2010-02-09

NPV of an MBA

Digg my article


Reposting an old post I had written on a shared ISB blog. Some of the readers of my blog are ISB aspirants. Thought, it may help them. Incidentally, this post got popular and got linked in Youthcurry and Pagalguy.

*****************************
 I have been saying this ad nauseam – the reasons to pursue an MBA program have to be ‘individual’. The reasons cannot be generic – what applies to somebody else need not apply to you. One of the many decisions to make before considering giving up a job to do an MBA program is financial. It would however be myopic and sometimes silly to take into account just financial aspect of the benefits of MBA. Life and Career are not straight lines and cannot be put to a linear regression to understand. The complexity of these requires that we understand and appreciate all the variables, if ever we can enumerate all of these variables. Once the variables have been broadly figured out, doing a cost-benefit analysis is pivotal. Many of the popular magazines and newspapers refer to the payback period as a measure to appreciate investment in an MBA program. But now that I have attended one class of Corporate Finance course, I can, with some confidence, say that payback period approach is flawed and does not capture the time value of money (thanks to my Prof. who used a similar example).

Calculating NPV of the investment is much better way of analyzing the decision. Of course, all math and analysis begin with assumptions. Here too we make some assumptions to be able to start.

I take an example of a person with following variables to explain how the NPV can be calculated

Age – 27
Present Salary – INR 500000
Age of retirement – 60 Years
Return on alternate investment opportunity, r – 10 %

First, let us calculate the Present Value of the income during the career time when MBA is not pursued. Let us call this PV (No MBA)

Assume, Expected growth rate of income without an MBA degree – 5%

C1= Current Salary; C1 (1+Gt) = salary during subsequent years; t = 1, 2….32; Gt=growth rate, which is 5 %

PV (No MBA) = C1+ C1 (1+G1) / (1+r) +…..C1 (1+G32) / (1+r)^32 = C(1+G) [ 1-(1+G)^32 / (1+r)^32] / [ r – G]

=> 500000 + 500000(1+0.05) / 1.1 +….+ 500000(1+0.05)/ (1.1)^32 = INR 9017000


Let us now calculate the Present Value of the income during the career when MBA is pursued. Let us call this PV (MBA)

Assume, Starting Salary after MBA, C2 – INR 800000; Expected growth rate of income, Gt – 7%; Retirement Age – 60 Years;

Cost of MBA at ISB = INR 1500000

PV (MBA) = -1500000 + C2 (1+G1) / (1+r)+…..+ C2(1+G31)/(1+r)^31 = -1500000 + 800000/(1.1) + 800000 (1+0.07) / (1.1)^2+………+ 800000 (1+ 0.07) / (1.1)^31 = INR 15380000

NPV of investment = PV (MBA) Less PV (No MBA) = INR 6368000

Given the assumptions, investment in ISB MBA program is an attractive proposition.
One may alter the assumptions (according to the respective circumstances and expectations) and calculate the NPV of the investment.

I close this with a caveat – the benefits of an MBA are far greater than financial and I think a simple NPV calculation cannot capture the essence of such benefits. But, an NPV calculation will let one put down what one’s expectations from MBA are. It is to be realized that from the financial angle MBA plans need to be treated as any other financial investment and need to be put to NPV test. We need to explain to our people – parents or spouse or anyone else – on why we think this investment is worth its money and time and why we think they should make some sacrifices today to see a better tomorrow. Through NPV calculation, convincing them becomes easier – provided the NPV turns out to be positive and reasonably attractive.

Post Scriptum:

-Seek pardon from readers with non-quant/fin background. But this is the only way to go about making a financial decision

- INR is Indian Rupees
*******************************
Sometimes, what you want to say is already said by you in past. Why recreate?*

PS:
-*this does not apply to "I Love You". This has to be said many times. Seeking reassurance is addiction.
-apologies for boring others.

4 comments:

abhay pratap said...

as we all know the value any employee will be effected by the gaining Or getting training from outside the organisation.If we talk about a simple graduate he will not reach that level as an Mba reaches after 5 yrs . The main thing is the initial investment which is high or may be very high in comparision to a simple graduate.
Improvement opportunities are stupendous with the course named MBA. By opting for this, you actually get to reach the crescendo of academic qualification plus professional training. The exposure to the job that you will be offered after completing an MBA is offered as internship on the completion of your theoretical exams.The professional field, or rather the job market, is always a place that demands something extra from the applicants. The world of business is becoming more competitive with every passing year, and so is the job market. To excel in academics is not enough for securing a good job but one also needs to have considerable experience on a field so that you can be regarded as an expert on the same.

thanks for this article this very different concept

thanx
Abhay pratap

itheabsolute said...

Thanks Abhay for your comments. Sure, job markets, careers, life...are not linear. good luck!

Amit said...

I am quite interesting in this topic hope you will elaborate more on it in future posts.
mba

MBA Dissertation said...

it's good to see this information in your post, i was looking the same but there was not any proper resource, thanx now i have the link which i was looking for my research.

MBA Dissertation Proposal

2010-02-09

NPV of an MBA

Digg my article


Reposting an old post I had written on a shared ISB blog. Some of the readers of my blog are ISB aspirants. Thought, it may help them. Incidentally, this post got popular and got linked in Youthcurry and Pagalguy.

*****************************
 I have been saying this ad nauseam – the reasons to pursue an MBA program have to be ‘individual’. The reasons cannot be generic – what applies to somebody else need not apply to you. One of the many decisions to make before considering giving up a job to do an MBA program is financial. It would however be myopic and sometimes silly to take into account just financial aspect of the benefits of MBA. Life and Career are not straight lines and cannot be put to a linear regression to understand. The complexity of these requires that we understand and appreciate all the variables, if ever we can enumerate all of these variables. Once the variables have been broadly figured out, doing a cost-benefit analysis is pivotal. Many of the popular magazines and newspapers refer to the payback period as a measure to appreciate investment in an MBA program. But now that I have attended one class of Corporate Finance course, I can, with some confidence, say that payback period approach is flawed and does not capture the time value of money (thanks to my Prof. who used a similar example).

Calculating NPV of the investment is much better way of analyzing the decision. Of course, all math and analysis begin with assumptions. Here too we make some assumptions to be able to start.

I take an example of a person with following variables to explain how the NPV can be calculated

Age – 27
Present Salary – INR 500000
Age of retirement – 60 Years
Return on alternate investment opportunity, r – 10 %

First, let us calculate the Present Value of the income during the career time when MBA is not pursued. Let us call this PV (No MBA)

Assume, Expected growth rate of income without an MBA degree – 5%

C1= Current Salary; C1 (1+Gt) = salary during subsequent years; t = 1, 2….32; Gt=growth rate, which is 5 %

PV (No MBA) = C1+ C1 (1+G1) / (1+r) +…..C1 (1+G32) / (1+r)^32 = C(1+G) [ 1-(1+G)^32 / (1+r)^32] / [ r – G]

=> 500000 + 500000(1+0.05) / 1.1 +….+ 500000(1+0.05)/ (1.1)^32 = INR 9017000


Let us now calculate the Present Value of the income during the career when MBA is pursued. Let us call this PV (MBA)

Assume, Starting Salary after MBA, C2 – INR 800000; Expected growth rate of income, Gt – 7%; Retirement Age – 60 Years;

Cost of MBA at ISB = INR 1500000

PV (MBA) = -1500000 + C2 (1+G1) / (1+r)+…..+ C2(1+G31)/(1+r)^31 = -1500000 + 800000/(1.1) + 800000 (1+0.07) / (1.1)^2+………+ 800000 (1+ 0.07) / (1.1)^31 = INR 15380000

NPV of investment = PV (MBA) Less PV (No MBA) = INR 6368000

Given the assumptions, investment in ISB MBA program is an attractive proposition.
One may alter the assumptions (according to the respective circumstances and expectations) and calculate the NPV of the investment.

I close this with a caveat – the benefits of an MBA are far greater than financial and I think a simple NPV calculation cannot capture the essence of such benefits. But, an NPV calculation will let one put down what one’s expectations from MBA are. It is to be realized that from the financial angle MBA plans need to be treated as any other financial investment and need to be put to NPV test. We need to explain to our people – parents or spouse or anyone else – on why we think this investment is worth its money and time and why we think they should make some sacrifices today to see a better tomorrow. Through NPV calculation, convincing them becomes easier – provided the NPV turns out to be positive and reasonably attractive.

Post Scriptum:

-Seek pardon from readers with non-quant/fin background. But this is the only way to go about making a financial decision

- INR is Indian Rupees
*******************************
Sometimes, what you want to say is already said by you in past. Why recreate?*

PS:
-*this does not apply to "I Love You". This has to be said many times. Seeking reassurance is addiction.
-apologies for boring others.

4 comments:

abhay pratap said...

as we all know the value any employee will be effected by the gaining Or getting training from outside the organisation.If we talk about a simple graduate he will not reach that level as an Mba reaches after 5 yrs . The main thing is the initial investment which is high or may be very high in comparision to a simple graduate.
Improvement opportunities are stupendous with the course named MBA. By opting for this, you actually get to reach the crescendo of academic qualification plus professional training. The exposure to the job that you will be offered after completing an MBA is offered as internship on the completion of your theoretical exams.The professional field, or rather the job market, is always a place that demands something extra from the applicants. The world of business is becoming more competitive with every passing year, and so is the job market. To excel in academics is not enough for securing a good job but one also needs to have considerable experience on a field so that you can be regarded as an expert on the same.

thanks for this article this very different concept

thanx
Abhay pratap

itheabsolute said...

Thanks Abhay for your comments. Sure, job markets, careers, life...are not linear. good luck!

Amit said...

I am quite interesting in this topic hope you will elaborate more on it in future posts.
mba

MBA Dissertation said...

it's good to see this information in your post, i was looking the same but there was not any proper resource, thanx now i have the link which i was looking for my research.

MBA Dissertation Proposal