Qin has just graduated from the Harvard with a BA in mathematics and must decide
ID: 2648374 • Letter: Q
Question
Qin has just graduated from the Harvard with a BA in mathematics and must decide whether to start working now or to get a Masters in Financial Engineering (MFE). In either case, he intends to retire 40 years from today. An MFE requires an expenditure/tuition of $40,000 per year for each of the next two years, and Qin will start working immediately after getting his MFE. Qin's discount rate for valuing cash flows is 5% per year. Assume that cash inflows occur at the end of the year, while the cash outflows (tuition payments) occur at the beginning of the year. If Qin goes to work now, he can expect a starting salary of $40,000, with a growth rate of 1%, thereafter. If Qin gets an MFE, his starting salary will be $50,000 and will grow at 2% thereafter. What is the net present value (NPV) of his decision if Qin decides to do an MFE? [Ignore taxes.]
a) 142668.
b) 788513.
c) 931182.
Explanation / Answer
Qin in order to do his MFE requires an expenditure/tuition of $40,000 per year for each of the next two years (i.e. starting of Year 0 and Year 1), and Qin will start working immediately after getting his MFE (i.e. will receive the Cash Inflows in terms of his salary i.e. $50000 from starting of third year with an annual increment of 2%).
i.e. NPV = - $40000 - $40000/(1+5%)^1 + $50000/(1+5%)^3 + $50000*(1+2%)/(1+5%)^4.............+ $50000 (1+2%)/(1+5%)^40
Answer: NPV $931,182