MBA Masterclass Making Investment Decisions

Kara Northcutt: Hello, everybody. Greetings, from -- I'm in the Chicagoland area here in the United States. It's great to see everybody from literally all over the world. We're thrilled to have you here tonight or today. My name is Kara Northcutt. I'm a Senior Director of Employer Engagement and Admissions here at Chicago Booth. And on behalf of the executive, full-time, evening and weekend MBA admissions teams, thrilled to welcome you to our inaugural masterclass Making Investment Decisions with Kathleen. So tonight you're gonna get to experience two really key components of the Chicago Approach to business education. One of them is of course our data-driven, evidence-based approach that really teaches you to ask the right questions, to think more analytically, think more strategically, which really prepares you and gives you the confidence to take on business challenges that you're dealing with today, tomorrow and 15, 20, 30 years down the road. It really is a timeless approach to analyzing problems and situations. And another key advantage of the Chicago Approach is our most supportive and collaborative community. So at Booth, you get to join a phenomenal group of students, alumni, administrators -- all of us that are really here for you to make sure you have and hope to have a great experience. You'll make personal friends, you'll make business connections. So it's really a big part of it is that community piece. And tonight you're gonna experience an integral part of that community in our faculty and teaching assistants. It's quick knowing the faculty, this same faculty teach across all MBA programs, whether you are more interested in full-time or one of the part-time options, be it executive, weekend, full-time or excuse me, evening. You're gonna be able to get that same quality, same rigor and same faculty that teach across the programs. So keep that in mind as you learn about the programs. And we're really excited again for you to experience those components of the Chicago Approach. So tonight we're gonna hear from Lev Slavin. He works at Chicago Booth as an Associate Director of Executive MBA Academic Support. Since graduating from Booth's full-time MBA in 2011, Lev has also served as a teaching assistant for several Booth courses, covering topics like economics, operations, finance, strategy, entrepreneurship, to name a few. So very, very grateful to have Lev join us this evening. And he obviously is a teaching assistant for Kathleen. And of course, finally, Kathleen also earned her MBA from Chicago Booth in 2003. She's an adjunct Associate Professor of Strategic Management, brings a wide array of experience as an educator and a practitioner into the classroom. Professional experience comes from the auditing and tax group at Ernst & Young; worked in forensic accounting and consulting for Chicago Partners; and of course has been with us at Booth for quite a while. We're very lucky to have her. At Booth, Kathleen holds a position of Senior Director of Academic Support for our Chicago, London and Hong Kong campuses, so specifically our executive MBA campuses. But she of course teaches across all of the programs

- - evening, weekend, full-time, executive -- and teaches courses under finance, accounting, strategic management. So with that, I will turn it over to Kathleen and we hope you enjoy the session. Thanks, Kathleen.

Kara: Thanks, Lev.

Kathleen Fitzgerald: OK. Thank you so much, Kara. And thanks to everyone for coming. I'm gonna go with, you can hear me unless you say you can't hear me. I hope everyone's doing well, coping well in these kind of tough times. I suppose we're getting used to being online. So tonight we're gonna do an example. We're gonna talk about making investment decisions. So at your work, how do you decide what investments to make or if you don't make them, how might you make them? And we thought that the example that would be kind of fun to do is you deciding whether you should fork out the cash, right, to end time to do an MBA. All right? So that's the plan. If you wanna know who's here, everyone was kind of putting up where they came from, so thanks very much for that. But this is a selection of all of you that registered and where you said you were dialing in from. If anyone is geographically challenged, you can go back and forth and figure out where everyone is. What else about you all? So this event is for full-time, part-time, evening, weekend, and EMBA. So there's people on here with a wide range of experience. We even have a couple people didn't come up blue with 27 to 30 years of experience. You can see that most of you have about three to six years of experience. Most of you are interested in the full-time MBA but a lot in the executive, the evening and the weekend, and a few PhD students. Some of you are MBA only and some of you are interested in some of these joint degrees that are possible. I'm not sure that all are possible here but you definitely can take classes in these other departments. I know we've got the JD MBA now, I think that just started. So what are we gonna do? So we're gonna talk about a few things and I apologize for it if I'm writing down, just that my iPad is below my camera. So we're gonna talk a little bit in general about what firms do. What's the goal of the firm? What types of things do we value? How do we estimate value? How do we decide whether to proceed with an investment and then do our investing in an MBA? Sound good? So let's get started. I mean, when we think about what firms do I like to think of it as firms doing four main activities: strategy, investing, financing and operating activities. And in fact, when you come to Booth your MBA program will be set up kind of in this way. So you'll have different types of strategy classes: so, competitive strategy, corporate strategy, marketing strategy, lots of different strategies, there's the basics. And then you can take a deeper dive into different types of strategy classes. On the investing side, you know, once your company has come up with your strategy, what product are we doing? What product market are we in? What products do we have? What industry are we in? What problem are we solving? Why are we solving it? What's our competitive advantage? Right? All of these types of questions, You know, you're gonna have to make investments. So the investing is saying, what investments do we need to make to put our strategy in place? Financing is saying, how do we pay for those things? So you'll have lots of classes here in corporate finance and investments that really help you answer these types of questions. And then finally, we come up with our strategy. We need to make these investments, put them in play. We're gonna pay for them this way or that way -- either through the earnings of the firm, issue debt, issue equity, different from ways of financing and you know, how much financing should be from debt and equity. You'll talk about all of these theories. And then the operating side is really running the business. So lots of opportunities to learn how to run the business from HR, actually, to operations, to go-to-market strategies, these types of things. Before you even get to these classes, of course, you need some foundations. So you will have things like financial accounting, microeconomics and stats, because these are really the language of business, right? You need to know these core foundations for you to be able to do these other classes. And then on top of that, you will have classes in management... lots of management classes, these are up to you. Decisions, how to make decisions. People -- all of these types of classes. And then you will wrap it up with, you know, you gotta have some type of class in the business environment. So while you don't really control what GDP is or inflation rates or interest rates in where you're working, you should be able to operate within any type of environment: whether it's a boom, recession, pandemic, right? All of these types of things. So really what you're getting here, when you do an MBA, which is a Master's, obviously, in Business Administration, you should be able to run a business. And this is what businesses do. So these are kind of the main things. The way that it will be set up with your curriculum, you'll have one class -- the only required class we have here, the one you must take, is leadership. So this is your chance to improve your leadership skills, competencies -- think about, you know, different ways of developing yourselves to become future leaders. Like I said, you'll have one from the different foundations and then you'll do one from the following seven categories, depending on what program you're in. So if you're in the executive MBA, you do one from every; if you're in the full-time evening, weekend, you choose six. Most people probably choose seven. And then you fill in your schedule with things that interest you, electives. So if you wanna be more about people, or you wanna know more about ethics, or you want CSR, or any of these types of things, those are the classes that you would do your electives in. So it's a very robust curriculum, and I think it very much mimics what we do in the real world, right? So enough about that. Let's think about, well, firms do these things, but why? So there's lots of different reasons people put forward for, "What's the goal of the firm?" And if you think you know what the goal of the firm is, you can always put anything in the chat. I'm happy to see what you put in the chat. A lot of you probably had gone through this. But what I'm gonna say is for today, which is a legitimate goal, I'm gonna say that our goal is to maximize current shareholder value. Exactly, exactly. Exactly what you guys are writing. It's not the only thing, right? I mean, especially lately. I don't know if you've seen a lot in the news and seen some of our events but some people might say, "What about stakeholder value?" What's wrong with that model? That's another model, right? That's exactly right. So for today, we're gonna say "maximize current shareholder value." But if you come to the session in November, Raghuram Rajan, he will do a talk on "what should be the goal of the firm?" And down here, we'll give you these slides. We just had a big online conference where we talked about this question in great detail. So just to give you a preview: Is shareholder value maximization evil? What should be the business of business, shareholders and stakeholders? These are the kind of things that we wrestle with all the time at a place like the University of Chicago. So I recommend going and checking out some of these videos if you can. But for now, for tonight, we can't do everything. We're gonna say, maximize shareholder value. How do we measure shareholder value? Like, how would you measure that? If you had to come up with a measurement? Yeah. So I would say something -- yes, these are all ways to get there. That's exactly right. What we can say is, maybe market cap. Have you heard of market cap? Market capitalization? Market capitalization is -- we will share all the links after, I promise -- the number of shares times the price per share. So if you look up, like on your Google market cap of Starbucks, you'll see how many billions of dollars it is. Market cap of Apple or Google, any of these things. So when you think about that, the shares portion is a little bit arbitrary. Because when you -- There's no set number of shares that a firm has to have. A firm is like a pie, right? You could have two shares, you could have four shares, you could have six, you could have eight. It really doesn't matter. That's how we can split things up. Lev, that's okay, no problem. We can just split that pie as many ways as we want. So I would say that the shares is not as important as the price per share. And that's really what we wanna think about is, how do we come up with the price? And just very easily, I'm gonna say it's the present value of the expected future cash flows that are attributed to the shareholders. OK? So that's one way to come up with the price per share. And we're gonna talk about this today in another context; I don't wanna get too deep into it. But when we think about, over here, when we said, "What do firms do?" you might start thinking about, "Hey, how do what we do affect these things?" Most of what you do is probably gonna affect the numerator, which is the free cash flows. Because this is about revenues, minus expenses, minus taxes, all of these types of things. Coming up with these free cash flows. What cash do we need to make investments? So you'll learn, all of those classes are gonna help you figure that out. Down here, this is going to reflect the risk of those cash flows. So this is just kind of like a big picture. I feel like we need a goal of why firms do what they do. So what do we value? Besides valuing those shares, if you are the shareholders, say you're from the perspective of a firm. And I think it's easy just to say we value assets. And another word for assets is investments. Another term for assets, if you're an accountant, is future benefits. I'm trying to like read and drink at the same time. Alright. So real assets, what are real assets? Assets used to produce goods and services. So a factory is a real asset; land is a real asset; human capital. What's human capital? You can write that in the chat. What would be an example of human capital? Yeah. Employees, know-how, your own human capital, talent. This could be things like experience. This can be skills. This can be ethics. This can be knowledge, talent, all these things that you're writing. All of these things are human capital. And when you come to, and you invest in, an advanced degree or any education, what you're really investing is in your human capital, your personal human capital. It's probably -- you know, if you think about your portfolio of as assets, it's probably the biggest one that you have, is mostly your human capital. I mean, a lot of you might have stocks and bonds and other things, businesses, but human capital is a large portion of your asset. We also have other things that we value. We value claims on assets. So normally debt, equity and derivatives. So when you take in an investments class, you will be learning about how to value all of those things. But let's take a big picture, right? How are we gonna estimate value? And so, I think the most intuitive way is to think about a discounted cash flow method. So say that I have an apartment building and I think that I'm gonna get, you know, 800 units of whatever for maybe 20 years. I'll just say 20. And then I'm gonna sell that thing for $10 million. I mean, these don't really make sense. Let's say $80,000, who knows? Just trust that the numbers make not a lot of sense. But the idea is, if I'm gonna buy this building what would I pay for it today? If those are what I think the rents are gonna be in the future and what I can sell that building for in the future, yeah, I wanna -- what I wanna do is I wanna bring these all back to today, add them up, and then that will be my value. So that's a discounted cash flow way of doing it. So what these are, these are I'm gonna say are cash flows. So this will be after we've already accounted for depreciation and everything else, right? That's kind of like our net profit on that. And maybe it'll be higher. Maybe it -- yeah, let's have a better building. Let's make it $800,000. Why not? It's fantasy anyway. Oh, that didn't work. Look what happened. My eraser is too blunt ... $800,000, $800, you get the picture I think. So we're gonna rent that thing out for a while and we're gonna sell it for a $10 million Maybe we're gonna sell it for a $100 million now. What a waste of time, right? Just adding zeros. But that's the whole idea. How would we do that? Like if I went to you and I said, "I need to borrow some money. I promise I'll pay you a $100,000, $10,000 a year from now." And you say, "OK, but I'm gonna charge you 10 percent interest," What would he lend me or she lend me today, if I can pay back $10,000 a year from now? Something like $9,091 or something, right? So the $9,091 is the present value of $10,000 in the future. If I put $9,091 in the bank today and I earn 10 percent, I would have $10,000 a year from now. That's the idea and that's a way to value any assets. How do I value a firm? Well, what are the cash flows gonna be generated by that firm? So it's actually not that bad. Present value is the future value brought back in time. OK? So does everyone kind of understand the concept of bringing money back in time to today? It's the opposite of when we put money in the bank and earn it. Can you just say, "Yeah, I get it." All right, cool! So the time value of money steps, students don't really have a problem with. But when we wanna value something, we have three main questions, then. Because we said value is the sum of -- you'll have to get used to notation when you come here -- it's our free cash flows, expected free cash flows brought back in time. So there's really only three things here. One is cash flows, two is math, and three is our cost of capital. Those are what we need to value any asset if we wanna use discounted cash flows. So the first question that we just talked about is, how do we calculate the present value? We just bring it back in time. It's a simple calculation in Excel, in your calculator, you can do it by hand. Someone just did it in his head or her head. I didn't catch the name. And it's the idea of just bringing money back in time. And you know, what am I going to pay for that today? So for example: If I told you, if we buy a share of my stock and you'd say, "Well, what am I gonna get?" And I'll say, "Well, I'm gonna give you $2 a year forever." And I told you that the cost of capital is 10 percent. This is a perpetuity, that's why I'm not adding one. You would say, "Oh, I'll pay you $20 a share." So you'll learn some of these basic math tools either before you get here or when you get here. So I think the present value is pretty simple. The future cash flows. What do we put into the numerator? This is another question. Like, how do we come up with those? Well, it depends on what you're trying to value. If you're trying to value a firm, you might look at what happened in the past. Maybe if it's a new firm. you might look at, what did other companies do. You'd probably use some type of ratio analysis. You might build a financial model. You might build a demand model. If it's a bond, you might just look at what are your contracted amounts, right? You just have to find some tangible way of figuring out: "I gotta come up with an estimate of these cash flows." Most of us would just build some type of financial model. These are what we think the revenues will be. These are what we think the expenses will be. Maybe this is our depreciation. This is our EBIT. We take out our tax. We come up with, you know, an EBIT after tax. We add the depreciation back, because it wasn't a cash flow, but could give us a tax shield. We subtract any capital expenditures we need to make. We subtract any working capital that we need. So purchasing inventory, accounts receivable, accounts payable. And you could come up with your free cash flows that way. There's lots of different ways that you would come up with free cash flows and it really does depend on what you're trying to value. So if you're trying to value a project, you would look at incremental cash flows. Assumptions are the key to everything, it's so true. Garbage in garbage out, Pablo. So we'd look at incremental cash flows, right? What are the cash flows we would have, positive or negative, that we wouldn't have if we didn't do the project? For example, your MBA. When we're thinking about later, about valuing your MBA, you're gonna think about, "What are my cash inflows and outflows that I expect to have with the MBA that I wouldn't have, if I didn't do the MBA?" A firm might think about, "Well, what if I invest in this new inventory system? What are gonna be my cash savings from buying this inventory system that helps me manage my supply chain better?" Keep track of things that are happening. If I wanna value a firm, then I'm going to use what I put here. Free cash flows to the unleveraged firm. Yes, Jose, you sure can. Where are we? Project. So if I wanna use a firm, I'm gonna value the cash flows from the firm. If I just value the equity of the firm, then I'm gonna look at the cash flows that are left over for the equity after I have taken care of my debt holders, for example. And if I wanna value the debt, I'll look at the cash flows for debt. This is normally some type of coupon payment. You may think of it as interest rate and principal. All that really matters is when we think of value being the sum of expected cash flows over time, you know, you can do the math. The cash flows depend on what you're trying to value and where you're gonna get this information again depends on what your experience has been, whether you've been around for a while, there's a comparable firm. OK? So two of the three things we have. The third thing is: How do we know what the denominator is? So if we think of this, expected cash flows brought back in time, the real question is, what is this "r"? Like I just told you, you were gonna charge me 10 percent, so you were only gonna lend me $9,091 if I pay you back $10,000. But we have to think about, what should we bring those money back, those cash flows back in time at? And the most important thing is that this "r," it must reflect the risk of the cash flows. That's right. So normally what we do is some type of risk-free rate, because you should at least pay me a risk-free rate, plus a risk premium depending on how risky those cash flows are. All right? So let's think about that. We're gonna call it the opportunity cost of capital, OK, because what that's going to represent is what you could have earned on an equally risky investment over the same time horizon. So if Jason has a project and he's paying 12 percent and I have a project that's as equally as risky as Jason's and it's over the same time horizon, I need to pay 12 percent for you to invest in it because otherwise you're just gonna invest in Jason's. So this is about, called the opportunity cost of capital. Conceptually, that's what it is. But what should it be? Right? It should not be what -- So let's say I wanna invest in a project and I go to the bank, and I borrow money at 5 percent. That's not what should go in the denominator. What should go in the denominator is the risk of the cash flows in the numerator. So it's the risk of the investment. It depends on where you invest the cash, not where you raise it. Because what you're looking for is the risk of those cash flows, not the risk that the supplier of the cash has because he or she invested money in you. It's a very different concept. So what we always wanna make sure is that what we put in the denominator reflects how risky the cash flows are in enumerator, right? So if you were maybe to think of maybe like, down here, you know, we've got the risk free rate. Out here, we might have hedge funds. And we might have some venture capital, and we might have emerging markets. Emerging Markets. If we were to think about something like expected return and risk, down here. A lot of these are, as we move out to this what do we call it? North, Northeast corner? Northeast corner, yep. North, south, east, west, right? Those are getting riskier and requiring a higher expected return. Because you're taking on more risk. If you were to think about it from a statistics perspective, you might think of something that had a distribution much wider than something like this. So you will learn to connect all of these things together. But conceptually what I hope you'll get from this now is that the numerator -- the cash flows -- must be discounted at a risk-appropriate rate. So it's really easy to say, "Oh yeah, just pick the 'r' that reflects the risk." But how do you find the "r"? You need a model. So one model that we could use -- and there's lots of different models -- the only model I'm gonna talk about tonight is something called the capital asset pricing model. Has anyone heard of that? I'm sure some of you have. Some of you probably work with it. This model is pretty simple. This model says, basically what someone wrote in the chat before. If you want me to invest in something, you need to at least pay me the risk-free rate. Plus, you need to pay me a premium on top of that. And that risk premium should reflect the risk of this particular investment. So in the formula, it looks like this. So this is the risk-free rate and this is the risk premium. And as you can see the risk premium, the beta, that's gonna reflect the systematic risk of investment "I." OK? So whatever that investment is: debt, equity, a firm, doesn't really matter. And that is times the market risk premium. And you can think of the market risk premium as, it's E of RM minus RF, by the way. But the average risk premium that you would require to invest, let's say, in an index that captured the difference between a market index over what the risk-free rate is. A lot of people will use the S&P 500. That's not exactly representative of the market because, you know, there's larger firms in there, but you would use the market risk premium. That depends on what you want. You could also use, I don't know if you've heard of Professor Fama, I'm sure you have. I had him, by the way. This is a single-factor model; he might use a multifactor model where you don't just care about the market risk premium but you might add a risk premium for being a small firm or a risk premium for having ... being more distressed to like, yeah, that's exactly it. That's a multifactor model. So it's a little bit richer. If you wanna learn about those things before you come here, there's a great paper by Fama, 1992, that just started this: Fama/French "The Cross-Section of Expected Stock Returns." And that's where he actually introduced SMB and HML: mmall minus big and high book-to-market minus low book-to-market, which capture different risk factors. But we digress. For now, for today, we're using something very simple, OK? Which is just the capital asset pricing model. So we said we needed three things. We needed math, no problem. All of you can do the math. We needed cash flows. Probably one of the hardest parts, because you need to come up with models of where you think these cash flows are gonna be. And then, of course, the discount rate. You're gonna have to come up with an estimate of the discount rate: It's not always easy to do. But you can, and you'll do sensitivity analysis and scenario analysis, and you'll ballpark it. But once you do it, how do you make a decision? So what we're gonna focus on now, let's focus on a project. So we said we could do a firm, we can do equity, we could do debt, but we're gonna make an investment decision on a project. So how are you gonna decide, right? We know how to do this math. We know how to bring money back in time. How do you decide whether to make an investment or not? So we call this capital budgeting. We and everyone else. You have a certain amount of capital. How do you decide how to budget it? Should I take this is project or not? So one thing you can do is gut feeling. Like, "This feels like a good project: I'm doing it." While it's nice to feel good about the things that you do, I'm not sure it's the most analytical way

- - in fact, I'm sure it's not -- of deciding whether to take a project. So that's probably not my first choice. Payback. Some people like to use payback. So if I made an investment and I'm gonna return $$250 in three years and it's gonna cost me $500 today, my payback would be how long before I get my money back. If I were to put in $500 and I get $250 a year, yeah, I get the money back in two years. OK. That's great. But even from this small 10 or 15 minutes we've been talking about it, we know that $250 from the future is not worth $250 today. It's worth something less than $250. It's worth $250 over one plus "r." And the 250 two years from now is $250 over one plus r-squared. And the $250 three years from now, we gotta bring it back three years. So the problem with payback is it doesn't discount those cash flows. Yeah. So unless we were at zero interest rates,

- - I guess, Eugene, we're almost there -- we can just add up the cash flows, but we're not. It's probably not the best way of doing it. So why do people use it? They use it because, say you're a small firm. Most likely you're gonna get your money from borrowing it. You actually do have to pay the money back to the bank at a certain point in time. So if your loan is for two years and you don't think you're gonna get your cash back in two years, even if it's a good project -- if there's some reason that you're cash constrained -- you probably can't do the project. So I wouldn't say it's a substitute for some of these more, some of these better ones, which are five and six. But I do understand why people do it. Some people, instead of doing payback, do discounted payback; that's an improvement. Some people use an accounting rate of return. I don't recommend an accounting rate of return. That would be something like ROA, ROIC, things using accounting numbers. The problem with accounting numbers is there's a lot of assumptions in there and there's a lot of non-cash things in there. So those are actually not the best way. So the two best ways are internal rate of return and net present value. Internal rate of return just says, what is the "r" that makes the present value of these investments equal to these cash flows, equal to $500? So if I just -- do I have my phone? Let's see if I have my phone. Oh, I have my calculator. So I can say, "All right. If $500 is the present value and I'm making $250 in payment

- - no future value, three "n"-- then it says that my rate of return is 23 percent, 23.38." So what you would do is you would say, "Okay, 23.38 is what I'm earning on this investment. My cost of capital that I figured out using the CAPM or some other model is 15 percet. I should definitely do this project." That's like, if you go borrow are money for your MBA at 5 percent and you decide to invest it in the market, take your chances. Right? I'm not recommending that, I'm just using that as an example. So that's 23.38 percent. That's IRR. NPV says, "Well, let's take the present value of the inflows and subtract the present value of the outflows." And so if my cost of capital was indeed 15 percent, what I would do is I would bring these back: I would be like, $250 over 1.15, plus $250 over 1.15 squared and $250 over 1.15 cubed. I would add them all up and subtract $500. So if I do that, 15 interest, my NPV is $571. I'm not expecting you to do these calculations in an intro class. I'm just showing you that it's $571, which of course I would expect it's positive because I had, I was earning more than it cost me to get the funds using opportunity cost of capital. Is that clear to you? Can you let me know if this makes sense? Are you following? Yeah. OK, cool. I'm glad it makes sense. So what's kind of the big picture if we were to bring it all together? If we thought about what the firms do -- and let's just think about strategy, investing, financing and operations -- so you would be learning about these. You would be running a company, you'd have all these activities, you would look and see, "Where do I see the effects of these activities in the balance sheet, in the income statement, in the statement of cash flows?' Then you would -- Perfect. You would analyze them. So you would do some financial statement analysis. You would look at profitability. You would look at things like risk. You would look at growth. You would take those -- oh, NPV is 71. Yeah. Present value. Look, that's the beauty of a virtual pen. There we go; 71, thank you very much. You would do the FSA. Then what you would do is you would forecast financial statements. Once you forecast financial statements, you use the tools that you learned at school, forecast free cash flows. Then you would estimate your opportunity cost of capital. You would value the firm. You could subtract the value of the debt. You would get the value of the equity. You would divide by the number of shares, and you would get the price, right? Per share. So this is kind of like a big picture of thinking about how, where price comes from. And, you know, Every step along the way is you guys: making decisions, applying what you've learned, all of these types of things. And yeah, you can do the same thing with private firms, estimating the cost of capital. You'll have to find some comparable firms, to help you come up with that. But you see how the big picture goes? And you just think about, you know, if you're in an MBA program, you've got your prep and then you're learning and you're taking all these different classes on what's interesting to you. So I thought it would be fun to see,,, Let's use this example, this kind of methodology, to think about a project that you're investing in, which is an MBA -- which you may be investing in. Some of you might be thinking, "Do I want an MBA? Do I want a master's degree? Do I want graduate school at all? Would I rather just take my money and put it somewhere else? Is it worth it if I have to borrow this money?" But when you are deciding, we say firms maximize shareholder value, stakeholder value, depending on your beliefs, what would you be maximizing? Yeah, human capital I would say is your asset. What we kind of say, it's a little corny but what do people maximize? Utility, right? What's utility? For those of you that took micro. If someone wants to maximize their utility, what's another word for utility? It's like happiness. Yeah. Satisfaction. You wanna lead a good life, right? How to live a good life; we have a class here about that. So maximize your utility. I don't know what's in your utility function. There could be a lot of things; it could be money. It could be friends. It could be travel. It could be doing good, doing well, doing good -- doing nice things for people. All of you have different things that you would put into your utility function. Now this example, I wanna say, it's gonna be a numerical example but I am not in any way trying to say that the decision to do a graduate degree is only about money. It's just that it's easy to put money into a spreadsheet and it's harder to put these other things. So these are also factors that you would think about. But I just can't put it in my model so clearly. All right? So you're trying to think about maximizing your happiness in life. Your asset, I would say, is your human capital. That would be an example. You just wanna be fulfilled. And what do you have to consider, right? So think of yourself as a business but now the business is you. It's the business of you. And when you're thinking about whether to do an MBA, there's certain things that you probably are gonna consider. You need to think about those. You need to think about what's your cost of capital. And then you have to think about how to make your decision overall. So those are three, I think pretty big questions that are not unlike the questions that businesses think about when they're thinking about making a different type of investment. So we asked you: "What are you considering when making your investment?" Thanks to Lev. Lev put all these graphs together for us. Perfect job. Appreciate it very much, they're beautiful. So these were your responses, we coded them, Lev and Mallory,

- - both two people that I work with; you haven't met Mallory, she's not here tonight -- went through all of your responses, picked out the key terms. It's a very Chicago Booth kind of thing to do -- let's dig into the data -- and coded them into these different classifications. So when you were considering, most of you put value: The highest amount of hits was on value. Faculty and curriculum, meeting people, the network, career, fit, culture, brand, location, resources, international exposure, and then some things that we couldn't classify. They just didn't clearly. So if you want to know... Were you considering value? These were our key words. So we looked for keywords in your responses. We put all of these in the appendix so that you could look through them. And then we used, Lev used Excel to then put them into buckets. So value really does depend. We just picked words that we thought went with value. Is that clear? Make sense? Seemed like a very logical way of doing it. So these are the things that you said you were considering. And one of the things that you might be trying to measure since we are doing a financial model, is to think about what exactly are we trying to model? And what we're trying to model is, if this were "no MBA," for example, and this were "with MBA" -- I know the legend's below but I'm just writing it here -- How big is this earnings gap? Remember, I'm only talking about cash flows right now. I'm not talking about all of the other things that would affect your decision such as network, career, fit, culture, brand, wanting to meet new people, all of these things. We had to break it down into some kind of numerical thing to do a net present value. So we're trying to figure out, how big is this gap? Does it exist? Because, remember, there's another gap here. And that gap here is when you have your tuition and you have your lost wages. Right? These types of things. It's always, is it worth it? So what we did was we built a little financial model. We made this situation: Let's say you're 30 years old. Some of you are younger, some of you are older; it's just an example. Current salary of $80,000. We came up with these numbers: expected growth and salary without an MBA or with an MBA, and when you expect to retire -- because remember you're gonna live a long time and you'll love your job, so you wanna work for a long time. These are clearly person-specific. And they're industry specific. It depends on the business cycle and where we are. Some things are more risky than others. So what I wanna do is I wanna show you what we did. We are going to -- well actually, before I even go there, what are some of the cash flows that you would need to consider? So now just focus on cash flows. If you were doing the MBA, if you were making this decision and I assume you are, it doesn't have to be an MBA. It can be a law degree, medical degree, it can be nothing. Tuition, for sure. Cost of living. When we say cost of living, though, remember it's the incremental cost of living. It's like, you have to live anyway. So what's the additional living from being in Chicago maybe versus being in São Paulo? Might even be cheaper. So we came up with a list that looks just like what your list looks like: tuition, travel and expense, lost salary, comp, growth and comp, number of years until retirement -- all of these things would go into your financial model. So that's what we're gonna look at. So this is a simple model. We're just doing it to illustrate the things that we're talking about tonight. It's not the only factor in making your decision. We put it into a box. You should be able to... Lev, could you put that in the chat? In case someone... I don't know how to lock it in the chat. Did you put it in there? I don't see it.

Lev Slavin: Oh sorry, gotta find it first. One sec.

Kathleen: OK: He's gonna put it in the chat so don't write anything in the chat for a while so that Lev can put it in there and then you guys can link to it. In the meanwhile, I will open it. We had fun doing this. I think we had fun. There you go, there's the link. So this is something for you to play around with. If you can't see it, there is a way to zoom in on your Zoom. OK? I will try to make it bigger. And again, this is really individual-specific. So we're gonna say that you're 30 years old. You're gonna retire at 65 -- put in any number that you want at home. For those of you that are in the full-time program or evening, weekend, it's probably two years. Oh, did I not share? I didn't share properly. Thank you for letting me know right away. There we go, you see now? OK. Sorry for that. I was so excited, I didn't even share. All right. So we've got your current age, your retirement age; you can put anything in the blue, just change it. The number of years in the program: You know, if you're doing part-time or evening and you maybe wanna do it over three years. Weekends usually takes a little bit longer. You're gonna have to put in the cost of capital. Now you'll learn a lot more about this in your MBA program and in your finance classes. And always ask if you're a corporate finance professor, "What cost of capital should I use for my MBA?" For me I put in 5 percent, it's probably a little low. It does depend on the person. Your cash flows depend a lot on your chosen profession and your change. So say you're a very simple example. If you are a real estate broker, versus an accountant. An accountant is probably gonna have pretty steady cash flows, pretty secure job. Maybe their cost of capital is not -- those cash flows aren't as risky as like a real estate person that has very bulky cash flows. Or you might be in an industry that is more risky than others in terms of cash flows. You may depend more on your bonus. I don't know how volatile your cash flows are. So you will wanna think about these things. One of the things about an MBA is, you know, what you're acquiring here are general skills that can be applied in different businesses. And like Kara talked about earlier, about how we care about data and tools and models -- because these are things that can be applied across many different industries and many different professions. So you're developing a lot of general skills here. That's why you're required to take certain classes from certain buckets, even though you can go for depth or breadth with your electives. So we won't solve the problem of what the cost of capital will be but we will have fun moving it around. These numbers are made up. If you're taking the Executive MBA, the tuition is not $75,000 and $65,000. If you are doing it over three years because you're doing the weekend program, you would spread these things out. So these are really individual-specific, but let's just say the tuition was $75,000 and $60,000. Incremental travel and expense, something that you wouldn't have had if you weren't in the MBA, we just put for $10,000. Some of you might work while you're in the MBA in which case you should put more, a higher salary. Some of you are in full-time and will do it. An internship, so you will still have some cash coming in. You can put in your income growth, you can put in your effective tax rate. Depends on the country, depends on how much cash you're making. We didn't think your effective tax rate would be that high if you were in the MBA and, you know, just doing an internship. And so if you put all those numbers in, you can see from the graph... Here we go. Kinda shows you what the incremental cash flows will be over time. Shows you what the gap would look like in the cash flows. It gives a payback of 10 years, a discounted payback of 12 years, an NPV of 774, saying you're gonna earn 18 percent on this. Now I think we kinda lowballed things because I didn't wanna come off as saying, "Oh yeah, you should definitely come to Booth because you got a 50 percent IRR." I want you to decide what this is gonna be, right? Do your research. Go look at the Business Week, Financial Times; talk to career services at the schools that you're looking at. Try to figure out, what do people really make? If they were gonna make $150,000 when you graduate. Well, $150 won't do it. Why won't it let me put it $150? Oh, it's me. It's user error. You know, what happens if after the MBA you really think that you'll be growing at 7 percent a year? And remember, this is a super simple model and this is per probably not how your career progression is gonna go. You're probably gonna have a bunch of steps in here. As you move to a new job you're gonna get a pop in pay, these types of things. This is really in there for you to just kinda understand the idea of payback, NPV and IRR. Does this make sense to you? Do you think it's kind of fun to play with? Yeah. You should definitely put your last income in there. Yeah. And where is our last income? Where did we decide to put that, Lev? You could just add.

Lev: It's the... It's the flip-side of the incomes are in the MBA because you're making it lower

Kathleen: Yeah. than you would've had otherwise.

Kathleen: So you could just make that negative. Yeah. Thank you, Lev.

Lev: I don't think that will let you put a negative, unfortunately. Sorry.

Kathleen: Well, we can switch it so that it does. You could also just add it to travel and expense or something like that. But we'll fix it, in the box. Let me see if I can make mine $10,000.

Lev: I mean, you can't have negative income, though. You lost income, so your income is zero.

Kathleen: I know, but it's still opportunity cost. It's almost like a cost of coming. Yeah. So you could do tuition and lost income, something like that. Yeah, negative won't work. No, we didn't consider your financing. because we figured that was separate. We wouldn't actually know what everyone's financing was. But what we'll do is we'll give it a little upgrade, that won't take us very long. And you can just take it from there. These are the actual calculations, OK? Pre-MBA preparation, some of you it's already -- for some of you that might already be sunk, like if you already did it. But if you're planning on taking GMAT classes and things like that. So it's really, I think, a lot of fun to look at. And you could just put in those. But I really wanna make sure you understand payback, NPV and IRR, right? You feel good about it? You'll learn a lot more when you get here. It's just a teaser. OK. And you can always email us with questions. I wanna go back to the other deck. Because I know I'm running out of, I'm hitting the time limit. I always do. OK. So that was our Excel model. You can see this now. There are other reasons. These were the reasons why you wanted to do an MBA. The other graph that we showed was, what are you considering when making your decision? This was why you said you might wanna do an MBA. So, you know, it wasn't all about the money, right? It was about knowledge. It was about skills. It was about career growth, switching careers, personal growth and leadership, meeting a network, learning about entrepreneurship, making an impact. So while NPV and IRR and payback are kinda fun to think about a financial problem, I do think it's quite important... I'm reading a thing at the same time. ...to consider these things as well. So Jonathan, yeah. We will look at that. So this makes sense. It's just not about -- no one put, "All I care about is the money." People cared about other things as well. We just were using that example to make a point. Some of the written things on why people wanted to do it: increase your earnings power. You can read these on your own. We'll post this for you. But all of these type of things, I think should be very much considered when you wanna do an MBA. So that's kinda the end of the formal presentation. I just wanna show you what's in the appendix. So for every one of these questions, like I said, we showed you our coding. So you can kind of see what other people said. These were some of the things that you hoped to get out of the session. This was just more for us. I guess I didn't really need it but I left it anyway because you answered it. So I didn't want you to think we didn't do anything with your data. This other appendix is just saying -- remember we were talking about strategy, investing, financing, and operating -- these are some of the questions that you might ask yourself. So thank you very much for your attention. I'm sorry that it went so quickly, but do you have questions? Do you have some questions for us now? Can you put them in the Q&A so I don't have to follow two things? Or it doesn't really matter. I'm really glad that you came. I wish you a lot of luck with your decision. I mean, I did it. I loved it. I think... I don't regret it at all. So: How would I adjust the model? Thank you very much for coming.

Kara: Kathleen, if you look through the Q&A there are quite a few questions. If you wanna scroll through some of them.

Kathleen: Yeah, I'll scroll through this.

Kara: Thank you.

Kathleen: Well Manu, the selection bias, you are gonna do that on your own. So you decide what inputs go into that model. Laura? Yes. You are correct. Signing bonus. Yep. That could be a big pop in the first year. The video link? Yes we can share that as well. Lev, do you mind putting it, can you put that in the... At the end, we'll put the video link in the chat, 'cause people are still writing in the chat.

Kara: Yeah and we'll figure out follow-up with the recording, everything to everyone online. We'll make sure we get everything in the next couple days.

Kathleen: OK, that sounds great. And then, how do you account for the change in standard of living? Well in this particular example, it's pretty simple. So you would just probably change it. You can only put it in your cash flows from income. So it's just, it's not capturing that. If you look at the third tab, there are some other things you would want to consider. You can definitely use this for evening and Executive MBA. Just put your current income in the "during MBA" tab. OK? Oh, that's just an estimate, Salman. It could have been $1,000, it could have been zero. But Joseph answered you. You will have to do your own debt in that model. The difficulty applying it into the MBA decision? I don't think it's very difficult to apply. It's just a very blunt tool, right? 'Cause it's not as fine as one might want it to be, to capture the different step increases, changes and those types of things. Pablo, salary stuff? Yeah, I think career services has all that information. You should talk to career services. I don't know the answer but that's where I would go.

Kara: I'll post a link to the employment report in the chat right now.

Kathleen: Oh, OK. So the employment report is going in the chat. I don't know anyone else that has a model like this, Justus. If you mean for like an MBA or graduate degree, we've not seen one but you could try to use a business one, I think. I don't think you should use payback, Ajay. I mean, if it's more than 15 years... You mean for the MBA or in general? FIfteen years is a long time to make back the money. I would definitely use NPV or IRR because they really are -- IRR, they're really getting at how much value is added. So how do firms value human capital? Yeah. I mean, they have a whole HR -- and in fact we have a class here on HR where you think about talent development. So anytime your company is putting you through a program, they're definitely going to improve the human capital of the company. For firms, I don't think big firms are using payback. They're really using NPV or IRR. So assessing the opportunity cost to capital, you really need to think about how risky you are. If you think you're as risky as the overall market, then use like an average market rate. If you think for some reason your cash flows are not risky -- you're in a government job, you're pretty much locked in -- then I would use a lower cost of capital. If you have a highly fluctuating income, you can always try to build a model like that that just changes your salary every few years. Something like that. The opportunity cost to capital. I think I would just do a range. I would go from a low of seven to a high of 10 or 12. It depends on, really, what business you're in. It's so specific. I chose to do the PhD. It's funny, because I chose to do the PhD but I ended up with the MBA. I did most of the PhD but I never wrote a dissertation. I think our PhD is a, it's a research degree, right? And that's why. And so if you were very comfortable doing research -- I loved it. It's just that I liked teaching more. But if you have a different question, Dave, you can always email me separately about the PhD. I'll let you know and can hook you up with some PhD friends of mine. For the metrics, I think firms pretty much stick to a metric that they like. A lot of firms are not cash constrained. The problem with using IRR: if you have to choose between projects, you get into a little bit of a problem. Would you rather have -- 'cause if you rank IRR, would you rather earn 10 percent return on a $100 million project or a 75 percent return on a $10 million project? So the ranking gets a little tricky. Net present value will tell you dollar for dollar, how much value. I don't think there's an employment record for EMBA. Well they usually come in, like, 10-plus years into their presentation. Thanks to all of you for coming, by the way. I'm seeing a lot of thank you's and I wanna thank you and answer the questions. The exchange rates, I would probably, Juan, do that in my local currency. Put everything in today's currency rate, that's how I would do it. But what you'll have to do -- You'll do cases like this in class where you might have to put those dollars... Put your things into your local currency until... That's how I would do it. Because if you're coming home and then once you start going into your regular home currency, you can start putting them in that. So do the translation for the next few years. That's what I would do. But I do -- You know, there's a lot of things you can do. You can forecast forward rates and then each year in the future, bring them back to your home rate and then discount using a home discount rate. Or you can forecast them in U.S. dollars all the way out, bring them back to today, and then bring them back to your home currency in today's exchange rate. So there's two different methods of doing that. Doing five years? I don't know. I feel like that's a personal decision. I think you should talk to the advisors about what they say. I would probably think that two to three years is better but that's just my personal preference. It really does depend on your situation: your work life, your family life, your financial budgets, these types of things. Yeah, if you don't have a finance or accounting background, you actually don't need it. We do tell you what classes that you have to take, like one in each foundation and these different functions. There are lots of advisors there to help you. That's what they do. The school is very hands on about helping you. So student life is very strong. They will help guide you. And your peers will guide you. You know, it's a community. I don't think you have to worry about that. You can trust the fact that they will do that. Textbooks to cover, typical evaluation models in theory. We use Brealey and Myers here, and Bodie, Kane, and Marcus. Those are two very common ones. Send me a note, Chase, OK? There's one that's like, "The Dark Side of Valuation." That one, I always -- I bought it twice. I haven't read it yet, but I like the title. How do you estimate the rate of growth difference? I think, talk to people in the field. That's the best way. And the bump, when you graduate, talk to people that graduated. Talk to career services. The financing costs? Don't worry about those right now because you should be really -- Remember what I said before, you want the risk of the investment, of the benefits. So use those, because those are implicitly in there, Gotham. No. I don't think so, Eugene. I mean they will grow, but free cash flows are supposed to be over R minus G and if G is greater than R you really can't use that model. You'll have to forecast out until the thing doesn't blow up. Oh, the data? There are 1,780, Juliet. Thanks, Lucas. Thanks, y'all. Oh, I don't think we can. In fact, I think that we are actually trying to broaden the age group. It's not like the old days, right? And I'll tell you what, I work in the EMBA program. Our average age is 35. And it goes up to 50, 60, right? So it's not -- I wouldn't worry about that. There's not many at 60 and there's probably in a given class, a handful over 55, but definitely lots of 30s and 40s in the part-time programs. Not so much in the full-time program, but that's understandable to me. 'Cause a lot of those are younger and they're out for their first career. Not their second. Oh, yeah, Cooper, that looks good. I might email you. Command C. Yeah. Or maybe Cooper, you could send it to me. That would be good. So intangible benefits; I mean those are the things that are hard to quantify in dollars. And you know I would say, just like --for example, when you are being admitted into an MBA program. The whole thing is not about what you got on your GMAT or your Executive Assessment, right? It's one part of the puzzle. So this NPV and IRR and stuff: That's one part of the puzzle. Doing an MBA or any graduate degree or any type of education, even any travel: They're life-changing things. And there's a lot of intangibles. And that's very personal. Yeah. I don't think you need to worry about salvage value. Firms, I guess they could estimate it in their margins. Right? Companies with, it's very -- like, think about it in terms of an accounting group or a consulting firm. Clearly it has value, right, 'cause they're always trying to hire the best of the best, from the best schools. So that's a -- you can take a class here on HR. They talk about these things. Equity and debt are different risks. Yep. Equity holders get paid last. So it's more risky. I think students at Booth create models all the time. Lev did. Right, Lev? Yeah. A lot of them generate models from scratch. Yeah.

Lev: I've been making models for years, so yeah. And we definitely made models in school.

Kathleen: Yeah. Do I think it's worth doing an MBA program if only online? Well if you want my personal opinion, I think some online is fine. But for me, what I really enjoy is being around the people. I mean that's a lot of it. I think it's fine to start online. It's fine to take some classes online. My personal, personal preference -- right? -- would to be around the people. It's really a luxury to be back in school. So I want it, I want it to be luxurious, yeah. But other people, it depends on your lifestyle and where you're at. The youngest student in the MBA program? 'Cause I've taught some young kids. But in the MBA program, I was started in the Executive MBA. One was 24, but she was the youngest in the Executive that I know of. I don't know, Kara, what's the youngest?

Kara: Yeah it just --

Kathleen: Probably 21.

Kara: I would say, yeah usually people have at least one full year of work experience, that could be 21, 22, 23. But to Kathleen's point earlier, it's such a wide range of early 20s up to 40s, 50s, even 60s in the executive program; it's all about program fit. And I saw there was a question kinda like the differences between the Executive MBA and evening, weekend and full-time, and it's really the structure and the format of the program. So if you want a more structured, kind of predetermined curriculum with a cohort, Executive is the way to go. If you want more freedom, choice, flexibility, evening, weekend, or full-time. Again the admissions teams, we're more than happy to help you with those conversations. I'll be sure to post my email toward the end of the chat or here in a second in the chat, just -- Please sort of reach out to me, we can just talk it through and help you find the right fit.

Kathleen: Thank you, Kara.

Kara: Of course.

Kathleen: Yeah, there is a huge team supporting you here. And there is just, there's no 'one-size-fits-all.' We've got lots of sizes to fit all. So ... someone asks how we evaluate the uncertainty. We do have put in there, you know, the risk of being unemployed. That's one thing. But you could add other things. Yup, yup, yup. So some of these questions, I'm kind of answering a lot of the same type of questions. If you feel like I haven't answered your question, you can email me. They way that -- don't forget, Raghuram Rajan, he's doing his on November 9th. So you can definitely have that class with him. Yeah, you can always bid for classes. We bid for classes here. I think, Lizbeth, for the model, it's gonna impact the cash flows. And it could impact the risk in two ways. Yes. Financing is important, blah, blah, blah. OK. So I'm going over... me, when I did my MBA? Oh my God. I did two MBAs, actually. Because one, I was like in school and then I was working in a restaurant, and then I thought, "Oh, I had too many years I didn't do anything." So I went back and did the MBA, and then I went to Ernst & Young. I just had a couple. If managing a restaurant is experience. But then, before I came here, I worked two years at Ernst & Young, and then I went back to school. Ezra, that should be posted at any time now. I would say in the next week or so. A negative NPV? That means, well, that the future cash flows in today's dollars are worth less than what it's gonna cost you to do it. And some people don't mind that, right? I mean, I know a person that he just wanted to do the MBA for the network. He basically already had a job. He didn't need any of these things. He wasn't gonna change jobs. So he was buying a network. That was his thing. And it gave him happiness. Yeah. Alexis, yes. You could take very advanced finance classes here. Pietro Veronesi, who is a Deputy Dean, he teaches a lot of options classes. Yeah. All right. Are we good? ... All right. Thank you so much for coming. We really appreciate it.