Question

Question 5 (5 marks) Suppose that the USB wants to invest in the concept of life-long learning for its alumni. This proposal will allow past students to attend 2 academic workshops per year for the rest of their lives (assume infinity). While this is advertised as a 'free' service to students, USB must add the true cost of this service to the initial course fees of the MBA. If each workshop will cost the USB R1 000 per delegate (in 2018), and this cost is expected to increase at 10% per annum (into infinity), what is the minimum amount that USB should add to the course fee of the MBA per student if the school requires a return of 15% (if its cost of capital is 15%)?

Answer 1

Each delegate is offered 2 workshops each year.

It is assumed that the cost of both workshops in a single year is equal (no effect of cost escalation within a year)

Therefore, cost per delegate per year (C) = R 1000*2 = R 2000

Growth rate (g) =10% per year. Rate of return required (r ) = 15%

Present value of this infinite annuity is R 40,000 as follows:

A B C D E F G 1 Present Value of Annuity Payments at the end of each period 2 3 Present value of perpetual cash flow is calculated using the formula PV 4 Where P= Periodical payments, 5 r= Rate of interest per period in decimals 6 gr growth rate in decimals 7 All amounts in $ 8 Given that 9 Periodical payments (P)= 2000 Growth rate per year (%) 101 10 Rate of interest (% p.a)=R= 15 No. of payments a year (t)= 11 12 Calculations: 13 Formula Cell reference Value 14 Interest rate per period in decimals (r )= R/(100*t) D10/(100*G10) 0.15 15 Growth rate in decimals G/(100*t) G9/(100*G10) 0.1 16 Present value of perpetual cash flow PV=P/(r-g) D9/(G14-G15) 40000 17 Rounded to $40,000.00 18

Therefore, minimum amount to be added to course fee= R 40,000