Investigating the Value of an MBA Education using NPV Decision Model

Investigating the Value of an MBA Education

using NPV Decision Model

MBA or not to MBA?That is the question…

W5491: Math for Finance X410.21(Summer 2011-UCLA Extension )

Prof. Nicholas Nucho

Ashwin Shah

Mehnaz Alam

Nabil Quadri

Agenda

Background

Our Approach

Schools

Loans

Introducing… the Candidates

Our NPV Model in Action

Wait…How did that all work?

Pushing the Boundaries

Conclusion

2

Background

Image source: flickr.com3

MBA = Master of Business Administration

Core curriculum: Accounting, Communications, Economics, Finance HR, Marketing and Strategy.

Pros: Potential to accelerate careers across various industries MBA graduates usually command higher salaries Opportunity to change careers Exposure to different networks

Cons Expensive Risk of not increasing salary post MBA Time Commitment Strain on loved ones Loss of 2 years of income

4

Is an MBA worth it? The endless debate

Image source: flickr.com5

A decision of this magnitude can be an overwhelming

and stressful process.

The goal of this project is to provide a useful and

objective method to evaluate this complex decision.

Our Approach

6

Overview

We recognize there are many components that factor into

making such an important decision.

For the purposes of this project, we decided to focus on the

financial aspect as a form of measurement.

Our approach was to build a model that will calculate the

NPV of this investment as a tool to guide potential MBA

students.

7

Approach to Evaluation

Ultimately, this decision will vary based on an individual’s situation and potential.

To answer this question, we crafted 3 hypothetical candidate profiles and accessed the profiles against a variety of MBA programs.

This allowed for a thorough and complete analysis of the investment since each program leads to a different post-MBA income and income growth rate.

8

Our Process

Gathered detailed data about MBA programs, potential earnings, loan programs and historical interest rates from reliable sources

Created an elaborate NPV model to consider a number of variables including tuition and other expenses, loan rates and terms and pre- and post- MBA incomes

Ensured our model meets financial modeling best practices

Carefully crafted candidate profiles to reflect varied career situations

Merged NPV model with candidate profiles to provide a full quantitative picture of the impact of decision paths

9

Schools

10

Reviewed 4 types of MBA Programs

Ivy League

Big Ten

Private

Online

11

Sources of Profile Data

Bloomberg Business Week 2010 rankings used to order the schools to implicitly depict variation of NPV

Post-MBA incomes also taken from Bloomberg Business Week 2010

Expenses data taken from respective B-School online sources (for session starting fall of 2011)

Post-MBA income growth rates over 20-year horizon taken from paper Estimating the Internal Rate of Return on an MBA, John B. White., Morgan P. Miles, and Roger M. White

12

International MBA Programs

Originally, we considered including non-US schools and programs as part of the analysis

Difficulties in predicting and adjusting for: Foreign currency exchange trends International discount rates International income growth rates

Not directly comparable with US-only scenarios

So, for the purposes of this project, we did not include non-US MBA programs

13

Loans

14

Loan Programs

We took 3 loan programs: one for each “Loan Type”:

Federal Subsidized Graduate Loan

Federal Unsubsidized Graduate Loan

Citibank Graduate Student Loan (Private)

All US loans specified with APR rate (Truth in Lending Act of 1968)

Grace period is a standard 6 months after graduation

Monthly repayment is standardImage source: flickr.com

15

Introducing… the Candidates

16

Candidate #1: Mr. Non Profit

Currently: 26 year old male

currently working as a

marketing coordinator at a

non-profit in Atlanta, GA

Pre-MBA Income:

$38,000 per year.

Image source: flickr.com

17

Candidate #2: Ms. Wall Street

Currently: 28 year old

female currently working as a

Hedge Fund Research Analyst

in NYC

Pre-MBA Income:

$85,000 per year


18

Candidate #3: Mr. IT

Currently: 25 year old male

currently working as

Software Developer in San

Diego, CA

Pre-MBA Income:

$65,000 per year.


19

Our NPV Model in Action

20

Candidate #1: Mr. Non Profit

21

Calculated using :

Horizon of 30 years

Discount rate of 5%

Non MBA Income growth rate of 2%

22

$0.00

$200,000.00

$400,000.00

$600,000.00

$800,000.00

$1,000,000.00

$1,200,000.00

$1,400,000.00

NPV of MBA Investment by School-Mr. Non Profit

Federal subsidized graduate

Federal unsubsidized graduate

Citibank

23

Calculated using :

Horizon of 30 years

Discount rate of 5%


Loan Interest Rate of 6.8% with maturity of 20 years

$1.36

$1.10 $1.01

$0.63

$0.87 $0.92

$0.63

$0.39

$0.70

$0.30

$0.00

$0.20

$0.40

$0.60

$0.80

$1.00

$1.20

$1.40

$1.60

Federal Subsidized Graduate Loan-Mr. Non Profit


In millions

24

Calculated using :

Horizon of 30 years

Discount rate of 5%



$1.34

$1.08

$0.99

$0.61

$0.85 $0.90

$0.61

$0.38

$0.68

$0.28

$0.00

$0.20

$0.40

$0.60

$0.80

$1.00

$1.20

$1.40

$1.60

Federal Unsubsidized Graduate Loan-Mr. Non Profit


In millions

25

Calculated using :

Horizon of 30 years

Discount rate of 5%



$1.31

$1.06

$0.97

$0.59

$0.83 $0.88

$0.59

$0.35

$0.66

$0.26

$0.00

$0.20

$0.40

$0.60

$0.80

$1.00

$1.20

$1.40

Harvard Business School

Kellogg School of

Management

Columbia Kelley School of Business

Yale GeorgeTown McDonough

Babson Olin Rocheter Simon School

of Business

Arizona State Carey

Univ of Phoenix

Citibank Private Loan-Mr. Non Profit

Citibank

In millions

Candidate #2: Ms. Wall Street

26

Calculated using :

Horizon of 30 years

Discount rate of 5%


27

$(800,000.00)

$(600,000.00)

$(400,000.00)

$(200,000.00)

$-

$200,000.00

$400,000.00

NPV of MBA Investment by School-Ms. Wall Street



Citibank

28

Calculated using :

Horizon of 30 years

Discount rate of 5%



$0.39

$0.13

$0.04

($0.34)

($0.10)($0.05)

($0.34)

($0.57)

($0.27)

($0.58)

($0.80)

($0.60)

($0.40)

($0.20)

$0.00

$0.20

$0.40

$0.60

Federal Subsidized Graduate Loan-Ms. Wall Street


In millions

29

Calculated using :

Horizon of 30 years

Discount rate of 5%



$0.37

$0.11

$0.02

($0.36)

($0.12)($0.07)

($0.36)

($0.60)

($0.29)

($0.60)

($0.80)

($0.60)

($0.40)

($0.20)

$0.00

$0.20

$0.40

$0.60

Federal Unsubsidized Graduate Loan- Ms. Wall Street


In millions

30

Calculated using :

Horizon of 30 years

Discount rate of 5%



$0.33

$0.07

($0.01)

($0.39)

($0.15)

($0.10)

($0.39)

($0.63)

($0.32)

($0.63)

($0.80)

($0.60)

($0.40)

($0.20)

$0.00

$0.20

$0.40


Kellogg School of

Management




of Business

Arizona State Carey

Univ of Phoenix

Citibank Private Loan-Ms. Wall Street

Citibank

In millions

Candidate #3: Mr. IT

31

Calculated using :

Horizon of 30 years

Discount rate of 5%


32

$(400,000.00)

$(200,000.00)

$-

$200,000.00

$400,000.00

$600,000.00

$800,000.00

NPV of MBA Investment by School-Mr. IT



Citibank

33

Calculated using :

Horizon of 30 years

Discount rate of 5%



$0.80

$0.54

$0.45

$0.07

$0.31 $0.37

$0.08

($0.16)

$0.14

($0.20)

($0.40)

($0.20)

$0.00

$0.20

$0.40

$0.60

$0.80

$1.00

Federal Subsidized Graduate Loan-Mr. IT


In millions

34

Calculated using :

Horizon of 30 years

Discount rate of 5%



$0.78

$0.52

$0.43

$0.05

$0.29 $0.34

$0.05

($0.18)

$0.12

($0.22)

($0.40)

($0.20)

$0.00

$0.20

$0.40

$0.60

$0.80

$1.00

Federal Unsubsidized Graduate Loan-Mr. IT


In millions

35

Calculated using :

Horizon of 30 years

Discount rate of 5%



$0.75

$0.49

$0.40

$0.02

$0.26

$0.31

$0.02

($0.21)

$0.09

($0.25)

($0.40)

($0.20)

$0.00

$0.20

$0.40

$0.60

$0.80


Kellogg School of

Management




of Business

Arizona State Carey

Univ of Phoenix

Citibank Private Loan-Mr. IT

Citibank

In millions

Wait…how did that all work?

36

The NPV Model

Model Overview

Consists of 5 worksheets:

NPV Calculator: The main NPV calculation sheet

School Profiles: List of MBA programs under analysis with associated variables

Loan Profiles: List of loan programs under consideration with associated parameters

Candidate Profiles: List of Candidates with associated variables

NPV Iterator: Tool to apply the NPV model in one shot to various combinations of Schools, Loans and Candidates

37

Consistent Color Coding Used

38

User Input Value

Derived Input Value

Alternative Input for Sensitivity Analysis

Sensitivity Analysis Output

Intermediate Output Value

Output Value

NPV Calculator: Overview

39

Three main sections:

Profiles Selector

Model Inputs

Model Outputs

NPV Calculator: Profiles Selector

40

Used to select a desired combination of MBA Program, Loan Program and Candidate (from drop-down)

Drop-down options are linked to respective Profile worksheet

After selecting desired combination, click on Button to load all associated input variables from each profile worksheet into NPV Calculator Input fields

Selecting “Custom” retains earlier

values of the input variables, which

can then be changed manually in

NPV Calculator

NPV Calculator: Model Inputs

41

Divided into 4 sub-sections:

General Parameters (MBA parameters, Model Horizon, Discount Rate)

Non-MBA Path (Income Variables)

MBA Path (Income Variables)

MBA Expenses (Expenses and Loan Variables)

NPV Calculator: General Parameter Inputs

42

Length of MBA in Years School-related Input:

Can be loaded from School Profile

Affects: Beginning Principal Calculation

Forfeited Pre-Income Calculation

Horizon in Years (starting from MBA graduation) Length of time into future over which all cash-flows are considered

Constant Discount Rate (used in all PV calculations) We have assumed a standard rate of 5% and separately completed sensitivity analysis

Full-time or Part-time MBA (flag selected from drop-down) School-related Input: Can be loaded from School Profile

NPV Calculator: Non-MBA Path Inputs (1/2)

43

Pre-MBA Annual Income

As of date of commencement of MBA

Exclusive of taxes (to remove the effect of variations in tax

rates: standard NPV practice)

Candidate-related Input: Can be loaded from Candidate Profile

Non-MBA Income Growth Function

Can use constant income growth function or variable one: this

flag variable specifies which method to use

For all current analysis, we have used Constant function and

separately studied effect of using variable for one profile

NPV Calculator: Non-MBA Path Inputs (2/2)

44

Constant Annual Growth Rate of Non-MBA Income Used if “Constant” Growth function is selected Assumed as 2% for all current candidate analysis When MBA is of fractional-year length (e.g. 1.5 years MBA

programs), the growth during the partial year is calculated by taking effective period growth rate (EAR formula applied to Constant Growth Rate)

Variable Annual Growth Rate of Non-MBA Income Growth rate for each period up to horizon (including duration of

MBA) can be specified on timeline Using this it is possible to simulate various real-world scenarios such

as Interim raises, Diminishing growth, Effect of sign-on bonuses, Career Stagnation, Change of Career Paths, Change to Self-Owned Business, etc.

NPV Calculator: MBA Path Inputs (1/2)

45

Estimated Post-MBA Annual Income

As of date of MBA graduation

Exclusive of taxes (to remove the effect of variations in tax rates: standard NPV practice)

School-related Input: Can be loaded from School Profile. But note that the school profile gives average post-MBA income whereas actual post-MBA income would also vary based on the candidate’s experience and chosen career path

Post-MBA Income Growth Function

Can use constant income growth function or variable one: this flag variable specifies which method to use

For all current analysis, we have used Constant function and separately studied effect of using variable growth for one candidate

NPV Calculator: MBA Path Inputs (2/2)

46

Constant Annual Growth Rate of Post-MBA Income

Used if “Constant” Growth function is selected

School-related Input: Can be loaded from School Profile[1]

Variable Annual Growth Rate of Post-MBA Income

Growth rate for each period up to horizon (starting from graduating year) can be specified on timeline

Using this it is possible to simulate various real-world scenarios such as Interim raises, Diminishing growth, Effect of sign-on bonuses, Career Stagnation, Change of Career Paths, Change to Self-Owned Business, etc.

[1] Estimating the Internal Rate of Return on an MBA: A Comparison of the Return from Top-Ranked & Second-Tier Programs, John B. White., Morgan P. Miles, and Roger M. White

NPV Calculator: MBA Expense Inputs (1/5)

47

Total Tuition, Living and Other Expenses

Expenses for full duration of MBA

School Profile gives break-up of expenses by type (Tuition,

Room and Board, Utilities, Health Services, Other Fees, Misc.

Expenses).

Model allows flexibility of not considering a specific type of

expense (e.g. Room and Board need not be considered if the

candidate is a local with own residence). Simple change in

summation formula used on School profile sheet

Total of all of the relevant expenses is loaded into this NPV

Calculator to determine amounts to be borrowed or used up

from savings


48

Total Approved Loan Amount

Candidate-related Input: Can be loaded from Candidate Profile

In practice:

Candidates try to get the highest possible loan amount approved

First approach is to obtain Federal loans as the interest rate is lower but

these have a maximum approval limit

Remaining funds borrowed from private lenders

We have taken a slightly simplified approach for current analysis

Only one loan assumed – remaining amount must come from savings

All standard approved loan limits ignored (even for federal loans)

Extension to multiple loan framework explored separately &

developed as an add-on and the model continues to be refined


49

Upfront Payment of Tuition

Assumed to be from Savings and Interest-free Borrowings (e.g. from parents)

Derived Input : auto-calculated by NPV-Calculator Upfront Payment = Total MBA Expenses –Total Approved Loan Amount

Loan Interest Rate per Year

Loan-related Input: Can be loaded from Loan Profile

Affects calculation of beginning principal for amortization and determination of the amortized payments

Rate Convention (flag input selected from drop-down)

Indicates whether the annual interest rate is specified in EAR or APR terms – affects derivation of period interest rate from annual interest rate



50

Grace Period in Years

Specifies the duration after graduation during which the candidate is excused from making loan payments

Loan is amortized starting from date of expiry of grace period


Loan Maturity (in years)

Length of time over which loan is amortized

Loan-related Input: Can be loaded from Loan Profile. In practice, for private loans, loan maturity can vary quite a bit. Since model allows for custom inputs, this is easily handled.

Number of Payments per Year


Affects amortization schedule, period interest rate and PV of periodic loan payments


51

Loan type (input selected from Drop-down)

Specifies whether the loan is subsidized, unsubsidized or from a private institution


Affects the calculation of the actual beginning principal amount: For subsidized loans, the compound interest waived off the duration of the MBA.

In case for unsubsidized or private loan, beginning principle balance is equal to approved loan amount plus the compound interest accrued over duration of MBA. All loan payments are assumed to be deferred till graduation (reflects majority of real-world scenarios)

Period Interest Rate: Derived Input - Calculated from Annual Interest Rate using APR or EAR formula depending on Rate Convention

Beginning Principal Balance: Derived Input – Calculated from Approved Loan Amount using period interest rate, duration of MBA & grace period applied to basic compound interest formula

NPV Calculator: Model Outputs

52

Ultimate objective is to calculate NPV of doing MBA given the values of all the input variables

First model calculates PVs of the various cash flows involved: Present Value of Loan Repayments (PVLoan-payments): up to loan maturity

Present Value of Post-MBA Income (PVPost-MBA): projected from graduation to model horizon

Present Value of Projected Non-MBA Income (PVNon-MBA) : projected from start of MBA to model horizon

Present Value of Income forfeited during MBA (PVDuring-MBA)

Then PVs are combined to give NPV of MBA For full-time MBA programs

NPVMBA = PVPost-MBA – Upfront Expense – PVLoan-payment – PVNon-MBA

For part-time MBA programs

NPVMBA = PVPost-MBA – Upfront Exp. – PVLoan-payment – PVNon-MBA + PVDuring-MBA

NPV Calculator: PVLoan-payments (1/2)

53

First, amortized loan payment amounts (L-PMT) are calculated using Excel PMT function Rate used = Period Interest Rate No. of Periods = Total Payment Periods (Loan Maturity * No. of Payments

per Year) PV = Beginning Principal Balance

Then, the value of all loan payment amounts as of the date of commencement of loan repayments (FVL-PMT)is calculated using Excel PV function Rate used = Effective discount rate for each loan period (calculated from

Constant Discount Rate and No. of Payments per Year using EAR formula) No. of Periods = Total Payment Periods (Loan Maturity * No. of Payments

per Year) Annuity Amount = Amortized Loan Payment Amount (L-PMT)

NPV Calculator: PVLoan-payments (2/2)

54

Next, the Present Value of all loan payment amounts as

of date of commencement of MBA is calculated using

Excel PV function

Rate used = Constant Discount Rate

No. of Periods = Duration of MBA + Grace Period

Annuity Amount = 0

Future Value = FVL-PMT

Two-step process used here is equivalent to calculating PV of

all loan repayments in a single-step using raw PV formula

NPV Calculator: PVPost-MBA

55

Present value of post-MBA income is calculated using

time-line approach

First-year income is projected on an annual basis from

graduation to the model horizon

Growth rates used are the effective growth rates for each period

(Constant or Variable depending on Post-MBA inputs)

Present value of each year’s income calculated using Excel PV

formula

Rate = Constant Discount Rate

No. of Periods = Duration of MBA + Years after graduation

Future Value = Annual Post-MBA Income for that year

NPV Calculator: PVPre-MBA

56

Present value of lost income of non-MBA decision path is calculated using time-line approach Pre-MBA Income as of the date of starting the MBA is taken as the

starting point for income projection

This income is projected on an annual basis from the date of starting the MBA to the model horizon – so the timeline of Non-MBA path is longer than Post-MBA path by the length of the MBA

Growth rates used are the effective growth rates for each period (Constant or Variable depending on Non-MBA inputs)

Present value of each year’s income calculated using Excel PV formula Rate = Constant Discount Rate

No. of Periods = Years after start of MBA

Future Value = Annual Non-MBA Income for that year

NPV Calculator: PVDuring-MBA

57

Need for considering PVDuring-MBA for part-time MBAs: In PV calculation of non-MBA path, projected income is taken from

date of starting the MBA – i.e. projected income during MBA course is taken as lost income

In part-time MBA, candidate continues to earn (growing) pre-MBA salary over the duration of MBA

So, income earned during MBA must be added back to NPV of full-time MBA decision path to get NPV of part-time MBA path

NPVPart-time-MBA = PVFull-time-MBA + PVDuring-MBA

Handled by conditional addition of PVDuring-MBA in NPV cell formula. Condition is simple check of “Part-time/Full-time” flag specified in General Parameter Inputs section

Profile Worksheets

School Profiles: Define each MBA program along with:

Ranking

Expense breakup

Average historical income after graduation

Estimated constant annual income growth rate

Loan Profiles: Define each available loan program with applicable rate, payment term, maturity and type

Candidate Profiles: Define each candidate with pre-MBA annual income and total approved loan amount

58

Useful to setup multiple combinations of candidates, MBA programs and loan programs and calculate their NPVs at the click of a button

Enter name of candidate/B-school/loan-program exactly as given in respective Profiles worksheet

Enter an interest rate and loan maturity period to override defaults associated with loan program

Enter starting and ending rows for iterator (allows you to enter all data but calculate NPV only for some)

NPV Iterator: Calculate in Bulk

59

Pushing the Boundaries

Going above and beyond

60

Discount Sensitivity Analysis 1

61

1%

3%

5%

7%

9% -$1,000,000.00

-$500,000.00

$0.00

$500,000.00

$1,000,000.00

$1,500,000.00

$2,000,000.00

NPV (in USD)

NPV as function of MBA Program and Discount Rate

Candidate Profile Mr. IT

Model Horizon 30 years

Loan Program Citibank

Interest Rate 8%

Loan Maturity 30 years

Non-MBA Income Growth Rate 2%

Discount Sensitivity Analysis 2

62

-$500,000.00

$0.00

$500,000.00

$1,000,000.00

$1,500,000.00

$2,000,000.00

$2,500,000.00

0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%

NP

V (

in U

SD)

Discount Rate

NPV as function of Candidate Profile and Discount Rate

Mr. Non-Profit Ms. Wall Street Mr. IT

MBA Program Columbia



Interest Rate 8%


Non-MBA Income Growth

Rate 2%

Growth Function: Practical Utility

63

In candidate analysis we took a constant rate of growth of both pre-MBA and post-MBA incomes

Simpler to conceptualize

Real data for various programs available from previous studies

Gives a career-path agnostic NPV estimate

More realistic and practical NPV decision analysis can be done using Variable Growth Function feature of NPV model (natively supported)

Growth Function: Using It

64

To use feature, select “Variable” in the “Post-MBA Income Growth Function” drop-down

Enter growth rate applicable to each year in the row labeled “Variable Annual Growth Rate of Post-MBA Income”

Growth Function Analysis

65

In the interest of exploratory analysis, we assumed a number of realistic career paths and imagined hypothetical post-MBA growth functions for each of these

For simplicity non-MBA income path was still assumed to be growing at constant rate of 2%. Only post-MBA varied.

Fixed Variables:

Candidate Profile Mr. IT



Interest Rate 8%


Non-MBA Income Growth Rate 2%

Discount Rate 5%

Hypothesized Growth Functions

66

Scenario Growth Function

Constant Flat 3.5% growth. Simplifying Approximation

Career Consultant

1st year growth: 3% (sign-on bonus effect)Years 2-5: 4% (initial spurt)Years 6-13: 3% (plateau: middle management)Years 14-20: 7% (partnership: revenue share)

Law of Diminishing Returns

Starting with a rate of 7%, the growth itself decelerates @ 10% per year with a terminal value of 1.2%

Job HopperConstant rate of 2.5% except once every 5 years when candidate switches jobs and gets a one-time boost of 10% due to signing bonus and switching raise

I Have a Dream

Constant salary growth of 2.5% for first 8 years.Then candidate starts a new company (0% for 4 years).Once enterprise takes off, personal income growth shoots up to 15% per year

Growth Functions Visualized

67

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

16.00%

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Post-MBA Income Growth Functions Used For Exploratory Analysis of Hypothetical Career Paths

Constant

Career Consultant

Law of Diminishing Returns

Job Hopper

I Have a Dream

Growth Function Analysis Findings

68

-$200,000.00

-$100,000.00

$0.00

$100,000.00

$200,000.00

$300,000.00

$400,000.00

$500,000.00

$600,000.00

Impact on NPV of MBA by Varying Post-MBA Income Growth Function

Constant Career Consultant Law of Diminishing Returns Job Hopper I Have a Dream

Ability to add one more loan program

Conclusion

70

Applied to our candidates

71

Applying the NPV model to our 3 hypothetical candidates,

we can see that pursuing an MBA is a smart financial decision

for Mr. Non Profit and Mr. IT.

However, an MBA will not provide a good return on

investment for Ms. Wall Street, from a strictly financial

standpoint.

Takeaways

72

The NPV model can effectively provide a useful way of

evaluating the decision of whether to proceed with an MBA

and where to apply purely in a financial perspective taking

into consideration various market factors such as loan

programs, interest rates etc.

The NPV model does not take into consideration intangibles

such as the potential of building a professional network,

building on various skills such as entrepreneurship,

leadership and team-building.

Documents

Investigating the Value of an MBA Education using NPV Decision Model