In order to decide whether it is worth undertaking an MBA (or any other business school) program, it is necessary to compare the present value of the cost of taking the MBA program, including the loss of earnings, with the present value of the increase in earnings as a result of taking the program.

First of all the problem is broken down into four stages:

- Calculate the cost of the MBA program
- Calculate the loss in earnings while studying
- Calculate the value of the increased earnings
- Calculate the NPV of the program

Suppose, as an example, you are currently earning 45,000, and are planning to undertake a two year MBA program costing 20,000 a year, with payment in full at the start of each year. You estimate that after the MBA program, your earnings will increase to 60,000, and that you will work for a further 25 years after taking the program. Your discount rate (cost at which you could invest money) is 5%.

## 1. Calculate the Cost of the MBA Program

In this example, the MBA costs 20,000 a year for two years, with payment in full at the start of each year.

Period | 0 | 1 | 2 | 3 | . . . n |
---|---|---|---|---|---|

Cash flow | ↓ 20,000 | ↓ 20,000 |

The present value of these two payments is given by the lump sum formula as shown below:

Using PV = FV / (1 + i)^{n}PV = -20,000 - 20,000 / (1 + 5%)^{1}PV = -39,048

As the first payment is made at the start of year 1 (today), its present value is simply 20,000. The present value of the cost of the MBA program is -39,048.

## 2. Calculate the Loss in Earnings While Studying

During the two years of studying from the MBA program, the current earnings of 45,000 per year will be lost. For simplicity, the earnings are assumed to be paid at the end of each year. The present value of the lost earnings is calculated as follows:

Period | 0 | 1 | 2 | 3 | . . . n |
---|---|---|---|---|---|

Cash flow | 45,000 ↓ | 45,000 ↓ |

The present value of these two payments is given by the lump sum formula as shown below:

Using PV = FV / (1 + i)^{n}PV = -45,000 / (1 + 5%)^{1}- 45,000 / (1 + 5%)^{2}PV = -83,673

The present value of the lost earnings while studying for the MBA is -83,673.

## 3. Calculate the Value of the Increased Earnings

After taking the MBA program, the earnings increase by 15,000 each year from 45,000 to 60,000. If we assume that the differential between the earnings (15,000) remains constant throughout the next 25 years of working life, then the present value of this increase in earnings can be calculated using the annuity formula as follows:

Period | 0 | 1 | 2 | 3 | . . . 27 |
---|---|---|---|---|---|

Cash flow | 15,000 ↑ | 15,000 ↑ |

The table shows that the present value of these payments **at the start of year 3** is given by the present value of an annuity formula as shown below:

Using PV = Pmt x (1 - 1 / (1 + i)^{n}) / i PV = 15,000 x (1 - 1 / (1 + 5%)^{25}) / 5% PV = 211,409

This is the present value at the start of year 3, to calculate the present value at the start of year 1 (today), this lump sum (211,409) needs to be discounted back a further two years.

Using PV = FV / (1 + i)^{n}PV = 211,409/ (1 + 5%)^{2}PV = 191,754

The present value of the increase in earnings after taking the program is 191,754.

## 4. Calculate the NPV of the MBA Program

To calculate the net present value of this MBA we can simply add the present value of each of the three cash flows as follows:

NPV of MBA program = PV earnings increase + PV MBA cost + PV lost earnings NPV of MBA program = 191,754 - 39,048 - 83,673 = 69,033

Finally the net present value of the program is 69,033, this means that using the figures in this example, you would be better off by 69,033 is you undertook the MBA program.