Question

You have just turned twenty-six years of age and feel it is necessary to upgrade your qualifications. After some consideration, you feel that undertaking full-time study for an MPA degree at the Fletcher School is one alternative. For the two years of full-time study, tuition and living expenses will be $55,000 per year. In addition, you will have to give up your current job with a salary of $75,000 per year. Assume all cash flows occur at the end of the year. Assume a real interest rate of 3% per year, ignoring taxes. Also assume that the salary increase is a fixed real amount that starts after you complete your degree (at the end of the year following graduation) and lasts until retirement at age sixty-five. In order to justify the investment, by how much does your salary have to increase as a result of getting the MPA degree?

Answer 1

Total cost of upgrading qualification = 55000+75000 = $130000 per year

$130000 will be spent twice.

FV of 130000 of first year in second year will be =130000*(1+3%) = 130000*1.03 = $133900

Hence total cost at end of study = 133900+130000=$263900

Age at start of job = 26+2 = 28 years

Age of retirement = 65 years

Total no of years worked = 65-28 = 37 years

Hence the cost incurred of $263900 should be recovered over 37 years by additional salary.

Hence PV of additional salary = $263900

Hence, 263900=A*(1-(1+3%)^-37)/3%

or, 263900=A*(1-(1.03)^-37)/0.03

or, 263900=A*(1-0.3350)/0.03

or, 263900=A*0.665/0.03

or, A = or, 263900*0.03/0.665

or, A = 11904.96

Hence the increase of salary should be of $11904.96 to justify the investment