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Assume you will make $40,000/year with a high school diploma. You will make $50,000/year with art...

Assume you will make $40,000/year with a high school diploma. You will make $50,000/year with art degree. Assume you work for 40 years and earn 8%. How much is that art degree worth? (hint: compare PVs)

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Answer #1

The stream of cash flows represent an annuity. We have to calculate annuity factor and then find the present value of both the annuities in order to compare value with degree and value without degree

Annuity factor

= [ 1 – (1 + r) ^ -n] / r

Where,

r = Rate of interest = 8% or 0.08

n = Number of periods = 40 years

So, Annuity factor

= [ 1 – ( 1.08 ^ -40)] / 0.08

= [ 1 - 0.046031] / 0.08

= 11.9246125

So, value of degree

= Annuity factor x [ Earnings with degree – Earnings without degree]

= 11.9246125 x [ $50,000 - $40,000]

= $ 119,246.13

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