Question

Your brother, age 30, working for ABC corp.wants to quit his job and go back to school for MBA degree. At his current job, he is making $60000 per year and was planning to work until age 65 years. If he goes back to school, he will forego two years of income, but his real income after graduation would be $90000 per year until retirement at age 65. He has been accepted to an MBA program that costs a real $40000 per year. If his real opportunity cost is 10 percent, would leaving his job to get an MBA be a smart financial decision? Show all your calculations along with the recommendation

Answer 1

There are two cases (projects):

Project 1: Continuing with the same job for next 10 years.

Cash flow yearly = $60,000

Discount rate = 10% = 0.10

Time = 10 Years

by computing the Net present value, we can make a judgment on this project being chosen or not.

Case 2: Quitting the job today and joining an MBA program.

Cash flows are negative for first two years and then after starting a new job, positive cash flow for next few years till retirement at age of 40. Discount rate = 10% = 0.10

by computing the Net present value, we can make a judgment on this project being chosen or not.

Now, to calculate the Net Present value, we employ the following steps:

1. Write the cash flows for years.

2. Compute discount factor for each year. This done by the formula 1/(1+r)ⁿ where r is the rate of interest and n is the year.

3. Calculate the Discounted cash flow by finding the product of each cash flow and its corresponding discount factor.

4. Add all the discounted cash flows to calculate Net Present Value.

All the values described above as shown in the table as below.

Current JOB Discount factor MBA Discounted cash flow Year Cash Flow Discount Discounted cash flow Cash Flow ActivityYear Year Age of Brother 600 0,508616 89586 72850MBA Year4000 0.90991 3868304 0.909091 54545.454545 49586.776860 60000 0.751315 45078.888054 0.683013 40980.807322 60000 0.620921 37255.279384 0.564474 33868.435803 31 32 MBA Year 2 Job Year 12 Job Year 2 Job Year 3 Job Year 4 Job Year 5 Job Year 6 Job Year 78 Job Year 8 2 60000 0.826446 -40000 0.909091 36363.636364 0 0.826446 0 4 900000.751315 67618.332081 900000.683013 61471.210983 900000.620921 55882.919075 0.564474 50802.653705 900000.513158 46184.230641 90000 0.466507 41985.664219 0.424098 38168.785654 90000 0.385543 34698.896049 4 35 36 37 38 39 40 60000 6000 0.513158 30789.487094 60000 0.466507 27990.442813 60000 0.424098 25445.857102 0.385543 23132.597366 10 90000 Retire 10 NPV 368674.03 NPV 320449.06

Recommendation: Since the NPV for Current Job is greater than that of MBA program, the brother should stay in the current job.