Question

You currently make $70,000 a year and expect your salary to increase by 3% a year for 20 years. You are considering an MBA which will cost you $50,000 for the entire education. If you take the MBA, you will have to pay the full tuition at the end of the first year of your MBA studies and you will make zero earnings at the end of years 1 and 2. However, after graduation, you will have an opportunity to join a premier investment bank, which promises $100,000 a year, which will grow by 5% for 18 years after graduation. The discount rate is 6% What is the present value of all the cash flows for the no-MBA starting from year 1 (do not consider the current salary)?

Answer 1

The present value of all the cash flows for the no-MBA option is $2,579,322.73, which takes into account the expected salary increases over 20 years and the future salary after graduation.

Step-by-step explanation:

To calculate the present value of all cash flows for the no-MBA option, we need to discount each cash flow back to its present value using a discount rate of 6%. The cash flows consist of the expected salary increases of $70,000 per year with a 3% annual growth rate for 20 years, as well as the salary of $100,000 per year with a 5% annual growth rate for 18 years after graduation. We also need to subtract the cost of the MBA, which is $50,000.

Using the formula for present value of a growing annuity: PV = (C/R - g) * (1 - (1+R)^(-n)) / R, where PV is the present value, C is the cash flow in the first year, R is the discount rate, g is the growth rate, and n is the number of years, we can calculate the present value for each cash flow and sum them up to get the total present value.

The present value of the salary increases is: PV1 = (70,000/0.06 - 0.03) * (1 - (1+0.06)^(-20)) / 0.06 = $836,300.51

The present value of the salary after graduation is: PV2 = (100,000/0.06 - 0.05) * (1 - (1+0.06)^(-18)) / 0.06 = $1,793,022.22

The total present value of all cash flows is: PV_total = PV1 + PV2 - 50,000 = $2,579,322.73