The effectiveness of this method is dependent on the quality of the assumptions. Because the assumptions regarding future cash flows can be wildly inaccurate, it is best to include some non-quantifiable evaluations as well.
For Ben, the most important is the degree to which the MBA will help him meet his short- and long-term career objectives. He needs to discuss the issue with people in the industry to help him determine that the MBA is a vital component to his objectives. He has assumed that it is, but if it is not, he will ultimately be dissatisfied with the decision even in the event that he achieves his desired income levels.
5. In strictly financial terms, for Ben to be indifferent between attending Wilson University and retaining his current position, the two options would need to have equal net present values. The initial starting salary for that to occur is $65,770. At this level, the net present value of the Wilson education will be $787,763, the same value as if Ben kept his current job.
6. If Ben were forced to finance his MBA education rather than pay for it by cash, this would impact his decision because it would impact his cash flows. The current calculation does not contain any financing costs. Yet, these costs are future cash flows. If Ben needs to finance his education, those future cash flows must be incorporated into his calculation. The specifics of the loan agreement will dictate at what point principle and interest payments will begin, but for the purposes of this discussion we will assume a 20-year repayment period and that all payments begin at the end of year 2 for the Wilson option and year 1 for the Mount Perry option.
The initial costs are going to be reset to zero, since the loan offsets directly the initial payments costs. The net present value of the Wilson loan is $178,469. The net present value of the Mount Perry loan is $113,736. When these figures are deducted from the net present value of the future earnings, the total net present value of attending Wilson is $1.194 million. The total net present value of attending Mount Perry is $1.059 million. These figures still compare favorably with Ben retaining his current position. Indeed, from a strictly economic perspective, Ben should still opt to attend Wilson University's MBA program.
When the financing entered into the equation, it shifted the dynamic slightly. In our example, the difference was relatively minimal, but depending on the prevailing interest rates, the financing could play a major role in the decision. An extremely high rate of interest could negate the benefits of obtaining an MBA altogether. In this example, this is unlikely, but the assumptions about the future cash flows play a role here as well. If the future cash flows do not meet assumptions, then the need for financing and the terms at which financing are acquired…
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