Question

Ben Ofosu graduated from college six years ago with a finance undergraduate degree. Although he is satisfied with his current job, his goal is to become an investment banker. He feels that an MBA degree would allow him to achieve this goal. After examining schools, he has narrowed his choice to either GIMPA or UGBS. Although internships are encouraged by both schools, to get class credit for the internship, no salary can be paid. Other than internships, neither school will allow its students to work while enrolled in its MBA program.
Ben currently works at the money management firm. His annual salary at the firm is GHS 55,000 per year, and his salary is expected to increase at 3 percent per year until retirement. He is currently 28 years old and expects to work for 38 more years. His current job includes a fully paid health insurance plan, and his current average tax rate is 26 percent. Ben has a savings account with enough money to cover the entire cost of his MBA program.
The UGBS at University of Ghana (Legon) is one of the top MBA programs in the country. The MBA degree requires two years of full-time enrollment at the university. The annual tuition is GHS 63,000, payable at the beginning of each school year. Books and other supplies are estimated to cost GHS 2,500 per year. Ben expects that after graduation from Legon, he will receive a job offer for about GHS 98,000 per year, with a GHS 15,000 signing bonus. The salary at this job will increase at 4% per year. Because of the higher salary, his average income tax rate will increase to 31 percent.
The Green Hills School of Business at GIMPA began its MBA program 16 years ago. The Green Hills School is smaller and less well known than the UGBS. Green Hills offers an accelerated on-year program, with a tuition cost of GHS 80,000 to be paid upon matriculation. Books and other supplies for the program are expected to cost GHS 3,500. Ben thinks that he will receive an offer of GHS 81,000 per ear upon graduation, with a GHS 10,000 signing bonus. The salary at this job will increase at 3.5 percent per year. His average tax rate at this level of income will be 29 percent.
Both schools offer a health insurance plan that will cost GHS 3,000 per year, payable at the beginning of the year. Ben also estimates that room and board expenses will also cost GHS 20,000 per year at both schools. The appropriate discount rate is 6.5 percent.
QUESTIONS:
1. How does Ben’s age affect his decision to get an MBA?
2. What other, perhaps nonquantifiable, factors affects Ben’s decision to get an MBA?
3. Assuming all salaries are paid at the end of each year, what is the best option for Ben from a strictly financial standpoint?
4. Ben believes that the appropriate analysis is to calculate the future value of each option. How would you evaluate this statement?
5. What initial salary would Ben need to receive to make him indifferent between attending UGBS and staying in his current position?
6. Suppose instead of being able to pay cash for his MBA, Ben must borrow the money. The current borrowing rate is 5.4 percent. How would this affect his decision?

Answer 1

1]

How does Ben’s age affect his decision to get an MBA

As Ben is quite young and in the early phase of his career, he can afford stop working for 1 or 2 years and invest that time in an MBA. The MBA would better his career prospects and increase the probability of higher salary in the future. It can be seen as investment in his future and his career

2]

What other, perhaps nonquantifiable factors affect Ben’s decision to get an MBA

• The satisfaction and status achieved by having a master's degree
• networking and soft skills provided by an MBA program
• opportunity for career growth

3]

The best alternative is the one with the highest NPV.

To calculate the NPV of each alternative, we first calculate the cash inflows and outflows for each year as below :

Alternative 1 : stay in current job

Inflow for year 1 is the current salary (55000) increased by 3%, which is 56,550. Inflow for year 2 is 56,550 increased by 3%, and so on for each year.

Net inflow after tax for each year is Inflow multiplied by (1 - tax rate)

Discount factor for year x is = 1/(1+6.5%)^x

In this way, we calculate the PV of cash inflows for each year upto 37 years. The sum of these PVs is the NPV of Alternative 1.

NPV of Alternative 1 is 861,314

Alternative 2 : UGBS

Cash outflow for Years 0 and 1 = (tuition fee + books + health insurance + increased living expenses), which is (63,000 + 2,500 + 3,000 + 20,000), or 88,500. Cash inflow in year 3 is 113,000 (salary + signing bonus). Cash inflow in year 4 is 98,000 increased by 4%, which is 101,920. Cash inflow for each succeeding year is increased by 4%. Tax outflow is the cash inflow multiplied by tax rate, which is 31%. Net cash inflow = inflow - tax outflow - outflow. Discount factors remain the same as Alternative 1. The sum of PVs is calculated to find the NPV of Alternative 2.

NPV of Alternative 2 is 1,207,653

Alternative 3 : GHS

Cash outflow for the first year = (tuition fee + books + health insurance + increased living expenses), which is 80,000 + 3,500 + 3,000 + 20,000), or 106,500. Cash inflow in year 2 is 91,000 (salary + signing bonus). Cash inflow in year 3 is 81,000 increased by 3.5%, which is 83,835. Cash inflow for each succeeding year is increased by 3.5%. Tax outflow is the cash inflow multiplied by tax rate, which is 29%. Net cash inflow = inflow - tax outflow - outflow. Discount factors remain the same before. The sum of PVs is calculated to find the NPV of Alternative 3.

NPV of Alternative 3 is 1,098,516

As Alternative 2 has the highest NPV, UGBS at University of Ghana (Legon) should be chosen

4]

Either present value analysis or future value analysis can be done. Both will lead to the same decision.

However, care should be taken that future value of each option is compared with future value of the other options, or present value of each option is compared with present value of the other options.