Question

Nick is a 45 year-old civil engineer with a good work-life balance, but he is considering pursuing his MBA. It would take him three years of night courses to graduate, and he estimates that tuition would cost about $24,000 a year due at the beginning of each year. After he receives his MBA, he would apply to be a team leader, but Nick does not have any further desire to advance into management. The difference in salary between civil engineer and team lead is $7,800 annually. To pay for the MBA, Nick is going to borrow money from his 401k. Nick has been getting an average return of 7.5% in his 401k. Nick wants to retire at age 65.

Should Nick pursue his MBA? Which decision rule makes the most sense to use here and why?

Would your answer change if Nick was only 30 years old? Explain your answer.

Would your answer change if 45-year-old Nick’s 401k was only growing at a 4% rate of return? Explain your answer.

Answer 1

(i) - with 7.5% interest rate Given Current Age of Nick 45 Years Tuition Fee $ 24,000 Due at the Beginning of the year Value of Tution Fee as on date is the present value of payments made for the 3 years Since the due is at the beginning of the year, we can find Present Value by discounting 2nd year and 3rd year payment and adding first year payment Present Value of Tuition Fee is (A) --PV(7.5%,2,24000)+24000 $67,093.56 Additional Value of increase in salary is calculated as follows: Find the Present Value of Net benefit from increase in salary for the period after completion of MBA till the age of Retirement i.e., finding present value for a period of 17 years (Age of Retirement - 65 years (Minus) Age after completion of MBA - 48 years i.e., 65-48=17 years) and discounting back the same for 3 years to arrive the value at present i.e at 45 years Present Value of Net Benefit from Salary Increase at the age of 48 Years is =-PV(7.5%,17,7800) $73,584.89 Present Value of Net Benefit from Salary Increase at the age of 45 Years is (B) =73,584.89/((1+7.5%)^3) 59,232.93 Since Value of Tution Fee (A) is More than Value of Net Benefit Derived from Salary Increase (B), Hence it is not advisable to pursue MBA by Nick

(ii) - with 4% interest rate Given Current Age of Nick 45 Years Tuition Fee $ 24,000 Due at the Beginning of the year Value of Tution Fee as on date is the present value of payments made for the 3 years Since the due is at the beginning of the year, we can find Present Value by discounting 2nd year and 3rd year payment and adding first year payment Present Value of Tuition Fee is (A) --PV(4%,2,24000)+24000 $69,266.27 Additional Value of increase in salary is calculated as follows: Find the Present Value of Net benefit from increase in salary for the period after completion of MBA till the age of Retirement i.e., finding present value for a period of 17 years (Age of Retirement - 65 years (Minus) Age after completion of MBA - 48 years i.e., 65-48=17 years) and discounting back the same for 3 years to arrive the value at present i.e at 45 years Present Value of Net Benefit from Salary Increase at the age of 48 Years is =-PV(4%,17,7800) $94,892.22 Present Value of Net Benefit from Salary Increase at the age of 45 Years is (B) =94,892.22/((1+4%)^3) 84,358.84 Since Value of Tution Fee (A) is Less than Value of Net Benefit Derived from Salary Increase (B), Hence it is advisable to pursue MBA by Nick when the interest rate is 4%