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Homework answers / question archive / David Jetter graduated from college six years ago with a finance undergraduate degree
David Jetter 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 his goal. After examining schools, he has narrowed his choice to either Prentice Univers ity or Mount Alliance College. 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. Da vid currently works at the money management firm of Dewey and Louis. His annual salary at the firm is $ 50,000 per year, and his salary expected to increase at 3 % per year until retirement. He is currently 28 years old and expects to work for 40 more years .
His current job includes a fully paid health insurance plan, and his current average tax rate is 26 %. David has savings account with enough money to cover the entire cost of his MBA program. The Ritt College of Business at Prentice University 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 $65,000, payable at the beginning of each school year. Books and other supplies are estimated to cost $3000 per year.
David expects that after graduation from Prentice, he will receive a job offer for about $110,000 per year, with a $20,000 signing bonus. The salary at this job will increase at 4 % per year. Because of the higher salary, his average income tax rate will in crease to 31 %. The Brad el School of Business at Mount Alliance College began its MBA program 16 years ago. The Brad el School is smaller and less well known than the Ritt College. Brad el offers an accelerated, one – year program, with a tuition cost of $80 ,000 to be paid upon matriculation. Books and other supplies for the program are expected to cost $4,500. David thinks that he will receive an offer of $92,000 per year upon the graduation, with an $18,000 signing bonus.
The salary at this job will increas e at 3.5 % per year. His average tax rate at this level of income will be 29 %. Both schools offer a health insurance plan that will cost $3,000 per year, payable at the beginning of the year. David also estimates that room and board expenses will cost $2, 000 more per year at both schools than his current expenses, payable at the beginning of each year. The appropriate discount rate is 6.5 percent.
1. How does David ’s age affect his decision to get an MBA? Explain why?
2. What other, perhaps no n- quantifi able factors affect David ’s decision to get an MBA? Explain in detail.
3. Assuming all salaries are paid at the end of each year, what is the best option for David – from a strictly financial standpoint? Explain why in detail with calculations.
4. David believes that the appropriate analysis is to calculate the future value of each option. How would you evaluate this statement? So what is the future value of each option?
5. What initial salary would David need to receive to make him indifferent betwee n attending Prentice University and staying in his current position? Explain in detail with calculations
Answer:
1. How does David’s age affect his decision to get an MBA?
My opinion, Age is one of the important factor that affects someone decision to continue study. In this case, David is now 28 years old. He graduated from college six years ago when he’s age is 22 years old. Assuming that David already working for about 5 years since graduated from college, so that he would have enough money from salary saving in 5 years to do his MBA at 28 years age. If he starts the MBA program on 28 years old, he will spend two years for study and perhaps finish his MBA at 30 years old. At 30 years old, he will start working again for 40 more years after getting the MBA. With those reasons, age affects his decision for getting an MBA.
2. What other, perhaps no quantifiable factors affect David’s decision to get an MBA?
My opinion is there are several non quantifiable factors affect David’s decision to get an MBA. First, I think when assuming that David already working for about 5 years since graduated from college. he has job experiences as the MBA program usually put the requirement to the candidates at least having two years experiences in his respective field. Second, I think the current family situation. If he married with or without children, this will affect David’s decision because spouse or children supporting is also important. The third is his willingness to continue the study. If he eager to continue the study, he will continue the study. But if he has no willingness to study, he could do anything else, for example having jobs that would pay more or open the business.
3.Assuming all salaries are paid at the end of each year, what is the best option forDavid– from a strictly financial standpoint?
I think there are three options have to be calculated:
1. Keeping his current work for 40 years
There are several factors to be considered to calculate the present values (PV) of the first options are: His annual salary at the firm is $50,000 per year, and his salary expected to increase at 3 % per year until retirement, his current average tax rate is 26 % and discount rate is 6.5 percent.
In this case, to get the present value (PV), we can use the formula of growing annuity.
Salary = $50,000, tax rate = 26%, because of tax rate, c = $37,000
R (discount rate) = 6.5%
G (growth rate) = 3%
T (the number of period working) = 40
So the PV is = $781228.571
Present Value (PV) of Growing Annuity.
PVGA = C (1 – ( (1+g)/(1+r))t / r – g )
PVGA= $37000 (1 – ((1+3%)/(1+6.5%))40 / 6.5% - 3%)
PVGA = $37000 (1 – ((1.03)/(1.065))40 / 0.035)
PVGA = $ 37000 (1 – 0.261 / 0.035)
PVGA = $37000 (0.739 / 0.035)
PVGA = $781228.571
2. Getting the MBA at Prentice University
In this case, must compute 4 parts:
A. PV of salary for 38 years (40 – 2 years)
B. PV of signing bonus
C. PV of costs for 2 years (tuition, books and supplies, health insurance and rent fee)
D. PV of 2 years salary when he would work at the money management firm.
A. PV of salary for 38 years
The factors to consider are: He will receive a job offer for about $110,000 per year, with a $20,000 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 %.
Salary = $110,000, tax rate = 31%, so, C = $75,900
R (discount rate) = 6, 5%
G (growth rate) = 4%
T (the number of period working) = 38 (40 years – 2 years)
So the PV is = $ 1,806,116.4
Present Value (PV) of Growing Annuity.
PVGA = C (1 – ( (1+g)/(1+r))t / r – g )
PVGA = $75 900 (1 – ( (1+4%)/(1+6.5%))38 / 6.5% - 4%)
PVGA = $75 900 (1 – ((1.04)/(1.065))38 / 0.025)
PVGA = $75 900 (1 – (0.9765)38 / 0.025)
PVGA = $75 900 (1 – (0.40508) / 0.025)
PVGA= $75 900 (0.5949/0.025)
PVGA = $75 900 (23.796)
PVGA = $ 1,806,116.4
B. PV of signing bonus
The factors to consider are:
Signing bonus = $ 20,000
R (discount rate) = 6, 5%
T (the number of period working) = 38
So the PV is = $17,633.57
PV = FV / (1+r)t
PV = $20 000 / (1.065)38
PV = $20 000 / 1.1342
PV = $17,633.57
C. PV of cost for years ((tuition, books and supplies, health insurance and rent fee)
The factors to consider are: tuition $65,000, Books and other supplies are estimated to cost $3000 per year. Health insurance plan that will cost $3,000 per year, room and board expenses will cost $2,000.
Cost = $65 000 + $3000 + $3000 + $2000 = $ 73 000
R (discount rate) = 6, 5%
T (the number of period studying) = 2
So the PV is = $ 132,860
Present Value (PV) of Annuity:
PVA = c ( 1 – (1/(1+r)t / r )
PVA = $73 000 ( 1 – (1/(1.065)2 / 6.5%)
PVA = $73 000 ( 1 – (1/1.1342 / 0.065)
PVA = $73 000 (1 – 0.8817 / 0.065)
PVA = $73 000 (0.1183 / 0.065)
PVA = $73 000 (1.82)
PVA = $ 132,860
D. PV of 2 years salary when he would work at the money management firm.
The factors to consider are: His annual salary at the firm is $50,000 per year, and his salary expected to increase at 3 % per year until retirement, his current average tax rate is 26 % and discount rate is 6.5 percent.
Salary = $50,000, tax rate = 26%, because of tax rate, c = $37,000
R (discount rate) = 6.5%
G (growth rate) = 3%
T (the number of period working) = 2
So the PV is = $68398.2
Present Value (PV) of Growing Annuity.
PVGA = C (1 – ( (1+g)/(1+r))t / r – g )
PVGA = $3700 (1 – ((1+3%)/(1+6.5%))2 / 6.5% - 3%)
PVGA = $37000 (1 – ((1.03)/(1.065))2 / 0.035)
PVGA = $37000 (1 – 0.9353 / 0.035)
PVGA = $37000 (0.0647/0.035)
PVGA = $37000 (1.8486)
PVGA = $68398.2
3. Getting the MBA at Mount Alliance College
In this case, must compute 4 parts:
A. PV of salary for 39 years (40 – 1 years)
B. PV of signing bonus
C. PV of costs for 2 years (tuition, books and supplies, health insurance and rent fee)
D. PV of 1 years salary when he would work at the money management firm.
A. PV of salary for 39 years
The factors to consider are: he will receive an offer of $92,000 per year upon the graduation,. The salary at this job will increase at 3.5 % per year. His average tax rate at this level of income will be 29 %.
Salary = $ 92,000, tax rate = 29%, so, C = $ 65,320
R (discount rate) = 6, 5%
G (growth rate) = 3, 5%
T (the number of period working) = 39
So the PV is = $1,463,821.2
Present Value (PV) of Growing Annuity.
PVGA = C (1 – ( (1+g)/(1+r))t / r – g )
PVGA = $65 320 (1 – ((1+3.5%)/(1+6.5%))39 / 6.5% - 3.5%)
PVGA = $65 320 (1 – 0.3277/ 0.03)
PVGA = $65 320 (0.6723/0.03)
PVGA = $65 320 (22.41)
PVGA = $1,463,821.2
B. PV of signing bonus
The factors to consider are:
Signing bonus = $ 18,000
R (discount rate) = 6, 5%
T (the number of period working) = 39
So the PV is = $ 15,870.22
PV = FV / (1+r)t
PV = $18 000 / (1.065)39
PV = $18 000 / 1.1342
PV = $15,870.22
C. PV of cost for 1 years ((tuition, books and supplies, health insurance and rent fee)
The factors to consider are: tuition $ 80,000, Books and other supplies for the program are expected to cost $4,500. Health insurance plan that will cost $3,000 per year, room and board expenses will cost $2,000.
Cost = $ 89,500
R (discount rate) = 6, 5%
T (the number of period studying) = 1
So the PV is = $84,033.34
Present Value (PV) of Annuity:
PVA = c ( 1 – (1/(1+r)t / r )
PVA = $89 500 ( 1 – (1/(1+6.5%)1 / 6.5% )
PVA = $89 500 (0.06103 / 0.065)
PVA = $89 500 (0.93892)
PVA =$84,033.34
D. PV of 1 year’s salary when he would work at the money management firm.
The factors to consider are: His annual salary at the firm is $50,000 per year, and his salary expected to increase at 3 % per year until retirement, his current average tax rate is 26 % and discount rate is 6.5 percent.
Salary = $50,000, tax rate = 26%, because of tax rate, c = $37,000
R (discount rate) = 6.5%
G (growth rate) = 3%
T (the number of period working) = 1
So the PV is = $34,780
Present Value (PV) of Growing Annuity.
PVGA = C (1 – ( (1+g)/(1+r))t / r – g )
PVGA = $37,000 (1 – ((1+3%)/(1+6.5%))1 / 6.5% - 3%)
PVGA = $37,000 (1 – 0.9671 / 0.035)
PVGA = $37,000 (0.0329 / 0.035)
PVGA = $37,000 (0.94)
PVGA = $34,780
So the best option for David is getting the MBA at Prentice University. He will receive more money after finishing the study and get salary and signing bonus with total present value $1 823 749.97. The present value study expenses at Prentice University (tuition, books and supplies, health insurance and rent fee) is $132 860 and the present value study expenses at Mount Alliance College (tuition, books and supplies, health insurance and rent fee) is $84 033.34. Since David has savings account with enough money to cover the entire cost of his MBA program, it is the best option for him to get the MBA at Prentice University.
4. David believes that the appropriate analysis is to calculate the future value of each option. How would you evaluate this statement?
1. Keeping his current work for 40 years
There are several factors to be considered to calculate the future values (FV) of the first options are: His annual salary at the firm is $50,000 per year, and his salary expected to increase at 3 % per year until retirement, his current average tax rate is 26 %.
In this case, to get the present value (PV), we can use the formula of growing annuity.
Salary = $50,000, tax rate = 26%, because of tax rate, c = $37,000
G (growth rate) = 3%
T (the number of period working) = 40
So the FV is = $9,699,792.17
FV = PV x (1+r)t
FV = $781228.571 (1.065)40
FV = $9,699,792.17
2. Getting the MBA at Prentice University
In this case, must compute 4 parts:
A. FV of salary for 38 years (40 – 2 years)
B. FV of signing bonus
C. FV of costs for 2 years (tuition, books and supplies, health insurance and rent fee)
D. FV of 2 years salary when he would work at the money management firm.
A. FV of salary for 38 years
The factors to consider are: He will receive a job offer for about $110,000 per year, with a $20,000 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 %.
Salary = $110,000, tax rate = 31%, so, C = $75,900
G (growth rate) = 4%
T (the number of period working) = 38
So the FV is = $19,771,099.95
FV= PV x (1+r)n
FV = $1 806 116.4 (1.065)38
FV = $1 806 116.4 (10.94674)
FV = $19,771,099.95
B. FV of signing bonus
The factors to consider are:
Signing bonus = $ 20,000
G (growth rate) = 0 %
T (the number of period working) = 38
So the FV is = $ 20,000.43
FV = PV (1+r)n
FV = $17 633.57 (1.065)2
FV = $20,000.43
C. FV of cost for 2 years college
FV = PV (1+r)n
FV = $132 860 (1.065)2
FV = $ 150,693.13
D. FV of 2 years salary when he would work at money management firm
FV = PV (1+r)n
FV = $82 076.508 (1.065)2
FV = $93,093.23
3. Getting the MBA at Mount Alliance College
In this case, must compute 4 parts:
A. FV of salary for 39 years (40 – 1 years)
B. FV of signing bonus
C. FV of costs for 2 years (tuition, books and supplies, health insurance and rent fee)
D. FV of 1 years salary when he would work at the money management firm.
A. FV of salary for 39 years (40 – 1 years)
The factors to consider are: he will receive an offer of $92,000 per year upon the graduation,. The salary at this job will increase at 3.5 % per year. His average tax rate at this level of income will be 29 %.
Salary = $ 92,000, tax rate = 29%, so, C = $ 65,320
G (growth rate) = 3, 5%
R = 6.5%
T (the number of period working) = 39
So the FV is = $17,065,646.13
FV = PV (1+r)n
FV = $1 463 821.2 (1.065)39
FV = $17 065 646.13
B. FV of signing bonus
The factors to consider are:
Signing bonus = $ 18,000
G (Growth rate) = 0%
T (the number of period working) = 39
So the FV is = $ 18,000.40
FV = PV (1+r)n
FV = $15 870.22 (1.065)2
FV = $ 18,000.40
C. FV of costs for 2 years (tuition, books and supplies, health insurance and rent fee)
FV = PV (1+r)n
FV = $84 033.34 (1.065)
FV = $ 89,495.50
D. FV of 1 years salary when he would work at the money management firm.
FV = PV (1+r)n
FV = $44 400 (1.065)1
FV = $47,286
By calculate the future value of each option: The present value of his salary$937,474.28 is equal to future value $11,639,750.53 when keeping his current work for 40 years. The present value of salary $1,806,116.4 is equal to future value $ 19,771,099.95 plus $ 20,000 signing bonus when having a job for 38 years after getting the MBA at Prentice University. The present value of salary $1,463,821.2 is equal to future value$17,065,646.13 plus $18,000 signing bonus when having a job for 39 years after getting the MBA at Mount Alliance College. The best choice is he having study at Prentice University.
5. What initial salary would David need to receive to make him indifferent between attending Prentice University and staying in his current position?
Staying in his current position, PV 1 = $937,474.28
Getting the MBA at Prentice University, PV2 = $ 1,804,927.68
When PV1=PV2
21,06C1 = $75,900 * 23,78
21, 06 C1 = $ 1 806 116.4
C1 = $85,760.51
The amount $ 85,760.51 already deducted with 26% taxed, the salary before tax deduction is $ 108,508.2. So, the initial salary would David need to receive to make him indifferent between attending Prentice University and Staying in his current position is $108,508.2
