The value of education
Amanda Collins graduated from UC-Santa Barbara two years ago with a B.S. degree in mathematics. Amanda is 24 today and works as a credit analyst for a southern California bank. She earns $75,000 per year. Both personal curiosity and job mobility has Amanda thinking about an MBA. Does the degree make sense for Amanda?
In her current position, Amanda has brought her analytical skills to the evaluation of the credit risk of commercial loan customers and stands out among her peers. Amanda’s future in the local banking community is promising. Amanda is bright. In her free time, she writes R code, applying statistical analysis to hot topics in the news. She is an avid golfer, and that person who is often pushed out of the art museum at the end of the evening following the opening of a new exhibit. Amanda has varied interests.
The education question is important because the evidence is clear that higher levels of education are related to higher salaries. However, the question is complicated because a quality education commands a premium price and often there is a substantial reduction in living standard while chasing the advanced degree. Two questions for Amanda to answer are key,
Amanda’s preferences are important, too. Amanda states, “I’d like to work three more years to gain more job experience and have time to prepare for entrance exams. Think that will make my b-school application stronger.” “Full-time, two-year programs are my target. The internship many MBA programs generate for their students between years is a plus in my view.”
The “value of education” problem for Amanda now has some clarity. Amanda plans on starting a program at age 26 and will then give up her work as a credit analyst for two-years. One result, she hopes, is to amp up her future income flow. At this moment, Amanda prefers to work until age 70 regardless of her job position.
The data needed to evaluate this problem are outlined in Table 1. Salary information today is easy to obtain. More uncertain will be salaries in the future. The best that can be done is to make reasonable approximations of the future and know that the result has risk. Uncertainty shouldn’t prohibit a decision if best available information and reasonable assumptions about the future are guiding principles. For this vignette, the conceptual set-up is the takeaway. When the concept is implemented well on a spreadsheet, better information will yield a new answer quickly.
Amanda’s current position pays her $75,000 per year. A financial services position with an MBA will pay Amanda $110,000. The MBA “tuition” cost is the cost of a full-time MBA program today at the Cox School of Business at SMU. The cost to receive a graduate degree varies by reputation, geography, private or public and other variables and is generally well known. “Tuition” defined here is all the expenses of education including tuition, fees, books, supplies, and health insurance. Living expenses are not included because living expenses still go on whether the MBA is pursued or not. It is not a differentiating characteristic to the decision. The numbers that follow are based on salary growth rates and tuition cost increases approximately equivalent to the annual rate of inflation, 3% for Amanda.
The analysis of Amanda’s education decision is outlined in Table 2. Undergraduate salary, MBA salary and cost of an MBA are projected from Amanda’s current age through age 31. Assumed growth rates are contained in these projections. Amanda’s question of whether the nearly $129,000 cost of an MBA over two years is worth it can be addressed by looking at the salary differential once the MBA has been obtained over her working lifetime.
Amanda is a planner and wants to make a decision today. Table 3 adds a column to Table 2 that shows the cash flow differential for Amanda. The cash flow differential column displays those cash flows that will change if Amanda begins her MBA in two years. The view of the table offered here is truncated for space and shows years prior to retirement in addition to the first few years. As one can see, the differential between future salaries increases. While growth rates are the same, the baseline salary with an MBA is higher than without an MBA thus dollar amounts are higher.
What do the economics suggest? A casual look at Table 3 reveals differentials in the last few years of Amanda’s working life that are substantially higher than the near-term cost of an MBA. However, that isn’t too insightful because a $3.10 gallon of gas will cost Amanda about $12 by the time she retires. So, the economics need to be placed on present value terms. If the decision is a positive present value, then today’s decision is to go forward with the MBA in two years. A negative present value advises to stay the current course and don’t add an MBA.
Amanda’s answer is in Table 4. The net present value (NPV) of Amanda’s decision at a 4% annual discounting of all the future cash flows suggests that Amanda will benefit by nearly $1 million by pursuing her MBA, if, of course, assumptions hold. Amanda’s answer is clear.