Business Univ of Phoenix

In millions

Calculated using : Horizon of 30 years Discount rate of 5% Non MBA Income growth rate of 2% Loan Interest Rate of 8.0% with maturity of 30 years

35

The NPV Model

36

Model Overview

Consists of 5 worksheets:

NPV Calculator: The main NPV calculation sheet School Profiles: List of MBA programs under analysis with associated

variables

parameters

Candidate Profiles: List of Candidates with associated variables NPV Iterator: Tool to apply the NPV model in one shot to various

37

User Input Value Derived Input Value Alternative Input for Sensitivity Analysis

Intermediate Output Value Output Value

38

Three main sections:

Profiles Selector Model Inputs Model Outputs

39

Used to select a desired combination of MBA Program, Loan

Drop-down options are linked to respective Profile worksheet After selecting desired combination, click on Button to load all

associated input variables from each profile worksheet into NPV Calculator Input fields values of the input variables, which can then be changed manually in NPV Calculator

40

Divided into 4 sub-sections:

General Parameters (MBA parameters, Model Horizon,

Discount Rate)

41

Length of MBA in Years School-related Input:

Beginning Principal Calculation Forfeited Pre-Income Calculation

Horizon in Years (starting from MBA graduation) Length of time into future over which all cash-flows are considered Constant Discount Rate (used in all PV calculations) We have assumed a standard rate of 5% and separately completed sensitivity analysis Full-time or Part-time MBA (flag selected from drop-down) School-related Input: Can be loaded from School Profile

42

Pre-MBA Annual Income

As of date of commencement of MBA

Exclusive of taxes (to remove the effect of variations in tax

rates: standard NPV practice) Candidate-related Input: Can be loaded from Candidate Profile

Non-MBA Income Growth Function

Can use constant income growth function or variable one: this

flag variable specifies which method to use For all current analysis, we have used Constant function and separately studied effect of using variable for one profile

43

Constant Annual Growth Rate of Non-MBA Income

Used if Constant Growth function is selected Assumed as 2% for all current candidate analysis When MBA is of fractional-year length (e.g. 1.5 years MBA

programs), the growth during the partial year is calculated by taking effective period growth rate (EAR formula applied to Constant Growth Rate)

Growth rate for each period up to horizon (including duration of

MBA) can be specified on timeline Using this it is possible to simulate various real-world scenarios such as Interim raises, Diminishing growth, Effect of sign-on bonuses, Career Stagnation, Change of Career Paths, Change to Self-Owned Business, etc.

44

Estimated Post-MBA Annual Income

As of date of MBA graduation Exclusive of taxes (to remove the effect of variations in tax rates:

standard NPV practice) School-related Input: Can be loaded from School Profile. But note that the school profile gives average post-MBA income whereas actual post-MBA income would also vary based on the candidates experience and chosen career path

Post-MBA Income Growth Function

Can use constant income growth function or variable one: this flag

variable specifies which method to use For all current analysis, we have used Constant function and separately studied effect of using variable growth for one candidate

45

Constant Annual Growth Rate of Post-MBA Income

Used if Constant Growth function is selected School-related Input: Can be loaded from School Profile[1]

Growth rate for each period up to horizon (starting from graduating

year) can be specified on timeline Using this it is possible to simulate various real-world scenarios such as Interim raises, Diminishing growth, Effect of sign-on bonuses, Career Stagnation, Change of Career Paths, Change to Self-Owned Business, etc.

[1] Estimating the Internal Rate of Return on an MBA: A Comparison of the Return from Top-Ranked & Second-Tier Programs, John B.White., Morgan P. Miles, and Roger M.White

46

Total Tuition, Living and Other Expenses

Expenses for full duration of MBA

School Profile gives break-up of expenses by type (Tuition,

Room and Board, Utilities, Health Services, Other Fees, Misc. Expenses). Model allows flexibility of not considering a specific type of expense (e.g. Room and Board need not be considered if the candidate is a local with own residence). Simple change in summation formula used on School profile sheet Total of all of the relevant expenses is loaded into this NPV Calculator to determine amounts to be borrowed or used up from savings

47

Total Approved Loan Amount

Candidate-related Input: Can be loaded from Candidate Profile

In practice: Candidates try to get the highest possible loan amount approved First approach is to obtain Federal loans as the interest rate is lower but these have a maximum approval limit Remaining funds borrowed from private lenders We have taken a slightly simplified approach for current analysis Only one loan assumed remaining amount must come from savings All standard approved loan limits ignored (even for federal loans) Extension to multiple loan framework explored separately &

48

Upfront Payment of Tuition

Assumed to be from Savings and Interest-free Borrowings (e.g. from parents)

Derived Input : auto-calculated by NPV-Calculator

Upfront Payment = Total MBA Expenses Total Approved Loan Amount

Loan-related Input: Can be loaded from Loan Profile Affects calculation of beginning principal for amortization and determination

Indicates whether the annual interest rate is specified in EAR or APR terms

affects derivation of period interest rate from annual interest rate Loan-related Input: Can be loaded from Loan Profile

49

Grace Period in Years

Specifies the duration after graduation during which the candidate is

excused from making loan payments Loan is amortized starting from date of expiry of grace period Loan-related Input: Can be loaded from Loan Profile

Loan Maturity (in years)

Length of time over which loan is amortized Loan-related Input: Can be loaded from Loan Profile. In practice, for

private loans, loan maturity can vary quite a bit. Since model allows for custom inputs, this is easily handled.

Loan-related Input: Can be loaded from Loan Profile Affects amortization schedule, period interest rate and PV of periodic loan

payments

50

Loan type (input selected from Drop-down)

Specifies whether the loan is subsidized, unsubsidized or from a private

institution Loan-related Input: Can be loaded from Loan Profile Affects the calculation of the actual beginning principal amount:

For subsidized loans, the compound interest waived off the duration of the MBA.

In case for unsubsidized or private loan, beginning principle balance is equal to

approved loan amount plus the compound interest accrued over duration of MBA. All loan payments are assumed to be deferred till graduation (reflects majority of realworld scenarios)

Rate using APR or EAR formula depending on Rate Convention Beginning Principal Balance: Derived Input Calculated from Approved Loan Amount using period interest rate, duration of MBA & grace period applied to basic compound interest formula

51

Ultimate objective is to calculate NPV of doing MBA given the values of all the

input variables

First model calculates PVs of the various cash flows involved: Present Value of Loan Repayments (PVLoan-payments): up to loan maturity Present Value of Post-MBA Income (PVPost-MBA): projected from graduation to model horizon Present Value of Projected Non-MBA Income (PVNon-MBA) : projected from start of MBA to model horizon Present Value of Income forfeited during MBA (PVDuring-MBA)

Then PVs are combined to give NPV of MBA

For full-time MBA programs

For part-time MBA programs

52

First, amortized loan payment amounts (L-PMT) are calculated

Rate used = Period Interest Rate No. of Periods = Total Payment Periods (Loan Maturity * No. of Payments

Rate used = Effective discount rate for each loan period (calculated from

Constant Discount Rate and No. of Payments per Year using EAR formula) No. of Periods = Total Payment Periods (Loan Maturity * No. of Payments per Year) Annuity Amount = Amortized Loan Payment Amount (L-PMT)

53

Next, the Present Value of all loan payment amounts as

Rate used = Constant Discount Rate No. of Periods = Duration of MBA + Grace Period Annuity Amount = 0 Future Value = FVL-PMT

54

Present value of post-MBA income is calculated using

time-line approach

First-year income is projected on an annual basis from

graduation to the model horizon Growth rates used are the effective growth rates for each period (Constant or Variable depending on Post-MBA inputs) Present value of each years income calculated using Excel PV formula

Rate = Constant Discount Rate No. of Periods = Duration of MBA + Years after graduation

55

Present value of lost income of non-MBA decision path is

starting point for income projection This income is projected on an annual basis from the date of starting the MBA to the model horizon so the timeline of Non-MBA path is longer than Post-MBA path by the length of the MBA Growth rates used are the effective growth rates for each period (Constant or Variable depending on Non-MBA inputs) Present value of each years income calculated using Excel PV formula

Rate = Constant Discount Rate

Future Value = Annual Non-MBA Income for that year

56

Need for considering PVDuring-MBA for part-time MBAs: In PV calculation of non-MBA path, projected income is taken from date of starting the MBA i.e. projected income during MBA course is taken as lost income In part-time MBA, candidate continues to earn (growing) pre-MBA salary over the duration of MBA So, income earned during MBA must be added back to NPV of fulltime MBA decision path to get NPV of part-time MBA path NPVPart-time-MBA = PVFull-time-MBA + PVDuring-MBA Handled by conditional addition of PVDuring-MBA in NPV cell

formula. Condition is simple check of Part-time/Full-time flag specified in General Parameter Inputs section

57

Profile Worksheets

School Profiles: Define each MBA program along with:

Ranking Expense breakup Average historical income after graduation Estimated constant annual income growth rate

58

Useful to setup multiple combinations of candidates, MBA

programs and loan programs and calculate their NPVs at the click of a button

Enter name of candidate/B-school/loan-program exactly as

given in respective Profiles worksheet Enter an interest rate and loan maturity period to override defaults associated with loan program Enter starting and ending rows for iterator (allows you to enter all data but calculate NPV only for some)

59

Going above and beyond

60

NPV as function of MBA Program and Discount Rate

NPV (in USD)

$2,000,000.00 $1,500,000.00 $1,000,000.00 1% 3% 5% $500,000.00 $0.00

7%

9%

-$500,000.00 -$1,000,000.00

61

Candidate Profile Model Horizon Loan Program Interest Rate Loan Maturity Non-MBA Income Growth Rate

NPV as function of Candidate Profile and Discount Rate

$2,500,000.00 $2,000,000.00

$1,500,000.00

$1,000,000.00

$500,000.00

$0.00 0% -$500,000.00 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% MBA Program Columbia Model Horizon 30 years Loan Program Citibank Interest Rate 8% Loan Maturity 30 years Non-MBA Income Growth Rate 2%

Discount Rate

Mr. Non-Profit Ms. Wall Street Mr. IT

62

In candidate analysis we took a constant rate of growth of

both pre-MBA and post-MBA incomes Simpler to conceptualize Real data for various programs available from previous studies Gives a career-path agnostic NPV estimate

More realistic and practical NPV decision analysis can be

done using Variable Growth Function feature of NPV model (natively supported)

63

To use feature, select Variable in the Post-MBA Income

Enter growth rate applicable to each year in the row

64

In the interest of exploratory analysis, we assumed a

number of realistic career paths and imagined hypothetical post-MBA growth functions for each of these

For simplicity non-MBA income path was still assumed to

Candidate Profile Model Horizon Mr. IT 20 years Citibank 8% 10 years 2% 5%

Fixed Variables:

Loan Program Interest Rate Loan Maturity Non-MBA Income Growth Rate Discount Rate

65

Scenario Constant Growth Function Flat 3.5% growth. Simplifying Approximation

Career Consultant

1st year growth: 3% (sign-on bonus effect) Years 2-5: 4% (initial spurt) Years 6-13: 3% (plateau: middle management) Years 14-20: 7% (partnership: revenue share)

Starting with a rate of 7%, the growth itself decelerates @ 10% per year with a terminal value of 1.2% Constant rate of 2.5% except once every 5 years when candidate switches jobs and gets a one-time boost of 10% due to signing bonus and switching raise Constant salary growth of 2.5% for first 8 years. Then candidate starts a new company (0% for 4 years). Once enterprise takes off, personal income growth shoots up to 15% per year

Job Hopper

I Have a Dream

66

Post-MBA Income Growth Functions Used For Exploratory Analysis of Hypothetical Career Paths

16.00% 14.00% 12.00% Constant 10.00% Career Consultant 8.00% 6.00% 4.00% 2.00% 0.00% 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Law of Diminishing Returns Job Hopper I Have a Dream

67

Impact on NPV of MBA by Varying Post-MBA Income Growth Function

$600,000.00

$500,000.00 $400,000.00 $300,000.00 $200,000.00 $100,000.00 $0.00 -$100,000.00 -$200,000.00

Constant

Career Consultant

Job Hopper

I Have a Dream

68

Conclusion

70

Applying the NPV model to our 3 hypothetical candidates,

we can see that pursuing an MBA is a smart financial decision for Mr. Non Profit and Mr. IT.

71

Takeaways

The NPV model can effectively provide a useful way of

evaluating the decision of whether to proceed with an MBA and where to apply purely in a financial perspective taking into consideration various market factors such as loan programs, interest rates etc.

such as the potential of building a professional network, building on various skills such as entrepreneurship, leadership and team-building.

72

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